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Nicholas Stern

The World Bank’s former top economist took heat when he called for huge investments to head off climate change. Now he says he underestimated how much is needed.
June 21, 2011

The Stern Review, published five years ago this fall, framed the threat of climate change in stark, even shocking, economic terms. The 700-page analysis, which was commissioned by the U.K. government and authored by Nicholas Stern, an economic adviser to Prime Minister Tony Blair and a former chief economist of the World Bank, estimated that the costs of climate change, if not addressed, will be equivalent to losing 5 percent (and potentially as much as 20 percent) of the global gross domestic product (GDP) “each year, now and forever.” Hundreds of millions of people could be threatened with hunger, water shortages, and severe economic deprivation. Climate change, Stern wrote, “is the greatest market failure the world has ever seen.”

The report concluded that staving off such crises would require immediate investments equivalent to 1 percent of global GDP over each of the next 10 to 20 years, before the window of opportunity to mitigate the biggest impacts of climate change closes. And it argued that governments need to set a price on carbon dioxide emissions, through either a tax, a trading scheme, or direct regulations.

The report received much attention from the public and from policy makers, but reaction from economists was mixed. A number criticized its methods, arguing that it improperly calculated the value of today’s investments relative to the same unit of investment in the future. The seemingly esoteric debate over what economists call “discounting” has a critical implication: it greatly affects conclusions about how rapidly investments in addressing climate change need to be made.

William Nordhaus, a professor of economics at Yale University, was one of the most vocal critics of Stern’s methodology, disagreeing with the Review’s conclusions on the magnitude and pace of investments needed to combat climate change. Still, the Stern Review has “been enormously influential” since its publication, Nordhaus says now, and it has “sharpened my thinking about the major issues.”

Stern, a professor at the London School of Economics and Political Science, now heads the Grantham Research Institute on Climate Change and the Environment. In May, TR’s editor, David Rotman, visited him at his home, about 100 kilometers south of London.

TR: How has the debate evolved over the five years since the Stern Review was published?

Stern: More people have accepted its arguments. The idea that the economics should be framed in terms of managing enormous risk has gained [acceptance] in the public discussion and the professional discussion.

The fact that climate change poses such enormous risks affects how you do the economic analysis?

Exactly. You can’t assume some underlying growth story on top of which climate change is laid. It fundamentally changes the whole growth story and could indeed radically reverse growth in what is a quite short period of time—50 or 100 years. Climate change over the course of the century could create environments so hostile it would reverse development and force the movement of hundreds of millions and possibly billions of people. You have to think about making policy to manage risks of that magnitude. Since the Review, I think the idea that the scale of the risk fundamentally influences the analytic methods you must use has been increasingly understood.

How have the politics around global warming changed?

In 2005, apart from [French president Jacques] Chirac and Blair, leaders just weren’t interested in climate change. Now it is a political subject around the world. If you look at how dramatically China has changed over the last two years, it’s quite extraordinary. Politics in China, politics in India, have changed. In the U.S. it is highly controversial; in other countries, much less so. In the U.K., all the major political parties see that strong action is necessary. The politics have changed profoundly.

Do you think that by framing climate change as an economic problem, the Review has helped clarify the issue?

It has reduced the amount that people discuss it only in terms of “Do you want income or do you want the environment?” It has become less often expressed as a trade-off. That is a very important shift in the business world and, increasingly, in the government world.

Businesses are all looking at a carbon-constrained world­­—some with enthusiasm and some with worry about their own vested interests. But they are looking very hard at a carbon-constrained world and planning on that basis. There is enough intensity in the policy discussion, even though it is not won, that people making investments think about what the policy will be like in 10 years. High carbon is, in everyone’s mind, quite risky now—and good, because it is quite risky. People think of the low-carbon stuff as risky—and there are risks because you don’t know exactly how the costs will turn out. But low carbon is risky and getting less risky, and high carbon is risky and getting more risky.

You called climate change the greatest market failure in history.

