The 'Stern Review' and its Critics: Implications for the Theory and Practice of Benefit-Cost Analysis

Abstract:     
The UK's Treasury's "Stern Review: The Economics of Climate Change" (Oct. 2006) reached dramatically different conclusions and policy recommendations than most earlier economic analyses of climate change. It found that the costs of climate change, as well as the potential net benefits of greenhouse gas reductions, were much higher that previously estimated, and consequently recommended more rapid and extensive cuts in emissions than other economist analysts. The Stern Review estimated that a 1% annual investment of global GDP in mitigation could prevent a 5% (or more) reduction in annual global GDP from climate change harm, forever. A number of prominent economists, including William Nordhaus, Partha Dasgupta, Richard S.J. Tol, Robert Mendelsohn, and Martin Weitzman, have criticized the Stern Review on various grounds, including its damage estimates and the selection of parameter values (the utility discount rate and the elasticity of marginal utility), which affect the interest rate at which future costs and benefits are discounted to present value. This paper summarizes the Stern Review and its critiques, and assesses them from a process-oriented perspective to determine what they can teach us, positively and negatively, about how benefit-cost analyses (BCAs) should (or should not) be done.

Keywords: benefit-cost analysis, discounting, discount rate, climate change

JEL Classification: D6, D81, D9, H4, K32, O1, Q2

Accepted Paper Series