Cost benefit analysis L6 Stern Review · Climate change presents very serious global risks, and it demands an urgent global response . Stern (2006) was an independent review commissioned by the Chancellor of the Exchequer, as a contribution to assess the evidence and build understanding of the economics of the climate change · CBA of (policies to tackle) global warming · Estimates the cost of business as usual (no action) and uses this to justify the scale of action needed . "The overall costs and risks of climate change will be equivalent to losing at least five per cent of global GDP each year, now and forever. If a wider range of risks and impacts are taken into account, the estimates of damage could rise to 20 percent of GDP or more" (Executive Summary, page vi) · Much higher than previous estimates which has calculated damages to be around 1 percent . The Review proposes that 1% of global GDP per annum is required to be invested to avoid the worst effects of climate change · Why do a CBA? - Policies have (opportunity) cost. Should governments spend money cutting greenhouse gas emissions or combating AIDS or malaria? - How much money should we spend - what is the efficient level of carbon emissions reduction? - See e.g., Copenhagen Consensus Center web pages (https://www.copenhagenconsensus.com/), especially the post 2015 climate change link. Basic approach · Assume a fixed rate of consumption growth going forward . Work out (discounted sum of) damages arising from BAU in terms of lost consumption in the future . Simplified causal model of the impact of emissions emissions => concentrations -> temperature changes -> impacts on environment -> socio-economic damage · Value of damages - market: lost crops, insurance premiums - non-market: health, life, species extinction - social contingent: migration, unrest - 5% excludes consequences for human health and socially contingent consequences . Many of the benefits of climate change mitigation occur in the future · What is the current value of damages occurring in 100+ years' time? BAU = business as usual Damage would rise to 20% if included other consequences, not just 5%. Social Time Preference (STP) method · Focuses on society's' willingness to trade-off present consumption for future consumption . Based on the work of Frank Ramsey
Agent - maximise social welfare function Inter-temporal optimization problem · Representative agent maximizes a social welfare function · Over infinite periods · Welfare is function of per-capita consumption over time · Through investment, consumption increases over time · Choose the optimal level of public investment . Maximization implies that on optimal growth path, society's MRTP would consist of two components reflecting 1. impatience 2. consumption smoothing . Social time preference (STP) should be used as the social discount rate How much to consume, save, invest? Higher weightage to consumption now than later. Richer in future; borrow now. Solve agent problem to find STP. The Ramsey formula · Ramsey's rule SDR = p + ge · SDR is