Stern Review
The Stern Review on the Economics of Climate Change is a 700-page report commissioned by the UK Treasury and authored principally by economist Sir Nicholas Stern, which was released on 30 October 2006 and assessed the economic impacts of climate change alongside policy options for mitigation.[1] The Review estimated that unmitigated climate change could impose ongoing global economic costs equivalent to 5% or more of annual GDP—potentially rising to 20% when including non-market impacts and risks of abrupt changes—while arguing that stabilizing greenhouse gas concentrations could be achieved at an average annual cost of about 1% of global GDP through investments in low-carbon technologies and efficiency measures.[1] It emphasized that the benefits of strong, early action to curb emissions outweigh the costs, framing inaction as a failure to safeguard future economic stability against risks like sea-level rise, extreme weather, and ecosystem disruptions.[1][2] The report's influence extended to shaping international policy discussions, including contributions to the IPCC's Fourth Assessment Report and advocacy for carbon pricing mechanisms such as emissions trading and taxes, though its projections drew from integrated assessment models that incorporated uncertain damage functions and feedback loops from empirical data on temperature sensitivity and adaptation limits.[3] However, the Stern Review provoked substantial debate among economists, with prominent critics like William Nordhaus arguing that its effective social discount rate of around 1.4%—derived from a near-zero pure rate of time preference (0.1%) plus a low risk-free rate—unduly prioritized distant future damages over present consumption, yielding benefit-cost ratios far higher than those from conventional rates of 4-6% aligned with observed market returns and growth projections.[4][5][6] Additional scrutiny targeted the Review's damage estimates as potentially overstated by aggregating high-end tail risks without sufficient probabilistic calibration, and by underemphasizing adaptive capacities in market economies, leading some analyses to conclude that optimal policy warranted more gradual abatement rather than immediate aggressive cuts.[4][7] Despite these challenges, the Review catalyzed empirical research into climate-economy interactions, highlighting tensions between ethical valuations of intergenerational equity and empirical discounting observed in financial data.[8]Background and Commissioning
Origins and Objectives
The Stern Review on the Economics of Climate Change was commissioned in July 2005 by Gordon Brown, then Chancellor of the Exchequer in the UK government, to Sir Nicholas Stern, who was then head of the UK Government Economic Service and chief economist at the Department for International Development.[3][9] The initiative stemmed from growing international recognition of climate change as an economic risk, particularly following the G8 Gleneagles summit in 2005, where leaders emphasized the need for integrated economic analysis of environmental challenges. Stern assembled a team of approximately 20 economists, scientists, and policy experts to conduct the independent assessment, which was overseen by the HM Treasury and aimed to synthesize existing evidence rather than generate primary data.[10] The review's primary objectives, as outlined in its terms of reference, were to evaluate the economics of transitioning to a low-carbon global economy over the medium to long term, including implications for that shift; to analyze the macroeconomic and policy challenges arising from climate change itself and potential responses to it; and to advance analytical frameworks for designing effective climate policies at national and international levels.[11] These goals focused on quantifying the costs of inaction versus mitigation, using integrated assessment models and empirical data on damages, while emphasizing market-based mechanisms and international cooperation. The UK government intended the review to inform domestic and global policy, bridging gaps in prior economic literature that had often understated climate risks due to conventional discounting assumptions.[3] Completed ahead of schedule, the full report—spanning over 700 pages—was published on 30 October 2006, coinciding with pre-COP12 discussions to bolster arguments for stringent emissions reductions.[9] Its objectives reflected a precautionary approach, prioritizing intergenerational equity and avoiding high-end risk scenarios, though subsequent critiques have questioned the selection of parameters to align with advocacy for aggressive action.[5]Nicholas Stern and the Review Team