It’s a market failure because the price we pay for products and services that involve emissions of greenhouse gases does not reflect the costs they cause through damage to the climate. Economists like me think market systems have a tremendous amount to offer if you correct the failure by putting a price on carbon.

But in the U.S., at least, schemes for carbon pricing have failed.

I think you have to take the long view. I think it will get there in the end, but regulations are okay too. You probably need a combination of these things. We didn’t go from leaded to unleaded petrol by putting a price on lead. We did it mostly through regulations.

Has technology changed in the five years since the Review was published?

Technology has moved faster than I had anticipated. We’ve seen tremendous progress with car technologies. Five years ago, you wouldn’t have thought General Motors would be making electric cars now; you wouldn’t have thought the argument now would be “How fast can you bring down the costs of electric cars to be competitive?” Wherever you look now, you have quite remarkable progress—from the most imaginative kind, like algae [biofuels] and [new types of] batteries, to engineering, just making a diesel engine much more efficient, much better. So the technology has changed faster than I had expected. I find it quite encouraging.

But carbon pricing would surely help speed up the commercialization of these new technologies.

It takes a combination of things. If you ask about market failure, then carbon pricing is the big one. It will be hard to do it without that. But I would also emphasize the importance of regulations as well. Let’s not have a simplistic approach by thinking, “Set a price on carbon and the wonderful entrepreneurship processes will do the whole lot for you.”

Support for R&D falls into the category of smart policies?

Yes. And support for deployment also.

The Review expresses a sense of urgency about the next five to 10 years.

That’s one place where I think our arguments have not been successful enough: to get people to realize just how important the next five and 10 years are. If we wait until people really start to see the full horror of severe climate change, it will be very difficult to pull out. And that is where the great challenge in communication lies.

Is there a point where if things haven’t ramped up, you would become discouraged? Is there a deadline for action?

I think action has to accelerate now. China is accelerating its effort. It’s quite remarkable. They have seven key industries which [its leaders] are marking to grow from 3 percent of the economy to 15 percent in the next 10 years. And the economy itself will likely double, from $6 trillion to $12 trillion. The investment they will need to do that is probably a half a trillion a year for each industry. Three of these industries are renewables, energy efficiency, and clean technologies. Why? Because [the leaders] see China as extremely vulnerable to climate change, they see China as big enough to affect its own future on the climate side, and they see these industries as growth stories in the future. A remarkable change, and it is not just in China. But I still worry that it is not fast enough. We have to accelerate.

How has the science changed since the publication of the Review?

The science looks more worrying. There are some very nasty feedbacks [that are increasing the pace of climate change] that we left out five years ago because they are very difficult to model. A lot of the drivers seem to be bigger and faster, and the feedback loops even more worrisome.

Given that, how would you change the findings of the original report?

I suspect that I underdid the costs of the impact of unabated climate change. I suspect, looking back, you would want to argue that the risks are a good deal greater. And because of the rapid technical progress, the costs of action may be a bit lower. But I don’t want to suggest that it is an easy no-brainer decision. You have to make big investments now to manage the risks in the future and lay the foundation for low-carbon growth.

The Review estimates that it would take 1 percent of GDP annually to mitigate climate change.

I would up that now. I would say 1 to 2 percent now, because I think we have to act more strongly than I suggested in the Review, because the risks are bigger. But I would emphasize that for that 1 to 2 percent of GDP, we get not just risk reduction but tremendous innovation, creativity, learning, and discovery.

What does 1 to 2 percent of GDP mean? Will people feel the pain?

The investment is significant, but it’s not that difficult to see why it is needed—particularly when you recognize that growth is likely to accelerate over 10 to 15 years as these learning processes kick in. And, of course, it is a very important point that the time to do your long-term investments is at a time of slack in the economy. There is less pressure on resources, and interest rates are low. Now is the time to start investing in some of these grid structures and other infrastructure.

But can we afford it?

It is an investment. You have got to recognize it as an investment, which it is. And now is the moment to make those investments. You can’t afford not to make those investments: the risks are too great, and the rewards are high if you do.

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