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35–906 PDF 2007

S. HRG. 110–52

ECONOMICS OF CLIMATE CHANGE

HEARING

BEFORE THE

COMMITTEE ON 

ENERGY AND NATURAL RESOURCES 

UNITED STATES SENATE

ONE HUNDRED TENTH CONGRESS

FIRST SESSION

TO

RECEIVE TESTIMONY ON THE STERN REVIEW OF THE ECONOMICS OF 

CLIMATE CHANGE, EXAMINING THE ECONOMIC IMPACTS OF CLIMATE 

CHANGE AND STABILIZING GREENHOUSE GASES IN THE ATMOSPHERE

FEBRUARY 13, 2007

(

Printed for the use of the 

Committee on Energy and Natural Resources 
(II)

COMMITTEE ON ENERGY AND NATURAL RESOURCES 

JEFF BINGAMAN, New Mexico, Chairman

DANIEL K. AKAKA, Hawaii 

BYRON L. DORGAN, North Dakota 

RON WYDEN, Oregon 

TIM JOHNSON, South Dakota 

MARY L. LANDRIEU, Louisiana 

MARIA CANTWELL, Washington 

KEN SALAZAR, Colorado 

ROBERT MENENDEZ, New Jersey 

BLANCHE L. LINCOLN, Arkansas 

BERNARD SANDERS, Vermont 

JON TESTER, Montana 

PETE V. DOMENICI, New Mexico 

LARRY E. CRAIG, Idaho 

CRAIG THOMAS, Wyoming 

LISA MURKOWSKI, Alaska 

RICHARD BURR, North Carolina 

JIM DEMINT, South Carolina 

BOB CORKER, Tennessee 

JEFF SESSIONS, Alabama 

GORDON H. SMITH, Oregon 

JIM BUNNING, Kentucky 

MEL MARTINEZ, Florida

ROBERT M. SIMON, Staff Director 

SAM E. FOWLER, Chief Counsel 

FRANK MACCHIAROLA, Republican Staff Director 

JUDITH K. PENSABENE, Republican Chief Counsel 

JOHNATHAN BLACK, Professional Staff Member 

KATHRYN CLAY, Republican Professional Staff Member 
(III)

C O N T E N T S 

STATEMENTS 

Page

Bingaman, Hon. Jeff, U.S. Senator from New Mexico .......................................... 1

Domenici, Hon. Pete V., U.S. Senator from New Mexico ..................................... 2

Stern, Sir Nicholas, Head of The Government Economic Service, United Kingdom ........................................................................................................................ 4

Jacoby, Henry, Ph.D., Massachusetts Institute of Technology ............................ 28

Yohe, Gary, Ph.D., Economics Professor, Wesleyan University .......................... 33 

APPENDIX 

Responses to additional questions .......................................................................... 61

(1)

ECONOMICS OF CLIMATE CHANGE 

TUESDAY, FEBRUARY 13, 2007 

U.S. SENATE, COMMITTEE ON ENERGY AND NATURAL RESOURCES, Washington, DC. 

The committee met, pursuant to notice, at 10:07 a.m., in room 

SD–106, Dirksen Senate Office Building, Hon. Jeff Bingaman, 

chairman, presiding. 

OPENING STATEMENT OF HON. JEFF BINGAMAN, U.S. 

SENATOR FROM NEW MEXICO 

The CHAIRMAN. Why don’t we go ahead with the hearing? Thank 

you all for being here. 

For the past 6 years the United States has done far too little in 

my view on the issue of global warming. There are two reasons for 

this. First, significant numbers of lawmakers have not been persuaded that the threat is real, and the critics have cited too many 

uncertainties that needed to be resolved before we took significant 

policy action. The second reason is the concern that economic impacts to the country would be too great and could lead to the 

United States sacrificing its ability to compete in world markets, 

and the loss of jobs and other factors that would result. 

Earlier this month the latest scientific report from the United 

Nations, a report by the intergovernmental panel on climate 

change, did much to lay to rest the debate on the first problem. The 

problem that there are too many scientific uncertainties the report 

affirmed with over 90 percent certainty, that most of the warming 

of the climate system has experienced in the last 50 years is due 

to human-caused greenhouse gas emissions, and that extreme 

weather events, heat waves, and heavy precipitation will become 

more frequent. 

The second concern over the impact to our economy has been 

more difficult to overcome. The debate over what we can and cannot afford has persisted in every discussion on global warming that 

has occurred here in the Senate. Now we have the release of the 

report by Sir Nicholas Stern, the Stern Review, on the economics 

of climate change. Sir Nicholas gave me a copy yesterday. I’ve read 

it to make sure there are no mistakes in there. 

[Laughter.] 

But with the issuance of that report we’re beginning to understand and to focus not just on the cost of action, but the cost of inaction. Since release of the Stern Review and the November elections in the United States the ground on this issue has shifted substantially. I believe there’s an opportunity for us to move forward 
2

with legislation on global warming this year. My colleague Senator 

Domenici was just pointing out that this is one of three hearings 

on this issue this morning here in the Congress so clearly there is 

great interest and focus on the issue. 

The challenge now will be to get a majority of the Congress to 

agree on specific proposals. There are a number of proposals introduced and circulated already this year. I think it’s vital that in trying to craft a proposal that would make good policy sense, we work 

together and try to get something enacted sooner rather than later. 

Science tells us that action is needed immediately and that the 

longer we delay, the more difficult the problem will be. 

Let me call on Senator Domenici for his opening statement and 

then I’ll introduce our witnesses. 

STATEMENT OF HON. PETE V. DOMENICI, U.S. SENATOR FROM 

NEW MEXICO 

Senator DOMENICI. Well Mr. Chairman, you indicated that there 

are three hearings today in the U.S. Congress on the issue. I would 

think that maybe our witnesses would figure that with that many 

hearings, maybe by this afternoon or maybe the day after tomorrow, we’ll be able to solve this problem. But frankly the number of 

hearings, Mr. Chairman hasn’t produced significant proposals that 

this Senator would be willing to sign on to. Yours comes closest to 

any, for which I complement you. I don’t know where the others 

will be coming from. 

I have a statement. I’d ask you to put it in the record, because 

I think we want to hear from these witnesses. But I do want to say 

in my opening remarks that Sir Nicholas Stern accepted a big job, 

and he produced a big report, but there is no question that it is 

vulnerable. It is vulnerable in a big way with reference to the way 

he uses the economic calculations. We can do that by asking him 

questions—far smarter people than I have said that, so I’m not 

dreaming it up—and I believe it’s understandable what he has 

done, but I think it’s probably not something we’re going to take 

seriously in terms of a bill. That is, the way he calculated, the way 

he put in the discount, which is a little bit different than most 

would have used. 

I also want to say that I grow more and more fearful with the 

passage of each month. What’s going to happen to this world, to 

our country if we go out and try to settle this issue here and nothing significant is done with reference to China and India? 

I just want to state for the record, because the facts begin to develop and begin to get very frightening, and begin to say to me that 

somebody in a big leadership role has to get together with the Chinese and the Indians and decide whether they have a stake or not, 

and if they do, that we try to do something together. 

China uses more coal than the United States, Europe and Japan 

combined. It has increased coal consumption 14 percent in each of 

the past 2 years and every week to 10 days, another coal-fired 

power plant opens somewhere in China. That’s big enough to serve 

all the households in Dallas or San Diego. In fact, China’s economy 

continues to grow at 10 percent on an annual basis and it is projected to continue to do so in the near future. We must say at the 

same time the United States has not built a new power plant. We 
3

have a consortium in Texas that plans to build 11 over a rather 

long period of time. I’m not sure that they will be able to complete 

that because we’re in such a state of flux, as to whether we want 

those or don’t want them or what we want to do with reference to 

clean up. 

My last observation would be that all the nations of the world—

in my opinion including the big two that I just mentioned, and 

America—must join together and put up large amounts of capital 

for research efforts, the likes of which we have never seen. If we 

intend to attack this issue with new technology and sequestration 

and permanent placement of the CO underground or someplace, we 

can’t do that one alone. Somebody must bring China and India in, 

and even then when you look at the dimensions of the clean-up 

we’re talking about with new technology, it is rather—just almost 

defies doing. Sometimes I think that the suggestion that maybe we 

ought to set up some group to start analyzing how we’re going to 

adapt to this might be in order. Maybe we ought to do that rather 

quickly, and let them start looking at how we might adapt, because 

we might just have to. I yield. Thank you very much. 

[The prepared statements of Senators Domenici and Sanders follow:]

PREPARED STATEMENT OF HON. PETE V. DOMENICI, U.S. SENATOR FROM

NEW MEXICO

I want to add my thanks to our distinguished panel of witnesses for participating 

in our hearing today. 

Last month, this Committee held a hearing to consider an analysis of Chairman 

Bingaman’s draft climate change legislation done by the Energy Information Administration. The EIA report estimated that the effect of the proposal on our national 

GDP would be perhaps 0.25 percent below baseline projections in 2030. 

However, the EIA analysis did not consider whether energy intensive industries 

might relocate to nations that do not impose costs on carbon—nations such as China 

and India. I continue to be concerned about the implications for our economy of limiting carbon emissions if other key nations do not impose similar requirements. 

Some industries would be facing difficult consequences under carbon-limiting legislation, both now and in the long-term. 

The projected growth in emissions from India and China is daunting. Even with 

dramatic cuts in our own greenhouse gas emissions, we will not solve the problem 

without key developing countries. Limiting our own emissions without the participation of these nations would not only harm our economy, but would also accomplish 

nothing for the climate. 

I do thank Chairman Bingaman for holding a second hearing on the economics 

of climate change. I believe that economic analysis is crucial to the climate change 

policy debate. We have to make every effort to know exactly the effects on our citizens of whatever course of action we pursue. 

I understand that the Stern Review’s methods have been the subject of controversy among economists. Several highly respected economists—including our panelists Professor Jacoby and Professor Yohe—have published papers questioning 

some of the Review’s methods. 

For example, both Professors Jacoby and Yohe have questioned the very small 

‘‘discount rate’’ used in the Stern Review. The discount rate gives a comparative 

weight to spending money now, compared to spending money later. This is an important point in an issue like climate change, which took generations to create and 

would take generations to address. 

If we are confident that the world economy will continue to grow, then we can 

be confident that people living in future decades will be much wealthier than people 

living today. It only makes sense that some of the costs of our response to climate 

change should be shared among generations. 