Nicholas Stern, Baron Stern of Brentford, is a British economist with expertise in development economics, public policy, and environmental issues. Born on April 22, 1946, he was appointed in July 2005 by UK Chancellor Gordon Brown to lead an independent review on the economics of climate change, leveraging his prior roles including Chief Economist and Senior Vice President of the World Bank (2000–2003), where he focused on global economic development and poverty reduction, and his academic positions such as Professor of Economics at the London School of Economics (LSE). Stern's selection reflected his interdisciplinary approach, combining economic modeling with policy analysis, though critics later noted his advocacy for aggressive climate policies may have influenced the review's framing.[12][13] The Stern Review team comprised around 23 core members primarily from HM Treasury economists and officials, supported by external consultants and over 100 global experts in economics, climate science, and related fields, working over 16 months to synthesize evidence on climate impacts and mitigation costs. Led operationally by Siobhan Peters, the team included key contributors such as Vicki Bakhshi, Alex Bowen, Catherine Cameron, Sebastian Catovsky, Simon Dietz, Sam Fankhauser, Chris Hope, Cameron Hepburn, and Jim Skea, who handled modeling, damage assessments, and policy analysis. This composition drew on Treasury resources for economic rigor but incorporated inputs from institutions like the Met Office and academic collaborators, enabling a broad assessment despite limited direct involvement from skeptical climate economists at the time.[11][14][15] The team's multidisciplinary nature facilitated integration of integrated assessment models and empirical data, but its heavy reliance on government-affiliated personnel raised questions about independence, as evidenced by parliamentary scrutiny where team member Lorraine Hamid testified on methodological choices. External advisors, including figures from the International Energy Agency and World Bank, provided specialized input, though the final report's conclusions aligned closely with Stern's pre-existing views on high-stakes climate intervention.[10]Methodological Framework
Choice of Discount Rate
The social discount rate determines the present value of future costs and benefits in economic assessments of climate policy, with lower rates assigning greater weight to distant future impacts. In the Stern Review, published on October 30, 2006, the chosen rate was derived from the Ramsey formula: r = \rho + \eta g, where \rho is the pure rate of time preference (set at 0.1% per year, reflecting minimal ethical discounting of future generations' welfare), \eta is the elasticity of the marginal utility of consumption (set at 1, indicating standard inequality aversion), and g is the expected per capita consumption growth rate (1.3% per year). This yielded an effective annual discount rate of approximately 1.4%, substantially lower than market interest rates or conventional social rates used in public policy.[5][8] Stern justified the near-zero \rho on ethical grounds, arguing that future generations facing climate risks deserve comparable moral consideration to the present, absent empirical evidence for high time preference in social welfare functions; he viewed higher \rho values as implicitly accepting extinction risks or indifference to posterity, which he deemed inconsistent with sustainable development principles. The low rate amplified the present value of projected climate damages, estimated to equate to 5-20% of global GDP annually in the long term, thereby supporting aggressive near-term mitigation costing about 1% of GDP yearly.[6][8] Critics, including William Nordhaus, contended that Stern's prescriptive approach—prioritizing ethical priors over observed behavior—deviated from descriptive economics, where \rho should align with market rates (around 3-5%) reflecting opportunity costs and revealed preferences; they argued this low rate overstated mitigation benefits by factors of 10 or more, as empirical growth and saving data imply higher effective discounting. Yale economist Nordhaus specifically noted the choice's reliance on "a very low discount rate" without robust empirical backing for \rho, contrasting it with integrated assessment models using 4-5% rates that yield modest optimal carbon taxes. The UK Treasury's standard rate for public projects was 3.5% at the time, highlighting the Review's departure from official practice.[16][17][6]Integrated Assessment Models and Damage Functions
