Greg Mankiw's Blog: Nordhaus on the Stern Review

Friday, November 24, 2006

Nordhaus on the Stern Review

Yale economist Bill Nordhaus, an expert on climate change, reads the Stern Review of the topic and does not like what he finds. The Review's apocalyptic conclusions are, according to Nordhaus, severely overstated because of its assumption of a near-zero discount rate (0.1 percent per year) and log utility (so marginal utility does not decline much as technological progress causes consumption to rise). Here is an excerpt from Nordhaus:

The Review proposes using a social discount rate that is essentially zero. Combined with other assumptions, this magnifies enormously impacts in the distant future and rationalizes deep cuts in emissions, and indeed in all consumption, today. If we were to substitute more conventional discount rates used in other global-warming analyses, by governments, by consumers, or by businesses, the Review’s dramatic results would disappear....
Suppose that scientists discover that a wrinkle in the climatic system will cause damages equal to 0.01 percent of output starting in 2200 and continuing at that rate thereafter. How large a one-time investment would be justified today to remove the wrinkle starting after two centuries? The answer is that a payment of 15 percent of world consumption today (approximately $7 trillion) would pass the Review’s cost-benefit test. This seems completely absurd. The bizarre result arises because the value of the future consumption stream is so high with near-zero discounting that we would trade off a large fraction of today’s income to increase a far-future income stream by a very tiny fraction.

Thanks to Tyler Cowen for the pointer.