Future generations will also have the advantage of improved technologies that 

will be better able to address climate change. I believe an essential part of today’s 

response to climate change is to increase our commitment to developing new energy 

technologies. Research and development funding, both public and private, is vital to 
4

addressing many of our nation’s energy challenges, and the climate change issue is 

no exception. 

I am interested in learning as much as I can about the Stern Review, and the 

questions surrounding it. 

PREPARED STATEMENT OF HON. BERNARD SANDERS, U.S. SENATOR FROM VERMONT

Chairman Bingaman, Ranking Member Domenici, as you both know, global warming threatens the very future of the planet—its people, its places, and its life-sustaining resources. The world is longing for leadership to address the threat and if 

I have anything to do with it, the United States will rise to the occasion and send 

clear signals that we understand the magnitude of the problem. 

One of the issues that, up to this point, has stifled progress on addressing global 

climate change is the question of what it will cost to do so. While I have no doubt 

that acting with purpose and vision on this most important environmental issue will 

actually create new jobs and save us money in the long run, I understand that there 

are those who disagree with me. And that’s why I sincerely appreciate the Committee leadership holding today’s hearing on the Stern Review of the Economics of 

Climate Change. 

The Stern Review, written by Sir Nicholas Stern, a former chief economist of the 

World Bank, tells us that it is a lack of bold vision that will financially cost us. In 

turning the old economic arguments against taking action on climate change on 

their head, the report suggests that taking aggressive action to combat global warming will, in fact, save industrial nations money and that failing to act to boldly to 

curb global warming is what will cost us—and he says it won’t be cheap. I think 

his report is groundbreaking and having him testify today helps to highlight the fact 

that acting on climate change is a pro-growth strategy. 

I thank all of the witnesses here today and look forward to their testimony. Their 

thoughts will surely be referenced time and time again as the Senate moves closer 

to passing global warming legislation.

The CHAIRMAN. Thank you very much. Let me introduce our witnesses here. First, let me acknowledge—he’s not a witness, but has 

joined us this morning as an observer—is Ambassador David Manning, from the British Embassy. We’re very pleased to have you 

here and thank you for coming. 

Sir Nicholas Stern, who is the head of the government economic 

service and advisor to her majesty’s government on the economics 

of climate change, the author of the Stern Review which I mentioned before, will be our first witness. Accompanying him is 

Siobhan Peters, who is head of the review team that worked with 

Nicholas Stern on the development of this Review, and we appreciate her being here as well. Professor Henry Jacoby from MIT is 

here and we very much appreciate his presence, a very respected 

economist who has insights on this same issue. Also Gary Yohe, 

who is a professor at Wesleyan University, is a respected economist 

as well. So we have three very distinguished witnesses and we look 

forward to hearing from each of you. 

Why don’t we just take any written statement that you have, include it in the record and why don’t you take whatever time you’d 

like and summarize the main points that you think this committee 

should understand. Then, of course, we’ll try to ask some questions 

after that. Let me start with you, Sir Nicholas Stern. 

STATEMENT OF SIR NICHOLAS STERN, HEAD OF THE 

GOVERNMENT ECONOMIC SERVICE, UNITED KINGDOM 

Mr. STERN. Thank you very much. Chairman, Senators, it’s an 

honor to be with you today. Thank you for the opportunity to address this committee. 
5

Uncontrolled climate change will transform the physical geography, and thus the human geography, of the world. That means 

where we live and how we live our lives. 

It involves great risks of economic and social disruption, migration and conflict. The recent report that the U.N.’s expert panel of 

climate scientists to which you referred, Mr. Chairman, confirms 

that global average temperatures have already risen 0.7 degrees 

centigrade from pre-industrial levels. If emissions continue to rise, 

the panel’s central estimate that further warming for the end of 

this century is 4 degrees centigrade. This would also give a greater 

than 50 percent probability of increases over 5 degrees centigrade. 

Those of you who like to speak in Fahrenheit, that’s 9 degrees 

Fahrenheit in the next century, so more than 50 percent probability of increases of over 5 degrees Fahrenheit in the next century, if we go on under business as usual. 

Their analysis is exactly in line with the analysis presented in 

the Stern Review last year. Warming on this scale is associated 

with widespread and serious impacts on the availability of water, 

on human health, on food production, and the environment. The 

impacts in the United States are likely to be substantial; for example, an increase in the intensity of hurricanes in the Gulf of Mexico, still greater water stress in California, sea level rise in Florida, 

and an increased risk of storm surges in New York. We’ve already 

seen how long-term shifts in weather patterns interact with other 

factors to generate movements of people and the conditions for conflict, for example in Darfur and Sudan. 

Abrupt regional shocks become more likely as average temperatures rise, including the risk of sudden changes to monsoon rains 

in densely populated regions in South Asia, or significant reductions in water flow in the river Nile—affecting 10 countries in 

North and East Africa. To reduce these risks in manageable proportions, we’d have to keep the atmospheric concentration of greenhouse gases below around 550 parts per million, a CO2 equivalent. 

Even at this level there are serious risks—indeed there’s only a 50 

percent chance that the eventual temperature rise would not exceed 3 degrees centigrade. 

So how can we reduce the risks? My initial observation is that 

previous delay in action means that we do not start in a good place. 

We cannot control the stock of gases already released in the atmosphere but we can, as a world, control the future flows. A global 

problem requires a global response. And equity demands that rich 

countries take the lead. It’s they who are responsible for the bulk 

of the problem, and it’s the poor countries who will be hit earliest 

and hardest. 

Controlling emissions will not remove all the risks of future climate change, but it can drastically reduce them, and we’ve shown 

in the Stern Review that the cost of controlling these flows is much 

less than the damages that are thereby averted. The case for taking strong action across the world is compelling and actually is urgent. The later we leave it, the greater the risks, and the higher 

will be the cost of controlling them. 

So how much will it cost to reduce the risks? We estimated the 

cost of the global economy of around 1 percent of GDP, a cost similar to one-off increase in the price of cost index, one-off. The models 
6

give the range of plus or minus 3 percent—a big range here. We’re 

uncertain about these costs, but higher estimates embody rather 

pessimistic assumptions about progress in technologies. Of course 

the cost of 1 percent extra is not trivial, but it’s similar to the costs 

we accommodate all the time, for example by changes in exchange 

rates. That will not slow growth. It is failing to act that will eventually damage growth. 

The message from the economics and climate change is clear. We 

must act strongly and we must act now. The damages that this 

strategy would avoid can be estimated in various ways, taking account of the more serious risks that are now evident. Simple economic models suggest that the damage is averaged over time and 

over the range of possible outcomes, or at least 5 percent of global 

consumption. There are uncertainties, there are technical challenges in the modeling, but there is no case to believe that the economic impacts will be small. Indeed on a number of key dimensions, the models we used underestimated the damages. For example, we excluded irreversibilities and a number of relevant risks. 

So what are the key elements in the strategy? First we must ensure that we correct the biggest market failure the world has ever 

seen. People should pay in the prices they face for the cost of their 

actions—in this case, cost to the climate. Pricing carbon directly 

through either tax or carbon trading or implicitly through regulation is fundamental to a policy response. Given the global nature 

of the market failure and the efficiency that comes from using economic instruments, developing a global price for carbon is crucial. 

In Europe we’ve long had strong taxes on fuel. The European 

Union has established the world’s largest emissions trading scheme 

and is taking steps to ensure that it’s long-term, ambitious, and 

open to trade with others. 

I hope that as your committee scrutinizes proposals for U.S. policy, including the range of different suggestions for cap and trade, 

you will bear in mind not only the potential gains in terms of cost 

reductions of creating schemes that can link to those in the EU, 

Australia and elsewhere, but also the value of using carbon finance 

as one key element in building cooperation on climate change with 

China and India and other developing countries, as Senator 

Domenici described. 

The United States has shown how regulation and standards can 

build markets, for example in energy efficient domestic appliances, 

and tackling other environmental problems, such as lead in gasoline. Leadership in the world’s largest markets sets the pace elsewhere. Indeed, the Sudan now uses lead-free gasoline. China and 

India are taking steps of their own: for example China is implementing a domestic goal of reducing the energy intensity by 20 percent in 5 years, and India, too, is focusing on energy efficiency and 

increasing renewable energy. But they can and will go further and 

faster with international support. 

The second element of the strategy after the pricing element: we 

must invest in policy to bring forward low carbon technologies. 

Spending on public energy research worldwide is halved over the 

last 20 or 30 years and public and private investment are highly 

correlated, of course. As a world we must double public R&D 

spending on energy and we must promote the development of key 
7

technologies, such as renewable energy and carbon capture and 

storage. Carbon capture and storage is a strategy that will allow 

us to continue to make use of abundant reserves of coal, vital for 

energy security without causing unacceptable harm to the environment. 

Urgent steps are required to move toward widespread deployment of this technology, as rich and poor countries alike invest in 

a new generation of coal-fired power generation plants. In transport, new technologies such as plug-in hybrid cars and the use of 

cellulosic ethanol could go a very long way to reducing emissions 

without changing our basic mobility. Further, these low carbon 

technologies will create opportunities: markets for low carbon 

power generation technologies alone could be worth $500 billion a 

year by 2050. 

The third, final element to the strategy is that we have to recognize there are many ways to reduce emissions now that do not 

need new technology. Energy efficiency and combating deforestation are very inexpensive ways to reduce emissions, but they require decisions and action on policy and changes in behavior—for 

example, problems in building regulations in tenant-landlord contracts—can prevent energy efficiency investments being made. In 

the case of deforestation, solutions should be based on supporting 

the countries in which the trees stand, to develop their own approaches to this complex problem. 

So given this, why would anyone deny this case for action? I’ve 

heard three reasons to do so. They are all in my view profoundly 

mistaken. The first is that the science is incorrect. I need to do no 

more than to refer to the conclusions at the recent U.N. panel on 

the science, which you mentioned, Mr. Chairman, which reported 

so clearly and strongly only 10 days ago. 

The second reason for denial is that we can adapt as a human 

race to any rising temperatures. That in my view is reckless. It ignores the risk of very high temperature increases. Business-asusual growth in emissions over the next 100 years will be likely to 

take the next century to a world that will be 5 or 6 degrees centigrade, more than 9 degrees Fahrenheit hotter than today. That’s 

a change which is equivalent to the difference between now and the 

last ice age 10,000 or 12,000 years ago. It would transform the 

world, involving massive dislocation and in all probability, conflict. 