The Stern Review employed integrated assessment models (IAMs) to integrate projections of socioeconomic development, greenhouse gas emissions, physical climate responses, and economic damages, thereby estimating the social cost of carbon and evaluating mitigation pathways. These models aggregate data from climate science, energy systems, and economic literature, often using simplified representations of complex interactions. The Review primarily drew on the PAGE2002 IAM, developed by Chris Hope and updated with inputs from the IPCC Third Assessment Report, which features probabilistic elements via Monte Carlo simulations across 1,000 runs to quantify uncertainties in parameters such as climate sensitivity (1.5–4.5°C equilibrium warming for doubled CO₂) and regional vulnerabilities.[1][18] Damage functions in PAGE2002 estimate impacts as a fraction of regional GDP, scaling nonlinearly with local temperature rise (T_R) according to the form damages ∝ (T_R / 2.5)^γ, where the exponent γ follows a triangular distribution between 1 and 3 (mode at 1.3 for baseline calibrations, or 2.25 in sensitivity analyses to reflect accelerating impacts). Market damages, encompassing sectors like agriculture (projected 15–35% yield reductions at 3–4°C) and coastal infrastructure, are calibrated to yield around 5% of global GDP under central estimates, while non-market damages—including health effects and ecosystem losses—add further losses up to 11% when equity-weighted to prioritize impacts in low-income regions. A stochastic component models catastrophic risks, with probability escalating 10% per degree above 5°C, drawing on probabilistic assessments of tipping points like ice sheet collapse.[1][19] These functions were parameterized using meta-analyses of empirical studies, such as those on crop yields and sea-level rise (e.g., 5% of global population at risk from 5 m rise), supplemented by sectoral bottom-up assessments rather than relying solely on historical analogies, which are limited for projections beyond 2–3°C warming. The resulting business-as-usual damage estimates equate to a mean 5% loss in global per-capita consumption (or up to 20% incorporating broader risks and distributional effects), expressed in balanced growth equivalents to compare perpetual consumption reductions with mitigation costs. Equity weighting, applying declining marginal utility of income (elasticity of 1.5), amplifies damages from developing regions, where vulnerabilities like limited adaptation capacity (reducing losses by only 30–90% at high warming) prevail.[1][20] While PAGE2002's structure allows for regional disaggregation (e.g., 2.5–9% GDP losses by 2100 in Africa and South Asia at the mean), the Review noted IAM limitations, including underrepresentation of high-end risks (>4°C) due to data scarcity and exclusion of dynamic feedbacks like permafrost thaw, prompting aggregation with non-IAM evidence from sources such as the Hadley Centre and Tyndall Centre. This hybrid approach yielded social cost of carbon estimates averaging $29 per tonne of CO₂ (range $0–$400), higher than some peer IAMs like FUND or DICE owing to PAGE's emphasis on fat-tailed uncertainty distributions and aversion to downside risks.[1][21]Treatment of Uncertainty, Equity, and Growth Assumptions
The Stern Review addressed uncertainty in climate impacts and economic damages through the use of probabilistic integrated assessment models, notably the PAGE2002 model, which employed Monte Carlo simulations to generate distributions of outcomes across variables such as emissions trajectories, climate sensitivity, and regional damage functions. This methodology emphasized the asymmetry of risks, particularly "fat-tailed" distributions where low-probability, high-damage events—like abrupt threshold crossings or elevated temperature responses—could yield disproportionately large expected losses, thereby justifying precautionary mitigation even under parameter ambiguity.[5][1] The Review contended that standard expected-value approaches understate these tail risks, as higher uncertainty effectively lowers the shadow price of capital and amplifies the social cost of carbon, though subsequent analyses have debated whether such fat tails robustly alter optimal policy timing or if they instead warrant higher risk premia in discounting.[22] Regarding equity, the Review framed intergenerational equity through a prescriptive ethical lens, setting the pure rate of time preference at 0.1 percent to reflect near-equality in moral weighting across generations, combined with Ramsey discounting tied to expected per capita consumption growth. This yielded a total social discount rate of about 1.4 percent, prioritizing future welfare over positive (market-observed) rates that incorporate revealed preferences and opportunity costs.