Nicholas Stern may have underestimated the cost of cutting carbon, whilst the latest OECD climate report fudged the science to cut costs. Zara Maung and Chris Bianchi investigate the real economics of climate change

Over the past two years, an increasing number of macro-economic reports and one major scientific report have been commissioned by governments to advise them on climate change policies.

The effect of these reports has been overwhelming. As a result, global warming has been established as one of the greatest threats to humankind this century.

The major scientific report predicted the effects of rising levels of CO2. It was compiled by the International Panel on Climate Change (IPCC) in 2007, the intergovernmental science body that subsequently shared the Nobel Peace Prize with Al Gore.

The trend for macro-economic reports on climate change began in 2006, when the UK economist Sir Nicholas Stern released his groundbreaking economic review estimating the costs of mitigating climate change.

In March 2008, four months after the release of the science report by the IPCC, the Organisation for Economic Co-operation and Development (OECD) released an economic report that, on the surface, seemed broadly to agree with Stern’s.

Credibility gap

Both the Stern and OECD reports play an important role in advising developed countries (in Stern’s case, the UK) on what they could do to lower their CO2 emissions to sustainable levels. Both claim to prescribe policies which would “avoid global warming’s harshest effects”.

However, it appears that although the CO2 stabilisation levels recommended by the Stern report mirror those indicated by the IPCC, the recommendations by the OECD are more generous with CO2 levels.

A growing voice of dissent amongst economists says that Stern’s original report may have underestimated government spending required to tackle climate change. Significant confusion has also arisen over the costs and imperative of mitigation efforts compared with the costs of adapting to the effects of climate change, a hidden expense which receives little mention in the Stern report.

Economists’ dismay at the rising cost of stopping global warming, combined with the pitiful record of under spending by governments so far, may be triggering a worrying economic policy shift away from IPCC targets towards ones that seem more economically achievable.

Confusion in the atmosphere

There are a number of conflicting climate science theories around, predicting different effects from rising CO2 levels, as well as differing economic theories on how governments should deal with rising CO2 emissions from industry.

Governments, however, need one accepted scientific viewpoint, not a barrage of conflicting ideas, in order to react. The IPCC and the macro-economic reports try to provide this, by aggregating the ideas and finding a “middle way” on the science and the economics of climate change.

Overall, the reports all agree that rising CO2 levels will lead to global temperatures warming and increasing damage to the environment and the economy.

Degrees of difference

The 2007 IPCC report, originally set up by the World Meteorological Organisation and the United Nations Environment Programme, concurred with Nicholas Stern’s target for stabilising CO2 levels – an upper limit of 550 CO2 parts per million – within 20 years. This would, according to the IPCC, probably involve a global temperature rise of around 2C (global average annual temperature change relative to 1980-1999).

According to the IPCC assessment, a 3C rise would bring about widespread damage to agriculture, a shift in disease vectors and infrastructural damage from floods and storms.
The main OECD policy package resulting from the OECD report, however, settles for a far higher rise in CO2 than Stern. It relies on spending 1% of projected growth in global GDP until 2030 to reduce the annual increase in greenhouse emissions from the current 37% to 13% by 2030.

A question of editing

Jan Corfee-Morlot, a senior OECD researcher who was involved in writing both the OECD and IPCC reports, is aware of the disparities between the economics and the climate science. She explains to ClimateChangeCorp that some of the economic recommendations in the OECD report that did correspond with the IPCC report were edited out of the OECD’s main policy recommendations to governments.

Corfee-Morlot says that in the earlier chapters of the OECD report the economic calculations were more ambitious: “We summarised the results of a fuller range of climate change policies… consistent with the lowest of the scenarios in the IPCC assessment, where emissions peak in about 2015.” The more ambitious recommendations suggested implementing an escalating global carbon tax.

Corfee-Morlot says that whilst the main policy package recommended by the OECD “includes a realistic set of mitigation policies for greenhouse gases”, she concedes it is “less ambitious than others analysed in the report”.