A third reason for refusing to act is that such risks and their impacts will happen a long way into the future and we, as this current generation, have little interest in what happens in the future. 

I trust that many of you would find this argument ethically untenable. 

Mr. Chairman, Senators, uncontrolled climate change constitutes 

a risk that as a global community we cannot afford to take. We 

have an understanding of the scale of action necessary and of the 

economic policies to deliver this action. Now is the time to act, urgently, strongly and internationally. Strong leadership from the 

United States of America is of the utmost importance. The decisions made by this committee will be fundamental in creating that 

leadership. Thank you very much. 

[The prepared statement of Mr. Stern follows:]
8

PREPARED STATEMENT OF SIR NICHOLAS STERN, HEAD OF THE GOVERNMENT

ECONOMIC SERVICE, UNITED KINGDOM

THERE IS STILL TIME TO AVOID THE WORST IMPACTS OF CLIMATE CHANGE, IF WE TAKE

STRONG ACTION NOW

The scientific evidence is now overwhelming: climate change is a serious global 

threat, and it demands an urgent global response. 

The recent report by the U.N.’s expert panel of climate scientists confirms that 

global average temperatures have already risen 0.7 degrees C from pre-industrial 

levels. If emissions continue to rise, the panel’s central estimate of further warming 

for the end of this century is 4 degrees C. This would also give a greater than 50% 

probability of increases over 5 degrees C in the next century beyond 2100—exactly 

in line with the analysis presented in the Stern Review last year. 

The Stern Review assessed a wide range of evidence on the impacts of climate 

change and on the economic costs, and has used a number of different techniques 

to assess costs and risks. From all of these perspectives, the evidence gathered leads 

to a simple conclusion: the benefits of strong and early action far outweigh the economic costs of not acting. 

Warming on the scale implied by allowing emissions to grow on business-as-usual 

basis is associated with widespread and serious impacts—on the availability of 

water, on human health, on food production, and the environment. The impacts in 

the U.S. are likely to be substantial—an increase in the intensity of hurricanes in 

the Gulf of Mexico, still greater water stress in California, sea level rise in Florida, 

an increased risk of storm surges in New York. 

We have already seen how long-term shifts in weather patterns interact with 

other factors to generate movements of people and the conditions for conflict—for 

example in Darfur. Abrupt regional shocks become more likely as average temperatures rise—including the risk of sudden changes to monsoon rains in densely populated regions of South Asia, or significant reductions in water flow in the River Nile 

affecting 10 countries in North and East Africa. 

To reduce these risks to manageable proportions, we would have to keep the atmospheric concentration of greenhouse gases below around 550 ppm CO2 equivalent. 

Even at this level there are serious risks: indeed, there is only a 50% chance that 

the eventual temperature rise would not exceed 3 degrees C. 

In contrast, the costs of action—reducing greenhouse gas emissions to avoid the 

worst impacts of climate change—can be limited to around 1% of global GDP each 

year. The models give a range of ∂/3%—but higher estimates embody pessimistic 

assumptions about progress in technologies and other issues. A cost of 1% is not 

trivial—but it is similar to a one-off increase in the price index, the kind of cost that 

we accommodate all the time, for example, through changes in exchange rates. It 

will not slow growth. It is failing to act that will damage growth. The message from 

the economics of climate change is clear: we must act strongly and we must act now. 

The investment that takes place in the next 10-20 years will have a profound effect on the climate in the second half of this century and in the next. Our actions 

now and over the coming decades could create risks of major disruption to economic 

and social activity, on a scale similar to those associated with the great wars and 

the economic depression of the first half of the 20th century. And it will be difficult 

or impossible to reverse these changes. 

So prompt and strong action is clearly warranted. Because climate change is a 

global problem, the response to it must be international. It must be based on a 

shared vision of long-term goals and mutual understanding that will accelerate action over the next decade. It must build on mutually reinforcing approaches at national, regional and international level. 

CLIMATE CHANGE COULD HAVE VERY SERIOUS IMPACTS ON GROWTH AND DEVELOPMENT

If no action is taken to reduce emissions, the concentration of greenhouse gases 

in the atmosphere could reach double its pre-industrial level as early as 2035, virtually committing us to a global average temperature rise of over 2 degrees C. In 

the longer term, there would be more than a 50% chance that the temperature rise 

would exceed 5 degrees C. This rise would be very dangerous indeed; it is equivalent 

to the change in average temperatures from the last Ice Age to today. Such a radical 

change in the physical geography of the world must lead to major changes in the 

human geography—where people live and how they live their lives. 

Even at more moderate levels of warming, all the evidence—from detailed studies 

of regional and sectoral impacts of changing weather patterns through to economic 

models of the global effects—shows that climate change will have serious impacts 

on world output, on human life and on the environment. 
9

All countries will be affected. The most vulnerable—the poorest countries and 

populations—will suffer earliest and most, even though they have contributed least 

to the causes of climate change. The costs of extreme weather, including floods, 

droughts and storms, are already rising, including for rich countries. 

Adaptation to climate change—that is, taking steps to build resilience and reduce 

the costs of impacts—is essential. It is no longer possible to prevent the climate 

change that will take place over the next two to three decades, but it is still possible 

to protect our societies and economies from its impacts to some extent—for example, 

by providing better information, improved planning and more climate-resilient infrastructure and crops. Adaptation will cost tens of billions of dollars a year in developing countries alone, and will put still further pressure on already scarce resources. Adaptation efforts, particularly in developing countries, should be accelerated. 

THE COSTS OF STABILISING THE CLIMATE ARE SIGNIFICANT BUT MANAGEABLE; DELAY

WOULD BE DANGEROUS AND MUCH MORE COSTLY

The risks of the worst impacts of climate change can be substantially reduced if 

greenhouse gas levels in the atmosphere can be stabilised between 450 and 550ppm 

CO2 equivalent (CO2e). The current level is 430ppm CO2e today, and it is rising at 

more than 2ppm each year. Stabilisation in this range would require emissions to 

be at least 25% below current levels by 2050, and perhaps much more. 

Ultimately, stabilisation—at whatever level—requires that annual emissions be 

brought down to more than 80% below current levels. 

This is a major challenge, but sustained long-term action can achieve it at costs 

that are low in comparison to the risks of inaction. Central estimates of the annual 

costs of achieving stabilisation between 500 and 550ppm CO2e are around 1% of 

global GDP, if we start to take strong action now and follow sound and economically 

efficient policies. 

Costs could be even lower than that if there are major gains in efficiency, or if 

the strong co-benefits, for example from reduced air pollution, are measured. Costs 

will be higher if innovation in low-carbon technologies is slower than expected, or 

if policy-makers fail to make the most of economic instruments that allow emissions 

to be reduced whenever, wherever and however it is cheapest to do so. 

It would already be very difficult and costly to aim to stabilise at 450ppm CO2e. 

If we delay, the opportunity to stabilise at 500-550ppm CO2e may slip away. Business as usual emissions for the next 30 years would already take us well over 

500ppm CO2e. 

ACTION ON CLIMATE CHANGE IS REQUIRED ACROSS ALL COUNTRIES, AND IT NEED NOT

CAP THE ASPIRATIONS FOR GROWTH OF RICH OR POOR COUNTRIES

The costs of taking action are not evenly distributed across sectors or around the 

world. Even if the rich world takes on responsibility for absolute cuts in emissions 

of 60-80% by 2050, developing countries must take significant action too. But developing countries should not be required to bear the full costs of this action alone, 

and they will not have to. Carbon markets in rich countries are already beginning 

to deliver flows of finance to support low-carbon development, including through the 

Clean Development Mechanism. A transformation of these flows is now required to 

support action on the scale required. 

Action on climate change will also create significant business opportunities, as 

new markets are created in low-carbon energy technologies and other low-carbon 

goods and services. These markets could grow to be worth hundreds of billions of 

dollars each year, and employment in these sectors will expand accordingly. 

The world does not need to choose between averting climate change and promoting growth and development. Changes in energy technologies and in the structure of economies have created opportunities to decouple growth from greenhouse 

gas emissions. Indeed, ignoring climate change will eventually damage economic 

growth. 

Tackling climate change is the pro-growth strategy for the longer term, and it can 

be done in a way that does not cap the aspirations for growth of rich or poor countries. 

A RANGE OF OPTIONS EXISTS TO CUT EMISSIONS; STRONG, DELIBERATE POLICY ACTION

IS REQUIRED TO MOTIVATE THEIR TAKE-UP

Emissions can be cut through increased energy efficiency, changes in demand, and 

through adoption of clean power, heat and transport technologies. The power sector 

around the world would need to be at least 60% decarbonised by 2050 for atmos-
10

pheric concentrations to stabilise at or below 550ppm CO2e, and deep emissions cuts 

will also be required in the transport sector. 

Even with very strong expansion of the use of renewable energy and other lowcarbon energy sources, fossil fuels would still probably make up over half of global 

energy supply in 2050. Natural resources dictate that coal will continue to be important in the energy mix around the world, including in fast-growing economies. If it 

proves a viable technology as expected, extensive carbon capture and storage will 

be required to allow the continued use of fossil fuels without damage to the atmosphere. 

Cuts in non-energy emissions, such as those resulting from deforestation and from 

agricultural and industrial processes, are also essential. 

With strong, deliberate policy choices, it is possible to reduce emissions in both 

developed and developing economies on the scale necessary for stabilisation in the 

required range while continuing to grow. 

Climate change is the greatest market failure the world has ever seen, and it 

interacts with other market imperfections. Three elements of policy are required for 

an effective global response. The first is the pricing of carbon, implemented through 

tax, trading or regulation. The second is policy to support innovation and the deployment of low-carbon technologies. And the third is action to remove barriers to 

energy efficiency, and to inform, educate and persuade individuals about what they 

can do to respond to climate change. 

CLIMATE CHANGE DEMANDS AN INTERNATIONAL RESPONSE, BASED ON A SHARED

UNDERSTANDING OF LONG-TERM GOALS AND AGREEMENT ON FRAMEWORKS FOR ACTION

Many countries and regions are taking action already: the EU, California and 

China are among those with the most ambitious policies that will reduce greenhouse 

gas emissions. The U.N. Framework Convention on Climate Change and the Kyoto 

Protocol provide a basis for international co-operation, along with a range of partnerships and other approaches. But more ambitious action is now required around 

the world. 