[23][24] Within-region equity was handled via diminishing marginal utility of consumption (elasticity of 1), while international equity weighting amplified damages in poorer regions by factors up to fourfold relative to richer ones, based on income differentials. Critics, including proponents of descriptive discounting, argued this approach embeds subjective value judgments that deviate from empirical market data, potentially overstating the present value of distant damages without sufficient empirical validation of the ethical priors.[22] Growth assumptions underpinned the Review's baselines, projecting global per capita consumption growth at 1.3 percent annually under business-as-usual scenarios, derived from IPCC SRES A2 projections implying a 13- to 20-fold rise in world consumption by 2200 despite unmitigated warming.[7] This optimistic trajectory—sustained even amid projected GDP losses of 5-20 percent from climate impacts—served to contextualize mitigation costs as low relative to avoided damages, yet relied on a single demographic-emissions pathway without sensitivity to endogenous growth feedbacks or historical precedents of slowdowns from environmental stressors.[16] Analyses have highlighted potential inconsistencies, as assumed high future growth conflicts with the Review's own high-damage estimates that could erode productivity through channels like sea-level rise or agricultural disruptions, suggesting the baselines may understate mitigation urgency or, conversely, inflate damage ratios by anchoring against unrealistically robust counterfactuals.[7][16]Core Conclusions
Projected Economic Impacts of Unmitigated Climate Change
The Stern Review projected that unmitigated climate change, following a business-as-usual emissions trajectory, would impose global economic damages equivalent to at least 5% of gross domestic product (GDP) annually, both in the present and perpetually into the future, representing a reduction in global per-capita consumption growth.[1] Incorporating a broader array of risks—such as non-market impacts, climate-carbon cycle feedbacks, distributional inequities, and potential tipping points—these damages could escalate to 20% of global GDP or higher.[1] These estimates derive from probabilistic simulations assuming temperature increases of 2–3°C by mid-century and 5–6°C or more by 2100–2200 under unmitigated emissions, with damages expressed as balanced growth equivalents to capture long-term welfare losses.[1] Projections relied on integrated assessment models (IAMs), including PAGE2002 as the primary tool, alongside FUND and DICE, which link emissions, climate dynamics, economic growth (assumed at 1.9% annually pre-2200), and convex damage functions that amplify losses at higher temperatures.[1] PAGE2002 simulations yielded mean damages of approximately 11% of global GDP by 2100 in baseline runs, with 5th–95th percentile ranges reaching 20%, escalating to 14.4% mean (32.6% at 95th percentile) when including non-market sectors and high-climate sensitivity scenarios.[1] FUND and DICE provided lower central estimates (0.5–2% and 9–11% at 6°C warming, respectively) but were adjusted in the Review via equity weighting—favoring poorer regions—and heightened risk aversion to emphasize tail risks, with a low pure time discount rate of 0.1% to value future generations comparably to the present.[1][25] Sectoral damages under unmitigated warming encompassed market impacts like 5–20% losses in U.S. agriculture above 3°C, 15–25% reductions in maize yields in the Middle East/North Africa at 3°C, and 0.5–1% of world GDP from extreme weather by mid-century, alongside non-market effects in health, ecosystems, and amenities.[1] Regionally, developing countries faced disproportionate burdens exceeding 10% GDP at 5–6°C due to limited adaptive capacity, with South Asia projected at 9–13% losses by 2100 (mean 2.5–3.5%, up to 13% in high-risk scenarios) and Africa/Middle East at 7–10%; developed nations at higher latitudes might experience initial net benefits at 2–3°C but 1–5% losses from escalating extremes thereafter.[1] These figures assume adaptation at individual and firm levels but exclude broader policy responses, post-2200 damage persistence, or full catastrophe probabilities, potentially understating long-term costs if emissions continue rising.[1]| Model | Central Damage Estimate (Global GDP, BAU Scenario) | High-Risk Range (e.g., 95th Percentile) | Key Adjustments in Stern Review |
|---|---|---|---|
| PAGE2002 | ~11% by 2100; 4.5% at 5°C mean | Up to 23.3% at 5°C; 32.6% with non-market impacts | Equity weighting, low discount rate (0.1%), damage exponent mode 2.25[1] |
| FUND | 0.5–2% equity-weighted at higher temperatures | Not emphasized | Heightened for risk aversion[1] |
| DICE | 9–11% at 6°C | Not specified in Review | Sensitivity to growth and feedbacks[1] |