Ambition scaled down

According to Robert Mendelsohn, a lecturer on the economics of climate change at Yale University, we may be starting to see economists’ recommendations for acceptable levels of CO2 differing to the scientists’. Achieving the IPCC’s (and Stern’s) recommendations on CO2 stabilisation, he says, would require the economic equivalent of a “knight on a white horse”.

Mendelsohn says Stern’s hope to achieve stabilisation at 550 parts per million of CO2 equivalent, which concurs with the findings of the IPCC, is “very optimistic”.

“It’s probably too strict a goal,” he says. “It’ll end up costing a tremendous amount of money to try and do that. And the benefits of stabilising at 550 don’t warrant spending that kind of resources.”

Cash worries

According to Stern, spending 1% of global GDP could stabilise emissions in the next 20 years, reducing emissions between 1% and 3% afterwards.

Mendelsohn hazards a few guesses at how Stern would hope to mitigate climate change at this rate, including “forego[ing] all the coal that’s in the ground” and “inventing a machine to take the CO2 out of the atmosphere”. He adds: “Things like that are very expensive. The Stern report underestimates just how expensive those choices are.”

According to Mendelsohn, the realistic options available include stabilising at much higher concentrations, like 650, 750 or even 850 CO2 parts per million, which he claims would provide enough time for carbon capture and storage from coal plants to become mainstream.

According to IPCC estimations, allowing these levels of carbon dioxide would lead to 3-4 degrees rise temperature change, relative to 1980-1999, and increasingly devastating consequences.

Mendelsohn disputes the climate predictions made by the IPCC, saying their data is too limited to judge the consequences of climate change based on temperature rise. The notion that a rise in temperature of more than 2C represents a dangerous environmental tipping point is “a myth”, he says.

Misplaced optimism

Dr Bjorn Lomborg, a professor at the Copenhagen Business School and well-known critic in the climate change field, told ClimateChangeCorp that Stern’s economic calculations are based on unrealistically efficient government spending. Stern’s figures are “unbelievably optimistic”, he says.

“Let’s just remember that this very clearly requires that all governments would be the very most optimal in their policy choices. And we know that governments very often are not,” Lomborg adds.

Dr Simon Dietz, environmental policy lecturer at the London School of Economics and policy analyst for the Stern review, agrees that the costs of mitigation may be higher than the report predicted. “[1% GDP] would be correct if policy is designed correctly,” Dietz said. “If policy is done badly, then there’s no doubt it will be more expensive than 1%.”

Stern’s cost predictions relied on governments consistently choosing the cheapest green technologies and using effective pricing methods to drive low-carbon behaviour.

Easy on the gas

Despite the gloomy economic picture painted by some economists, a growing number of people are choosing to support even stricter action on carbon dioxide levels than Stern suggests.

Seb Beloe, head of sustainable and responsible investment research at Henderson Global Investors, sides with environmental critics who say the carbon dioxide targets prescribed by the Stern Review are too lenient.

“I suspect it’s an underestimate,” says Beloe. “The emissions reduction that [Stern] foresaw as necessary, around 60% by 2050, is now likely to be… about 80%.”

He joins a number of UK environmental organisations and ethical businesses, such as WWF, Friends of the Earth and the UK’s Co-op Bank, who believe that Britain must set an 80% emissions reduction target by 2050.

Environmental organisations have commissioned reports from think tanks, documenting how we can achieve the goal. These include WWF’s 80% challenge, written by the Institute for Public Policy Research, which talks about the IPCC imperative of stabilising at 2C.

Friends of the Earth’s Home Truths, written by Brenda Boardman at the University of Oxford’s Environmental Change Institute, outlines a reduction in UK carbon dioxide emissions by at least 3% year on year until 2050.

Coming clean

The detailed reports, largely based on energy use reduction, seek to make climate change mitigation affordable, for Britain at least. Brenda Boardman, author of the Friends of the Earth report, has told ClimateChangeCorp, however, that her report does not deal with emissions from UK imports or aviation, two large contributors to global CO2 production.

What concerns policy academics like Boardman and Stern report analyst Simon Dietz more than the validity of Stern’s high level economic predictions is that little money, let alone 1% of GDP, has gone into mitigating climate change so far in the UK.