Countries facing diverse circumstances will use different approaches to make their 

contribution to tackling climate change, and will use different combinations of policy 

tools. As far as possible, a common carbon price across different sectors and countries will ensure that reductions are made in the most efficient way around the 

world. It is essential to create a shared international vision of long-term goals to 

provide the context for domestic policy, and to build the international frameworks 

that will help each country to play its part in meeting these common goals. 

Key elements of future international frameworks should include:

• Emissions trading.—Expanding and linking the growing number of emissions 

trading schemes around the world is a powerful way to promote cost-effective 

reductions in emissions and to bring forward action in developing countries: 

strong targets in rich countries could drive flows amounting to tens of billions 

of dollars each year to support the transition to low-carbon development paths. • Technology cooperation.—Informal co-ordination as well as formal agreements 

can boost the effectiveness of investments in innovation around the world. Globally, support for energy R&D should at least double, and support for the deployment of new low-carbon technologies should increase up to five-fold. International cooperation on product standards is a powerful way to boost energy efficiency. • Action to reduce deforestation.—The loss of natural forests around the world 

contributes more to global emissions each year than the transport sector. Curbing deforestation is a highly cost-effective way to reduce emissions; large-scale 

international pilot programmes to explore the best ways to do this could get underway very quickly. • Adaptation.—The poorest countries are most vulnerable to climate change. It is 

essential that climate change be fully integrated into development policy, and 

that rich countries honour their pledges to increase support through overseas 

development assistance. International funding should also support improved regional information on climate change impacts, and research into new crop varieties that will be more resilient to drought and flood. 

RESPONSES TO THE STERN REVIEW

Since publication, the Review team have travelled widely, presenting the results 

of the Review and listening to the reactions of policymakers, academics and business 

leaders, in particular in the EU, China, India, Japan, Africa and the U.S. 

In the academic literature, many people have supported the approach taken in the 

Review, but some have raised questions about particular technical aspects of the 
11

analysis—often based on misconceptions of the approach undertaken in review. We 

are publishing a detailed paper responding to the critiques this week. In summary, 

the economic analysis in the Review remains robust. The costs of inaction on climate 

change are much greater than the likely costs of early action to reduce the risks. 

THE ANALYSIS IS BUILT ON THE EXISTING LITERATURE, BUT THE ESTIMATES OF THE

COST OF DAMAGES WERE HIGHER FOR THREE REASONS

First, crucial advances of the science in the past few years have allowed estimates 

to be made of the probabilities of temperature rises associated with increases in the 

quantity of greenhouse gases in the atmosphere. These estimates point to significant 

risks of temperature increases above 5 degrees C under a business-as-usual scenario 

by the early part of the next century. Previous studies have mainly focused on 2-

3 degrees C temperature rises and our results for these temperatures are consistent 

with existing studies. 

Second, we have taken account of the impact on wellbeing across the full range 

of possible outcomes, including worst- and best-case scenarios, and have explicitly 

built in aversion to risk. Risks and uncertainties are the heart climate change modelling, and risk aversion entails giving more weight to the worse outcomes, as people 

routinely do in their daily lives, for example, in buying insurance. That, together 

with the risks of higher temperatures, and an ethically supportable approach to valuing future lives, is what drives our results. These results are supported by a detailed analysis of the economic impacts of climate change at the regional and country level. 

The review examines the application of discounting to the particular characteristics of climate change and the ethical issues involved. With higher discount factors, 

it becomes easy to see why climate change—which results in significant impacts in 

the future—gets a relatively low ethical weight. For example, a discount rate of 3% 

would give individuals existing at the end of this century roughly one tenth of the 

ethical weight of the current generation and only a 1% weight by 2200. Because we 

know that future generations will exist and that their consumption and welfare will 

be affected by the climate that they experience, we adopt a low pure time discount 

rate that gives future generations equal ethical weight. But this is only one element 

of the discount rate. How much we discount the future depends also on how much 

richer we expect to be. Risks and uncertainties surrounding climate change imply 

that strongly divergent paths for future growth are possible, so the use of a single 

discount rate is inappropriate. The discount rates used in the Review do include the 

appropriate rate of economic growth for each model run. 

Discounting has been the subject of much attention since publication of the Review, and rightly so, since it does drive the results to some extent. We welcome the 

legitimate debate on the values chosen given the ethical implications of different 

choices. But the discount rate is not the only factor driving the case for climate 

change. Our sensitivity analysis demonstrates that the treatment of risk and uncertainty and the extent to which projections of impacts reflect progress in the scientific literature are of roughly equal importance. 

Given that the assumptions underlying our model can be shown to be plausible 

and unbiased, the question is often asked why our results show a higher valuation 

of the impacts of climate change under business as usual when compared with previous studies? The answer should by this stage be clear:

• Our study takes on the published findings of the latest science including a probabilistic assessment of high climate change impacts. 

• We have explicitly accounted for the economics of risk, which has hitherto been 

mostly ignored. 

• We have taken an ethical judgement about the way we value future generations 

that is time-consistent and allows the Review to be objective with conclusions 

that do not discriminate on the basis of birth dates.

Having assessed the model properties and characteristics and compared the results with the disaggregated impacts associated with a business as usual emissions 

path, we remain confident that our estimates are very much in the centre of any 

plausible range of model projections. 

SINCE THE PUBLICATION OF THE REVIEW, MOMENTUM IN NATIONAL AND

INTERNATIONAL POLICY-MAKING HAS INCREASED

The messages in the Review have been well received by policymakers and business, and momentum has continued to build towards more effective domestic policies and more effective international links between them. 
12

The development of policy in the EU has accelerated significantly in the last few 

months. The European Commission rejected several of the draft National Allocation 

Plans for Phase II of the EU ETS, asking for allocations to be reduced in a number 

of countries—a move that will increase the credibility of the market for 2008-2012. 

This has sent a strong signal on the role of carbon markets at the centre of the EU’s 

strategy to deliver deeper emissions cuts. The EU’s Strategic Energy Review, published in January 2007, recommends a target for the EU to reduce greenhouse gases 

by up to 30% by 2020, and proposes other mandatory targets on energy efficiency, 

renewables and biofuels. 

In China and in India, policymakers are also demonstrating a strong interest in 

moving towards more secure and sustainable energy use. In China, we heard about 

the wide range of measures that China is beginning to implement towards its domestic target to improve energy intensity by 20% by 2010: energy efficiency audits 

and major investment projects for manufacturing industry, and tariffs on the export 

of energy-intensive products including for cement, iron and steel and aluminium. In 

India, we saw how the Integrated Energy Policy under the 11th Five Year Plan is 

being taken forward—including changes to energy subsidies, plans for more efficient 

coal-fired power plant and further development of innovative new technologies for 

renewable energy. 

In Japan, debates between government, industry and civil society on the challenges of designing further domestic and international action are intensifying. There 

was encouraging news of rapid technological progress—confidence on the role of 

plug-in hybrid vehicles and imminent breakthroughs in solar technology. There was 

increasing recognition of the role of trading and investment strategies in creating 

stronger co-operation with China and India, and interest in sectoral approaches that 

could mitigate concerns about competitiveness. 

In Africa, climate change has risen sharply up the agenda. The decision by the 

African Union to make climate change one of the key themes for its Summit in January 2007 has drawn the attention of African leaders to the vulnerability of their 

countries, and to the opportunities for adaptation, sustainable land management 

and low-carbon development. 

The U.S. has shown how regulation and standards can build markets, for example 

in energy efficient domestic appliances, and in tackling other environmental problems such as lead in gasoline. Leadership in the world’s largest markets sets the 

pace elsewhere—even the Sudan now uses lead-free gasoline. In the 2007 State of 

the Union President Bush outlined further plans to improve efficiency, reduce emissions and improve energy security particularly in the transport sector. 

In the light of these developments, there are clear opportunities to build momentum towards effective international collective action on climate change. 

CONCLUSION

Our analysis suggests that uncontrolled climate change constitutes a risk that we 

cannot afford to take. Three main reasons have been put forward to reject this conclusion. They are all profoundly mistaken. The first is that the science is incorrect. 

This is not borne out by the conclusions of the recent U.N. panel on the science, 

which reported so clearly and strongly only ten days ago. The second is that we can 

adapt as a human race to rising temperatures. That is reckless; it ignores the risk 

of very high temperature increases. Business-as-usual growth in emissions over the 

next hundred years would be likely to take us to a world that would be 5 or 6 degrees hotter than today—a change which is equivalent to the difference between 

now and in the last Ice Age. It would transform the physical geography of the world 

and that would, in turn, transform the human geography. It would involve massive 

dislocation and in all probability conflict. The final reason for refusing to act is that 

such risks and their impacts will happen a long way into the future, and we have 

little interest in what happens in the future. Many would find this argument ethically untenable. 

We have an understanding of the case for action, of the scale of action necessary, 

and of the economic policies to deliver this action. However, the scale of the response will have to increase dramatically in the coming decades. A shared vision 

of the goals for long-term climate polices will provide an essential reference point 

for the development of international and national policy. 

If we are to stabilise at 550ppm CO2e or below, reducing the risks of very high 

temperature increases, global emissions must peak in the next 10-20 years. Now is 

the time to act: urgently, strongly and internationally. Strong leadership from the 

U.S. is of the utmost importance in this endeavour. 
13

The full report of the Stern Review on the Economics of Climate Change is published by Cambridge University press and is available to download for free, along 

with supporting material and more recent papers, at www.sternreview.org.uk. 

Also available from this site is the 30 page executive summary, frequently asked 

questions, papers published since the launch and supporting commissioned research. 

STERN REVIEW: THE ECONOMICS OF CLIMATE CHANGE

EXECUTIVE SUMMARY

The scientific evidence is now overwhelming: climate change presents very serious 

global risks, and it demands an urgent global response. 

This independent Review was commissioned by the Chancellor of the Exchequer, 

reporting to both the Chancellor and to the Prime Minister, as a contribution to assessing the evidence and building understanding of the economics of climate change. 

The Review first examines the evidence on the economic impacts of climate 

change itself, and explores the economics of stabilising greenhouse gases in the atmosphere. The second half of the Review considers the complex policy challenges involved in managing the transition to a low-carbon economy and in ensuring that societies can adapt to the consequences of climate change that can no longer be avoided. 

