Discounting , risk and uncertainty in economic appraisals of climate change policy : comparing

The Stern (2006) and Garnaut (2008) Reviews argued for strong and early action to mitigate greenhouse gas emissions, while Nordhaus (2001, 2006, 2008a, 2010a) has consistently argued for weaker and more gradual policy action. While the economic debate immediately following the Stern Review focused on discount rates, the more recent literature draws attention to a wider range of issues that underlie these different policy prescriptions. This paper has two aims. The first is to place the Garnaut Review’s approach to discounting in the context of the literature on discounting in climate change policy, including recent applications of theories for intertemporal choice that deal explicitly with non-marginal outcomes while being robust to the use of higher discount rates. The second is to shed further light on claims about the relative importance of discounting and risk by examining their treatment across as well as within models used for climate policy evaluation. We reconcile differing analyses of the relative importance of risk and discounting by reiterating the significant differences in the treatment of risk and uncertainty across models. While discounting is important, several pieces of recent research highlight the importance of two key relationships – between greenhouse gas concentrations and temperatures, and between temperatures and the economic impacts of climate change – in determining the projected outcomes of unmitigated climate change and hence optimal mitigation policy. Nordhaus’s central choices for these relationships, combined with a minimal approach to uncertainty, are instrumental in DICE’s projections of the relatively modest outcomes of unmitigated climate change, and hence its prescription that the optimal amount of mitigation is also modest. In contrast, world leaders have agreed that deep emissions cuts are required. We outline the emissions trajectories and risks associated with Nordhaus’s preferred climate policy and paths consistent with meeting the international community’s two degree temperature goal. While Garnaut and Nordhaus both use deterministic models to evaluate climate policy, Garnaut endorses global action to stabilise concentrations of greenhouse gases at 450ppm CO2-e or lower – in line with the two degree temperature goal – as being consistent with Australia’s national interest. Considering Garnaut’s ‘off-model’ treatment of risk and uncertainty and comparing it with Stern’s formal analysis, we find that both quantitative and qualitative approaches to incorporating uncertainty and risk can be appropriate. Department of Climate Change and Energy Efficiency. The author would like to thank Thomas Abhayaratna, Steve Hatfield-Dodds, Frank Jotzo, Steven Kennedy and Keiran Sharpe for helpful comments and discussions, and the Garnaut Review Secretariat (in particular Elizabeth Edye, Stuart Evans, Steven Hamilton, Paul Ryan and Helen Wilson) for their generous help in preparing the paper for release. All remaining errors are the author’s. The views expressed are those of the author and do not necessarily reflect those of the Australian Government nor the Department of Climate Change and Energy Efficiency.