“I think our current government still has to prove its commitment to climate change,” says Dietz. “They have still to prove they have the desire and the skill to implement large-scale environmental policy.”

Technological drive

Limited resources have already caused a major sticking point for academics and investors in clean tech, with some wanting to see the money invested in subsidy reform and others wanting more invested in research and development. Dr Lomborg argues that the latter provides the best long-term solution.

“At the end of the day there’s this almost collective delusion that if we just cut carbon emissions, everything will be good,” Lomborg said. “If you are going to have any chance, you really need to have much cheaper technologies available.”

Seb Beloe also says investors would like to see climate research and development money increase. “The prospects for solar power in the UK are very under-explored,” he says.

Martin Blunt, professor of earth sciences at Imperial College, London, would rather see money invested in subsidising carbon capture and storage from power plants.

“[The primary spending goal] has to be carbon-free electricity generation,” Blunt said. “It’s the easiest thing to do … It’s estimated that carbon-capture storage would add about 50% to the cost of the consumer – that’s still cheaper than investing in nuclear power … the technology is available now.” R&D could bring the cost of carbon capture and storage down in the long run, he says.

The likelihood of governments spending more money on green technologies hangs in the balance. A report on financial flows from the United Nations Framework Convention on Climate Change (UNFCCC) concluded last year that much of the eventual investment in green technologies would have to come from the private sector.

Sir Partha Dasgupta, a professor of economics at the University of Cambridge, warned soon after the Stern report was released that whilst he considered 1% GDP affordable, “We should remember… that the figure in question is some seven times the annual global aid budget.”

Meanwhile, the OECD report’s recommendations that 1% of GDP growth should be spent mitigating climate change by 2030 may fall on deaf ears, as predictions (including from the OECD itself) say most GDP growth until 2030 will come from non-OECD countries.

Case for adaptation

The need for government spending on climate change is only likely to increase as adaptation becomes more of an issue. Economists such as Lomborg are asking why key preparation for climate change, like adaptation, was glossed over by Stern’s and other reports’ predicted costs of climate change.

Lomborg criticised Stern’s lack of emphasis on adaptation in the Wall St journal in 2006. “The Stern review acknowledges that simple initiatives like bracing and securing roof trusses and walls can cheaply reduce damage by more than 80%,” he says, “yet its policy recommendations on expensive carbon reductions promise to cut the damages by 1% to 2% at best.”

Yale University economist Mendelsohn predicts that global GDP will start to be affected by climate change in the latter half of this century, regardless of the success of current mitigation efforts. And with sea-level rise and extreme weather likely, one question hanging over investors’ heads is how businesses are going to afford to adapt to a new climate. The grim climactic outlook paints an expensive picture. Henderson Global Investors’ Seb Beloe believes that adaptation costs have been overlooked.

“I think some of [the money spent by governments] will be needed to be invested in adaptation as well, which people often forget about,” Beloe says. “We already have a warmed climate.”

Hidden price

One of the problems with adaptation is the difficulty identifying how much it may cost. The Stern report was much less specific on adaptation than mitigation, putting the cost at “tens of billions of dollars per year”. Less than one year later, the UNFCCC financial flows report boosted the estimation to “several tens of billions of US dollars” annually.

“I think the difficulty with adaptation is that nobody knows what the cost will be,” Dr John Llewellyn, senior economic policy advisor for Lehman Brothers Europe, told ClimateChangeCorp. “There’s a broad presumption on most people’s part that it’s more economical to mitigate than to adapt. Most people’s guess, but it really is a guess, is that we should give priority to mitigation.”

Mendelsohn believes that adaptation is something that individuals are likely to end up footing the bill for, as and when climate change makes itself felt.

Governments, such as Bangladesh and Bhutan, are already pleading for adaptation funds at UN conferences to protect their countries from devastating floods.

One observer at last December’s Bali UNFCCC conference may have spoken for a silent majority when he said: “Adaptation has been the Cinderella of climate change for too long. It needs to become the princess.”