The Review takes an international perspective. Climate change is global in its 

causes and consequences, and international collective action will be critical in driving an effective, efficient and equitable response on the scale required. This response will require deeper international co-operation in many areas—most notably 

in creating price signals and markets for carbon, spurring technology research, development and deployment, and promoting adaptation, particularly for developing 

countries. 

Climate change presents a unique challenge for economics: it is the greatest and 

widest-ranging market failure ever seen. The economic analysis must therefore be 

global, deal with long time horizons, have the economics of risk and uncertainty at 

centre stage, and examine the possibility of major, non-marginal change. To meet 

these requirements, the Review draws on ideas and techniques from most of the important areas of economics, including many recent advances. 

The Benefits of Strong, Early Action on Climate Change Outweigh the Costs. 

The effects of our actions now on future changes in the climate have long lead 

times. What we do now can have only a limited effect on the climate over the next 

40 or 50 years. On the other hand what we do in the next 10 or 20 years can have 

a profound effect on the climate in the second half of this century and in the next. 

No-one can predict the consequences of climate change with complete certainty; 

but we now know enough to understand the risks. Mitigation—taking strong action 

to reduce emissions—must be viewed as an investment, a cost incurred now and in 

the coming few decades to avoid the risks of very severe consequences in the future. 

If these investments are made wisely, the costs will be manageable, and there will 

be a wide range of opportunities for growth and development along the way. For 

this to work well, policy must promote sound market signals, overcome market failures and have equity and risk mitigation at its core. That essentially is the conceptual framework of this Review. 

The Review considers the economic costs of the impacts of climate change, and 

the costs and benefits of action to reduce the emissions of greenhouse gases (GHGs) 

that cause it, in three different ways:

• Using disaggregated techniques, in other words considering the physical impacts of climate change on the economy, on human life and on the environment, 

and examining the resource costs of different technologies and strategies to reduce greenhouse gas emissions; 

• Using economic models, including integrated assessment models that estimate 

the economic impacts of climate change, and macro-economic models that represent the costs and effects of the transition to low-carbon energy systems for 

the economy as a whole; 

• Using comparisons of the current level and future trajectories of the ’social cost 

of carbon’ (the cost of impacts associated with an additional unit of greenhouse 

gas emissions) with the marginal abatement cost (the costs associated with incremental reductions in units of emissions).

From all of these perspectives, the evidence gathered by the Review leads to a 

simple conclusion: the benefits of strong, early action considerably outweigh the 

costs. 
14

* Graphic has been retained in committee files. 

1 Referred to hereafter as CO2 equivalent, CO2e. 

The evidence shows that ignoring climate change will eventually damage economic growth. Our actions over the coming few decades could create risks of major 

disruption to economic and social activity, later in this century and in the next, on 

a scale similar to those associated with the great wars and the economic depression 

of the first half of the 20th century. And it will be difficult or impossible to reverse 

these changes. Tackling climate change is the pro-growth strategy for the longer 

term, and it can be done in a way that does not cap the aspirations for growth of 

rich or poor countries. The earlier effective action is taken, the less costly it will 

be. 

At the same time, given that climate change is happening, measures to help people adapt to it are essential. And the less mitigation we do now, the greater the 

difficulty of continuing to adapt in future. 

The first half of the Review considers how the evidence on the economic impacts 

of climate change, and on the costs and benefits of action to reduce greenhouse gas 

emissions, relates to the conceptual framework described above. 

The Scientific Evidence Points to Increasing Risks of Serious, Irreversible Impacts 

From Climate Change Associated With Business-As-Usual (BAU) Paths for 

Emissions. 

The scientific evidence on the causes and future paths of climate change is 

strengthening all the time. In particular, scientists are now able to attach probabilities to the temperature outcomes and impacts on the natural environment associated with different levels of stabilisation of greenhouse gases in the atmosphere. 

Scientists also now understand much more about the potential for dynamic 

feedbacks that have, in previous times of climate change, strongly amplified the underlying physical processes. 

The stocks of greenhouse gases in the atmosphere (including carbon dioxide, 

methane, nitrous oxides and a number of gases that arise from industrial processes) 

are rising, as a result of human activity. The sources are summarised in Figure 1 

below.* 

The current level or stock of greenhouse gases in the atmosphere is equivalent 

to around 430 parts per million (ppm) CO2

1, compared with only 280ppm before the 

Industrial Revolution. These concentrations have already caused the world to warm 

by more than half a degree Celsius and will lead to at least a further half degree 

warming over the next few decades, because of the inertia in the climate system. 

Even if the annual flow of emissions did not increase beyond today’s rate, the 

stock of greenhouse gases in the atmosphere would reach double pre-industrial levels by 2050—that is 550ppm CO2e—and would continue growing thereafter. But the 

annual flow of emissions is accelerating, as fast-growing economies invest in highcarbon infrastructure and as demand for energy and transport increases around the 

world. The level of 550ppm CO2e could be reached as early as 2035. At this level 

there is at least a 77% chance—and perhaps up to a 99% chance, depending on the 

climate model used—of a global average temperature rise exceeding 2 degrees C. 

Under a BAU scenario, the stock of greenhouse gases could more than treble by 

the end of the century, giving at least a 50% risk of exceeding 5 degrees C global 

average temperature change during the following decades. This would take humans 

into unknown territory. An illustration of the scale of such an increase is that we 

are now only around 5 degrees C warmer than in the last ice age. 

Such changes would transform the physical geography of the world. A radical 

change in the physical geography of the world must have powerful implications for 

the human geography—where people live, and how they live their lives. 

Figure 2* summarises the scientific evidence of the links between concentrations 

of greenhouse gases in the atmosphere, the probability of different levels of global 

average temperature change, and the physical impacts expected for each level. The 

risks of serious, irreversible impacts of climate change increase strongly as concentrations of greenhouse gases in the atmosphere rise. 

Climate Change Threatens the Basic Elements of Life for People Around the World—

Access to Water, Food Production, Health, and Use of Land and the Environment. 

Estimating the economic costs of climate change is challenging, but there is a 

range of methods or approaches that enable us to assess the likely magnitude of the 

risks and compare them with the costs. This Review considers three of these approaches. 
15

2 All changes in global mean temperature are expressed relative to pre-industrial levels (1750-

1850). 

This Review has first considered in detail the physical impacts on economic activity, on human life and on the environment. 

On current trends, average global temperatures will rise by 2-3 degrees C within 

the next fifty years or so.2 The Earth will be committed to several degrees more 

warming if emissions continue to grow. 

Warming will have many severe impacts, often mediated through water:

• Melting glaciers will initially increase flood risk and then strongly reduce water 

supplies, eventually threatening one-sixth of the world’s population, predominantly in the Indian sub-continent, parts of China, and the Andes in South 

America. • Declining crop yields, especially in Africa, could leave hundreds of millions 

without the ability to produce or purchase sufficient food. At mid to high latitudes, crop yields may increase for moderate temperature rises (2-3 degrees C), 

but then decline with greater amounts of warming. At 4 degrees C and above, 

global food production is likely to be seriously affected. • In higher latitudes, cold-related deaths will decrease. But climate change will 

increase worldwide deaths from malnutrition and heat stress. Vector-borne diseases such as malaria and dengue fever could become more widespread if effective control measures are not in place. • Rising sea levels will result in tens to hundreds of millions more people flooded 

each year with warming of 3 or 4 degrees C. There will be serious risks and 

increasing pressures for coastal protection in South East Asia (Bangladesh and 

Vietnam), small islands in the Caribbean and the Pacific, and large coastal cities, such as Tokyo, New York, Cairo and London. According to one estimate, by 

the middle of the century, 200 million people may become permanently displaced due to rising sea levels, heavier floods, and more intense droughts. • Ecosystems will be particularly vulnerable to climate change, with around 15-

40% of species potentially facing extinction after only 2 degrees C of warming. 

And ocean acidification, a direct result of rising carbon dioxide levels, will have 

major effects on marine ecosystems, with possible adverse consequences on fish 

stocks. 

The Damages From Climate Change Will Accelerate as the World Gets Warmer. 

Higher temperatures will increase the chance of triggering abrupt and large-scale 

changes.

• Warming may induce sudden shifts in regional weather patterns such as the 

monsoon rains in South Asia or the El Nin ̃ o phenomenon—changes that would 

have severe consequences for water availability and flooding in tropical regions 

and threaten the livelihoods of millions of people. • A number of studies suggest that the Amazon rainforest could be vulnerable to 

climate change, with models projecting significant drying in this region. One 

model, for example, finds that the Amazon rainforest could be significantly, and 

possibly irrevocably, damaged by a warming of 2-3 degrees C. • The melting or collapse of ice sheets would eventually threaten land which 

today is home to 1 in every 20 people.

While there is much to learn about these risks, the temperatures that may result 

from unabated climate change will take the world outside the range of human experience. This points to the possibility of very damaging consequences. 

The Impacts of Climate Change Are Not Evenly Distributed—The Poorest Countries 

and People Will Suffer Earliest and Most. And If and When The Damages Appear It Will Be Too Late To Reverse the Process. Thus We Are Forced To Look 

a Long Way Ahead. 

Climate change is a grave threat to the developing world and a major obstacle 

to continued poverty reduction across its many dimensions. First, developing regions 

are at a geographic disadvantage: they are already warmer, on average, than developed regions, and they also suffer from high rainfall variability. As a result, further 

warming will bring poor countries high costs and few benefits. Second, developing 

countries—in particular the poorest—are heavily dependent on agriculture, the most 

climate-sensitive of all economic sectors, and suffer from inadequate health provision and low-quality public services. Third, their low incomes and vulnerabilities 

make adaptation to climate change particularly difficult. 

Because of these vulnerabilities, climate change is likely to reduce further already 

low incomes and increase illness and death rates in developing countries. Falling 
16

farm incomes will increase poverty and reduce the ability of households to invest 

in a better future, forcing them to use up meagre savings just to survive. At a national level, climate change will cut revenues and raise spending needs, worsening 

public finances. 

Many developing countries are already struggling to cope with their current climate. Climatic shocks cause setbacks to economic and social development in developing countries today even with temperature increases of less than 1 degree C. The 

impacts of unabated climate change—that is, increases of 3 or 4 degrees C and upwards—will be to increase the risks and costs of these events very powerfully. 

Impacts on this scale could spill over national borders, exacerbating the damage 

further. Rising sea levels and other climate-driven changes could drive millions of 

people to migrate: more than a fifth of Bangladesh could be under water with a 1 

m rise in sea levels, which is a possibility by the end of the century. Climate-related 

shocks have sparked violent conflict in the past, and conflict is a serious risk in 

areas such as West Africa, the Nile Basin and Central Asia. 

Climate Change May Initially Have Small Positive Effects for a Few Developed 

Countries, but Is Likely To Be Very Damaging for the Much Higher Temperature 

Increases Expected by Mid- to Late-Century Under BAU Scenarios. 

In higher latitude regions, such as Canada, Russia and Scandinavia, climate 

change may lead to net benefits for temperature increases of 2 or 3 degrees C, 

through higher agricultural yields, lower winter mortality, lower heating requirements, and a possible boost to tourism. But these regions will also experience the 

most rapid rates of warming, damaging infrastructure, human health, local livelihoods and biodiversity. 

Developed countries in lower latitudes will be more vulnerable—for example, 

water availability and crop yields in southern Europe are expected to decline by 20% 

with a 2 degrees C increase in global temperatures. Regions where water is already 

scarce will face serious difficulties and growing costs. 

The increased costs of damage from extreme weather (storms, hurricanes, typhoons, floods, droughts, and heat waves) counteract some early benefits of climate 

change and will increase rapidly at higher temperatures. Based on simple extrapolations, costs of extreme weather alone could reach 0.5-1% of world GDP per annum 

by the middle of the century, and will keep rising if the world continues to warm.

• A 5 or 10% increase in hurricane wind speed, linked to rising sea temperatures, 

is predicted approximately to double annual damage costs, in the U.S. 

• In the U.K., annual flood losses alone could increase from 0.1% of GDP today 

to 0.2-0.4% of GDP once the increase in global average temperatures reaches 

3 or 4 degrees C. 

• Heat waves like that experienced in 2003 in Europe, when 35,000 people died 

and agricultural losses reached $15 billion, will be commonplace by the middle 

of the century.

At higher temperatures, developed economies face a growing risk of large-scale 

shocks—for example, the rising costs of extreme weather events could affect global 

financial markets through higher and more volatile costs of insurance. 

Integrated Assessment Models Provide A Tool for Estimating the Total Impact on the 

Economy; Our Estimates Suggest That This Is Likely To Be Higher Than Previously Suggested. 

The second approach to examining the risks and costs of climate change adopted 

in the Review is to use integrated assessment models to provide aggregate monetary 

estimates. 

Formal modelling of the overall impact of climate change in monetary terms is 

a formidable challenge, and the limitations to modelling the world over two centuries or more demand great caution in interpreting results. However, as we have 

explained, the lags from action to effect are very long and the quantitative analysis 

needed to inform action will depend on such long-range modelling exercises. The 

monetary impacts of climate change are now expected to be more serious than many 

earlier studies suggested, not least because those studies tended to exclude some of 

the most uncertain but potentially most damaging impacts. Thanks to recent advances in the science, it is now possible to examine these risks more directly, using 

probabilities. 

Most formal modelling in the past has used as a starting point a scenario of 2-

3 degrees C warming. In this temperature range, the cost of climate change could 

be equivalent to a permanent loss of around 0-3% in global world output compared 

with what could have been achieved in a world without climate change. Developing 

countries will suffer even higher costs. 
17

However, those earlier models were too optimistic about warming: more recent 

evidence indicates that temperature changes resulting from BAU trends in emissions may exceed 2-3 degrees C by the end of this century. This increases the likelihood of a wider range of impacts than previously considered. Many of these impacts, 

such as abrupt and large-scale climate change, are more difficult to quantify. With 

5-6 degrees C warming—which is a real possibility for the next century—existing 

models that include the risk of abrupt and large-scale climate change estimate an 

average 5-10% loss in global GDP, with poor countries suffering costs in excess of 

10% of GDP. Further, there is some evidence of small but significant risks of temperature rises even above this range. Such temperature increases would take us into 

territory unknown to human experience and involve radical changes in the world 

around us. 

With such possibilities on the horizon, it was clear that the modelling framework 

used by this Review had to be built around the economics of risk. Averaging across 

possibilities conceals risks. The risks of outcomes much worse than expected are 

very real and they could be catastrophic. Policy on climate change is in large measure about reducing these risks. They cannot be fully eliminated, but they can be 

substantially reduced. Such a modelling framework has to take into account ethical 

judgements on the distribution of income and on how to treat future generations. 

The analysis should not focus only on narrow measures of income like GDP. The 

consequences of climate change for health and for the environment are likely to be 

severe. Overall comparison of different strategies will include evaluation of these 

consequences too. Again, difficult conceptual, ethical and measurement issues are 

involved, and the results have to be treated with due circumspection. 

The Review uses the results from one particular model, PAGE2002, to illustrate 

how the estimates derived from these integrated assessment models change in response to updated scientific evidence on the probabilities attached to degrees of temperature rise. The choice of model was guided by our desire to analyse risks explicitly—this is one of the very few models that would allow that exercise. Further, its 

underlying assumptions span the range of previous studies. We have used this 

model with one set of data consistent with the climate predictions of the 2001 report 

of the Intergovernmental Panel on Climate Change, and with one set that includes 

a small increase in the amplifying feedbacks in the climate system. This increase 

illustrates one area of the increased risks of climate change that have appeared in 

the peer-reviewed scientific literature published since 2001. 

We have also considered how the application of appropriate discount rates, assumptions about the equity weighting attached to the valuation of impacts in poor 

countries, and estimates of the impacts on mortality and the environment would increase the estimated economic costs of climate change. 

Using this model, and including those elements of the analysis that can be incorporated at the moment, we estimate the total cost over the next two centuries of 

climate change associated under BAU emissions involves impacts and risks that are 

equivalent to an average reduction in global per-capita consumption of at least 5%, 

now and forever. While this cost estimate is already strikingly high, it also leaves 

out much that is important. 

The cost of BAU would increase still further, were the model systematically to 

take account of three important factors:

• First, including direct impacts on the environment and human health (sometimes called ‘non-market’ impacts) increases our estimate of the total cost of climate change on this path from 5% to 11% of global per-capita consumption. 

There are difficult analytical and ethical issues of measurement here. The 

methods used in this model are fairly conservative in the value they assign to 

these impacts. 

• Second, some recent scientific evidence indicates that the climate system may 

be more responsive to greenhouse-gas emissions than previously thought, for example because of the existence of amplifying feedbacks such as the release of 

methane and weakening of carbon sinks. Our estimates, based on modelling a 

limited increase in this responsiveness, indicate that the potential scale of the 

climate response could increase the cost of climate change on the BAU path 

from 5% to 7% of global consumption, or from 11% to 14% if the non-market 

impacts described above are included. 

• Third, a disproportionate share of the climate-change burden falls on poor regions of the world. If we weight this unequal burden appropriately, the estimated global cost of climate change at 5-6 degrees C warming could be more 

than one-quarter higher than without such weights.
18

* Graphic has been retained in committee files. 

Putting these additional factors together would increase the total cost of BAU climate change to the equivalent of around a 20% reduction in consumption per head, 

now and into the future. 

In summary, analyses that take into account the full ranges of both impacts and 

possible outcomes—that is, that employ the basic economics of risk—suggest that 

BAU climate change will reduce welfare by an amount equivalent to a reduction in 

consumption per head of between 5 and 20%. Taking account of the increasing scientific evidence of greater risks, of aversion to the possibilities of catastrophe, and 

of a broader approach to the consequences than implied by narrow output measures, 

the appropriate estimate is likely to be in the upper part of this range. 

Economic forecasting over just a few years is a difficult and imprecise task. The 

analysis of climate change requires, by its nature, that we look out over 50, 100, 

200 years and more. Any such modelling requires caution and humility, and the results are specific to the model and its assumptions. They should not be endowed 

with a precision and certainty that is simply impossible to achieve. Further, some 

of the big uncertainties in the science and the economics concern the areas we know 

least about (for example, the impacts of very high temperatures), and for good reason—this is unknown territory. The main message from these models is that when 

we try to take due account of the upside risks and uncertainties, the probabilityweighted costs look very large. Much (but not all) of the risk can be reduced through 

a strong mitigation policy, and we argue that this can be achieved at a far lower 

cost than those calculated for the impacts. In this sense, mitigation is a highly productive investment. 

Emissions Have Been, and Continue To Be, Driven by Economic Growth; Yet 

Stabilisation of Greenhouse-Gas Concentrations in the Atmosphere Is Feasible 

and Consistent With Continued Growth. 

CO2 emissions per head have been strongly correlated with GDP per head. As a 

result, since 1850, North America and Europe have produced around 70% of all the 

CO2 emissions due to energy production, while developing countries have accounted 

for less than one quarter. Most future emissions growth will come from today’s developing countries, because of their more rapid population and GDP growth and 

their increasing share of energy-intensive industries. 

Yet despite the historical pattern and the BAU projections, the world does not 

need to choose between averting climate change and promoting growth and development. Changes in energy technologies and the structure of economies have reduced 

the responsiveness of emissions to income growth, particularly in some of the richest 

countries. With strong, deliberate policy choices, it is possible to ‘decarbonise’ both 

developed and developing economies on the scale required for climate stabilisation, 

while maintaining economic growth in both. 

Stabilisation—at whatever level—requires that annual emissions be brought down 

to the level that balances the Earth’s natural capacity to remove greenhouse gases 

from the atmosphere. The longer emissions remain above this level, the higher the 

final stabilisation level. In the long term, annual global emissions will need to be 

reduced to below 5 GtCO2e, the level that the earth can absorb without adding to 

the concentration of GHGs in the atmosphere. This is more than 80% below the absolute level of current annual emissions. 

This Review has focused on the feasibility and costs of stabilisation of greenhouse 

gas concentrations in the atmosphere in the range of 450-550ppm CO2e. Stabilising at or below 550ppm CO2e would require global emissions to peak in 

the next 10—20 years, and then fall at a rate of at least 1—3% per year. The range 

of paths is illustrated in Figure 3.* By 2050, global emissions would need to be 

around 25% below current levels. These cuts will have to be made in the context 

of a world economy in 2050 that may be 3—4 times larger than today—so emissions 

per unit of GDP would need to be just one quarter of current levels by 2050. 

To stabilise at 450ppm CO2e, without overshooting, global emissions would need 

to peak in the next 10 years and then fall at more than 5% per year, reaching 70% 

below current levels by 2050. 

Theoretically it might be possible to ‘‘overshoot’’ by allowing the atmospheric GHG 

concentration to peak above the stabilisation level and then fall, but this would be 

both practically very difficult and very unwise. Overshooting paths involve greater 

risks, as temperatures will also rise rapidly and peak at a higher level for many 

decades before falling back down. Also, overshooting requires that emissions subsequently be reduced to extremely low levels, below the level of natural carbon absorption, which may not be feasible. Furthermore, if the high temperatures were to 

weaken the capacity of the Earth to absorb carbon—as becomes more likely with 
19

overshooting—future emissions would need to be cut even more rapidly to hit any 

given stabilisation target for atmospheric concentration. 

Achieving These Deep Cuts in Emissions Will Have a Cost—The Review Estimates 

the Annual Costs of Stabilisation at 500-550ppm CO2e To Be Around 1% of GDP 

by 2050—A Level That Is Significant but Manageable. 

Reversing the historical trend in emissions growth, and achieving cuts of 25% or 

more against today’s levels is a major challenge. Costs will be incurred as the world 

shifts from a high-carbon to a low-carbon trajectory. But there will also be business 

opportunities as the markets for low-carbon, high-efficiency goods and services expand. 

Greenhouse-gas emissions can be cut in four ways. Costs will differ considerably 

depending on which combination of these methods is used, and in which sector:

• Reducing demand for emissions-intensive goods and services; 

• Increased efficiency, which can save both money and emissions; 

• Action on non-energy emissions, such as avoiding deforestation; 

• Switching to lower-carbon technologies for power, heat and transport.

Estimating the costs of these changes can be done in two ways. One is to look 

at the resource costs of measures, including the introduction of low-carbon technologies and changes in land use, compared with the costs of the BAU alternative. 

This provides an upper bound on costs, as it does not take account of opportunities 

to respond involving reductions in demand for high-carbon goods and services. 

The second is to use macroeconomic models to explore the system-wide effects of 

the transition to a low-carbon energy economy. These can be useful in tracking the 

dynamic interactions of different factors over time, including the response of economies to changes in prices. But they can be complex, with their results affected by 

a whole range of assumptions. 

On the basis of these two methods, central estimate is that stabilisation of greenhouse gases at levels of 500-550ppm CO2e will cost, on average, around 1% of annual global GDP by 2050. This is significant, but is fully consistent with continued 

growth and development, in contrast with unabated climate change, which will 

eventually pose significant threats to growth. 

Resource Cost Estimates Suggest That an Upper Bound for the Expected Annual Cost 

of Emissions Reductions Consistent With a Trajectory Leading To Stabilisation 

at 550PPM CO2e Is Likely To Be Around 1% of GDP by 2050. 

This Review has considered in detail the potential for, and costs of, technologies 

and measures to cut emissions across different sectors. As with the impacts of climate change, this is subject to important uncertainties. These include the difficulties of estimating the costs of technologies several decades into the future, as well 

as the way in which fossil-fuel prices evolve in the future. It is also hard to know 

how people will respond to price changes. 

The precise evolution of the mitigation effort, and the composition across sectors 

of emissions reductions, will therefore depend on all these factors. But it is possible 

to make a central projection of costs across a portfolio of likely options, subject to 

a range. 

The technical potential for efficiency improvements to reduce emissions and costs 

is substantial. Over the past century, efficiency in energy supply improved ten-fold 

or more in developed countries, and the possibilities for further gains are far from 

being exhausted. Studies by the International Energy Agency show that, by 2050, 

energy efficiency has the potential to be the biggest single source of emissions savings in the energy sector. This would have both environmental and economic benefits: energy-efficiency measures cut waste and often save money. 

Non-energy emissions make up one-third of total greenhouse-gas emissions; action 

here will make an important contribution. A substantial body of evidence suggests 

that action to prevent further deforestation would be relatively cheap compared with 

other types of mitigation, if the right policies and institutional structures are put 

in place. 

Large-scale uptake of a range of clean power, heat, and transport technologies is 

required for radical emission cuts in the medium- to long-term. The power sector 

around the world will have to be least 60%, and perhaps as much as 75%, 

decarbonised by 2050 to stabilise at or below 550ppm CO2e. Deep cuts in the transport sector are likely to be more difficult in the shorter term, but will ultimately 

be needed. While many of the technologies to achieve this already exist, the priority 

is to bring down their costs so that they are competitive with fossil-fuel alternatives 

under a carbon-pricing policy regime. 
20

* Graphic has been retained in committee files. 

A portfolio of technologies will be required to stabilise emissions. It is highly unlikely that any single technology will deliver all the necessary emission savings, because all technologies are subject to constraints of some kind, and because of the 

wide range of activities and sectors that generate greenhouse-gas emissions. It is 

also uncertain which technologies will turn out to be cheapest. Hence a portfolio will 

be required for low-cost abatement. 

The shift to a low-carbon global economy will take place against the background 

of an abundant supply of fossil fuels. That is to say, the stocks of hydrocarbons that 

are profitable to extract (under current policies) are more than enough to take the 

world to levels of greenhouse-gas concentrations well beyond 750ppm CO2e, with 

very dangerous consequences. Indeed, under BAU, energy users are likely to switch 

towards more carbon-intensive coal and oil shales, increasing rates of emissions 

growth. 

Even with very strong expansion of the use of renewable energy and other lowcarbon energy sources, hydrocarbons may still make over half of global energy supply in 2050. Extensive carbon capture and storage would allow this continued use 

of fossil fuels without damage to the atmosphere, and also guard against the danger 

of strong climate-change policy being undermined at some stage by falls in fossilfuel prices. 

Estimates based on the likely costs of these methods of emissions reduction show 

that the annual costs of stabilising at around 550ppm CO2e are likely to be around 

1% of global GDP by 2050, with a range from 1% (net gains) to ∂3.5% of GDP. 

Looking at Broader Macroeconomic Models Confirms These Estimates. 

The second approach adopted by the Review was based comparisons of a broad 

range of macro-economic model estimates (such as that presented in Figure 4* 

below). This comparison found that the costs for stabilisation at 500-550ppm CO2e 

were centred on 1% of GDP by 2050, with a range of 2% to ∂5% of GDP. The range 

reflects a number of factors, including the pace of technological innovation and the 

efficiency with which policy is applied across the globe: the faster the innovation 

and the greater the efficiency, the lower the cost. These factors can be influenced 

by policy. 

The average expected cost is likely to remain around 1% of GDP from mid-century, but the range of estimates around the 1% diverges strongly thereafter, with 

some falling and others rising sharply by 2100, reflecting the greater uncertainty 

about the costs of seeking out ever more innovative methods of mitigation. 

Stabilisation at 450ppm CO2e is already almost out of reach, given that we are 

likely to reach this level within ten years and that there are real difficulties of making the sharp reductions required with current and foreseeable technologies. Costs 

rise significantly as mitigation efforts become more ambitious or sudden. Efforts to 

reduce emissions rapidly are likely to be very costly. 

An important corollary is that there is a high price to delay. Delay in taking action on climate change would make it necessary to accept both more climate change 

and, eventually, higher mitigation costs. Weak action in the next 10-20 years would 

put stabilisation even at 550ppm CO2e beyond reach—and this level is already associated with significant risks. 

The Transition to a Low-Carbon Economy Will Bring Challenges for Competitiveness 

but Also Opportunities for Growth. 

Costs of mitigation of around 1% of GDP are small relative to the costs and risks 

of climate change that will be avoided. However, for some countries and some sectors, the costs will be higher. There may be some impacts on the competitiveness 

of a small number of internationally traded products and processes. These should 

not be overestimated, and can be reduced or eliminated if countries or sectors act 

together; nevertheless, there will be a transition to be managed. For the economy 

as a whole, there will be benefits from innovation that will offset some of these 

costs. All economies undergo continuous structural change; the most successful 

economies are those that have the flexibility and dynamism to embrace the change. 

There are also significant new opportunities across a wide range of industries and 

services. Markets for low-carbon energy products are likely to be worth at least $500 

bn per year by 2050, and perhaps much more. Individual companies and countries 

should position themselves to take advantage of these opportunities. 

Climate-change policy can help to root out existing inefficiencies. At the company 

level, implementing climate policies may draw attention to money-saving opportunities. At the economy-wide level, climate-change policy may be a lever for reforming 
21

inefficient energy systems and removing distorting energy subsidies, on which governments around the world currently spend around $250bn a year. 

Policies on climate change can also help to achieve other objectives. These co-benefits can significantly reduce the overall cost to the economy of reducing greenhousegas emissions. If climate policy is designed well, it can, for example, contribute to 

reducing ill-health and mortality from air pollution, and to preserving forests that 

contain a significant proportion of the world’s biodiversity. 

National objectives for energy security can also be pursued alongside climate 

change objectives. Energy efficiency and diversification of energy sources and supplies support energy security, as do clear long-term policy frameworks for investors 

in power generation. Carbon capture and storage is essential to maintain the role 

of coal in providing secure and reliable energy for many economies. 

Reducing the Expected Adverse Impacts of Climate Change Is Therefore Both Highly 

Desirable and Feasible. 

This conclusion follows from a comparison of the above estimates of the costs of 

mitigation with the high costs of inaction described from our first two methods (the 

aggregated and the disaggregated) of assessing the risks and costs of climate change 

impacts. 

The third approach to analysing the costs and benefits of action on climate change 

adopted by this Review compares the marginal costs of abatement with the social 

cost of carbon. This approach compares estimates of the changes in the expected 

benefits and costs over time from a little extra reduction in emissions, and avoids 

large-scale formal economic models. 

Preliminary calculations adopting the approach to valuation taken in this Review 

suggest that the social cost of carbon today, if we remain on a BAU trajectory, is 

of the order of $85 per tonne of CO2—higher than typical numbers in the literature, 

largely because we treat risk explicitly and incorporate recent evidence on the risks, 

but nevertheless well within the range of published estimates. This number is well 

above marginal abatement costs in many sectors. Comparing the social costs of carbon on a BAU trajectory and on a path towards stabilisation at 550ppm CO2e, we 

estimate the excess of benefits over costs, in net present value terms, from implementing strong mitigation policies this year, shifting the world onto the better path: 

the net benefits would be of the order of $2.5 trillion. This figure will increase over 

time. This is not an estimate of net benefits occurring in this year, but a measure 

of the benefits that could flow from actions taken this year; many of the costs and 

benefits would be in the medium to long term. 

Even if we have sensible policies in place, the social cost of carbon will also rise 

steadily over time, making more and more technological options for mitigation costeffective. This does not mean that consumers will always face rising prices for the 

goods and services that they currently enjoy, as innovation driven by strong policy 

will ultimately reduce the carbon intensity of our economies, and consumers will 

then see reductions in the prices that they pay as low-carbon technologies mature. 

The three approaches to the analysis of the costs of climate change used in the 

Review all point to the desirability of strong action, given estimates of the costs of 

action on mitigation. But how much action? The Review goes on to examine the economics of this question. 

The current evidence suggests aiming for stabilisation somewhere within the 

range 450—550ppm CO2e. Anything higher would substantially increase the risks 

of very harmful impacts while reducing the expected costs of mitigation by comparatively little. Aiming for the lower end of this range would mean that the costs of 

mitigation would be likely to rise rapidly. Anything lower would certainly impose 

very high adjustment costs in the near term for small gains and might not even be 

feasible, not least because of past delays in taking strong action. 

Uncertainty is an argument for a more, not less, demanding goal, because of the 

size of the adverse climate-change impacts in the worst-case scenarios. 

The ultimate concentration of greenhouse gases determines the trajectory for estimates of the social cost of carbon; these also reflect the particular ethical judgements and approach to the treatment of uncertainty embodied in the modelling. Preliminary work for this Review suggests that, if the target were between 450-550ppm 

CO2e, then the social cost of carbon would start in the region of $25-30 per tonne 

of CO2—around one third of the level if the world stays with BAU. 

The social cost of carbon is likely to increase steadily over time because marginal 

damages increase with the stock of GHGs in the atmosphere, and that stock rises 

over time. Policy should therefore ensure that abatement efforts at the margin also 

intensify over time. But it should also foster the development of technology that can 

drive down the average costs of abatement; although pricing carbon, by itself, will 
22

not be sufficient to bring forth all the necessary innovation, particularly in the early 

years. 

The first half of the Review therefore demonstrates that strong action on climate 

change, including both mitigation and adaptation, is worthwhile, and suggests appropriate goals for climate-change policy. 

The second half of the Review examines the appropriate form of such policy, and 

how it can be placed within a framework of international collective action. 

Policy To Reduce Emissions Should Be Based on Three Essential Elements: Carbon 

Pricing, Technology Policy, and Removal of Barriers to Behavioural Change. 

There are complex challenges in reducing greenhouse-gas emissions. Policy frameworks must deal with long time horizons and with interactions with a range of other 

market imperfections and dynamics. 

A shared understanding of the long-term goals for stabilisation is a crucial guide 

to policy-making on climate change: it narrows down strongly the range of acceptable emissions paths. But from year to year, flexibility in what, where and when 

reductions are made will reduce the costs of meeting these stabilisation goals. 

Policies should adapt to changing circumstances as the costs and benefits of responding to climate change become clearer over time. They should also build on diverse national conditions and approaches to policy-making. But the strong links between current actions and the long-term goal should be at the forefront of policy. 

Three elements of policy for mitigation are essential: a carbon price, technology 

policy, and the removal of barriers to behavioural change. Leaving out any one of 

these elements will significantly increase the costs of action. 

Establishing a Carbon Price, Through Tax, Trading or Regulation, Is an Essential 

Foundation for Climate-Change Policy. 

The first element of policy is carbon pricing. Greenhouse gases are, in economic 

terms, an externality: those who produce greenhouse-gas emissions are bringing 

about climate change, thereby imposing costs on the world and on future generations, but they do not face the full consequences of their actions themselves. 

Putting an appropriate price on carbon—explicitly through tax or trading, or implicitly through regulation—means that people are faced with the full social cost of 

their actions. This will lead individuals and businesses to switch away from highcarbon goods and services, and to invest in low-carbon alternatives. Economic efficiency points to the advantages of a common global carbon price: emissions reductions will then take place wherever they are cheapest. 

The choice of policy tool will depend on countries’ national circumstances, on the 

characteristics of particular sectors, and on the interaction between climate-change 

policy and other policies. Policies also have important differences in their consequences for the distribution of costs across individuals, and their impact on the 

public finances. Taxation has the advantage of delivering a steady flow of revenue, 

while, in the case of trading, increasing the use of auctioning is likely to have strong 

benefits for efficiency, for distribution and for the public finances. Some administrations may choose to focus on trading initiatives, others on taxation or regulation, 

and others on a mix of policies. And their choices may vary across sectors. 

Trading schemes can be an effective way to equalise carbon prices across countries and sectors, and the EU Emissions Trading Scheme is now the centrepiece of 

European efforts to cut emissions. To reap the benefits of emissions trading, 

schemes must provide incentives for a flexible and efficient response. Broadening 

the scope of trading schemes will tend to lower costs and reduce volatility. Clarity 

and predictability about the future rules and shape of schemes will help to build 

confidence in a future carbon price. 

In order to influence behaviour and investment decisions, investors and consumers must believe that the carbon price will be maintained into the future. This 

is particularly important for investments in long-lived capital stock. Investments 

such as power stations, buildings, industrial plants and aircraft last for many decades. If there is a lack of confidence that climate change policies will persist, then 

businesses may not factor a carbon price into their decision-making. The result may 

be overinvestment in long-lived, high-carbon infrastructure—which will make emissions cuts later on much more expensive and difficult. 

But establishing credibility takes time. The next 10 to 20 years will be a period 

of transition, from a world where carbon-pricing schemes are in their infancy, to one 

where carbon pricing is universal and is automatically factored into decision making. In this transitional period, while the credibility of policy is still being established and the international framework is taking shape, it is critical that governments consider how to avoid the risks of locking into a high-carbon infrastructure, 
23

* Graphic has been retained in committee files. 

including considering whether any additional measures may be justified to reduce 

the risks. 

Policies Are Required To Support the Development of a Range of Low-Carbon and 

High-Efficiency Technologies on an Urgent Timescale. 

The second element of climate-change policy is technology policy, covering the full 

spectrum from research and development, to demonstration and early stage deployment. The development and deployment of a wide range of low-carbon technologies 

is essential in achieving the deep cuts in emissions that are needed. The private sector plays the major role in R&D and technology diffusion, but closer collaboration 

between government and industry will further stimulate the development of a broad 

portfolio of low carbon technologies and reduce costs. 

Many low-carbon technologies are currently more expensive than the fossil-fuel alternatives. But experience shows that the costs of technologies fall with scale and 

experience, as shown in Figure 5* below. 

Carbon pricing gives an incentive to invest in new technologies to reduce carbon; 

indeed, without it, there is little reason to make such investments. But investing 

in new lower-carbon technologies carries risks. Companies may worry that they will 

not have a market for their new product if carbon-pricing policy is not maintained 

into the future. And the knowledge gained from research and development is a public good; companies may under-invest in projects with a big social payoff if they fear 

they will be unable to capture the full benefits. Thus there are good economic reasons to promote new technology directly. 

Public spending on research, development and demonstration has fallen significantly in the last two decades and is now low relative to other industries. There 

are likely to be high returns to a doubling of investments in this area to around 

$20 billion per annum globally, to support the development of a diverse portfolio of 

technologies. 

In some sectors—particularly electricity generation, where new technologies can 

struggle to gain a foothold—policies to support the market for early-stage technologies will be critical. The Review argues that the scale of existing deployment 

incentives worldwide should increase by two to five times, from the current level of 

around $34 billion per annum. Such measures will be a powerful motivation for innovation across the private sector to bring forward the range of technologies needed. 

The Removal of Barriers to Behavioural Change Is a Third Essential Element, One 

That Is Particularly Important in Encouraging the Take-Up of Opportunities for 

Energy Efficiency. 

The third element is the removal of barriers to behavioural change. Even where 

measures to reduce emissions are cost-effective, there may be barriers preventing 

action. These include a lack of reliable information, transaction costs, and 

behavioural and organisational inertia. The impact of these barriers can be most 

clearly seen in the frequent failure to realise the potential for cost-effective energy 

efficiency measures. 

Regulatory measures can play a powerful role in cutting through these complexities, and providing clarity and certainty. Minimum standards for buildings and appliances have proved a cost-effective way to improve performance, where price signals alone may be too muted to have a significant impact. 

Information policies, including labelling and the sharing of best practice, can help 

consumers and businesses make sound decisions, and stimulate competitive markets 

for low-carbon and high-efficiency goods and services. Financing measures can also 

help, through overcoming possible constraints to paying the upfront cost of efficiency 

improvements. 

Fostering a shared understanding of the nature of climate change, and its consequences, is critical in shaping behaviour, as well as in underpinning national and 

international action. Governments can be a catalyst for dialogue through evidence, 

education, persuasion and discussion. Educating those currently at school about climate change will help to shape and sustain future policy-making, and a broad public and international debate will support today’s policy-makers in taking strong action now. 

Adaptation Policy Is Crucial for Dealing With the Unavoidable Impacts of Climate 

Change, but It Has Been Under-Emphasised in Many Countries. 

Adaptation is the only response available for the impacts that will occur over the 

next several decades before mitigation measures can have an effect. 
24

Unlike mitigation, adaptation will in most cases provide local benefits, realised 

without long lead times. Therefore some adaptation will occur autonomously, as individuals respond to market or environmental changes. Some aspects of adaptation, 

such as major infrastructure decisions, will require greater foresight and planning. 

There are also some aspects of adaptation that require public goods delivering global 

benefits, including improved information about the climate system and more climate-resilient crops and technologies. 

Quantitative information on the costs and benefits of economy-wide adaptation is 

currently limited. Studies in climate-sensitive sectors point to many adaptation options that will provide benefits in excess of cost. But at higher temperatures, the 

costs of adaptation will rise sharply and the residual damages remain large. The 

additional costs of making new infrastructure and buildings resilient to climate 

change in OECD countries could be $15-150 billion each year (0.05-0.5% of GDP). 

The challenge of adaptation will be particularly acute in developing countries, 

where greater vulnerability and poverty will limit the capacity to act. As in developed countries, the costs are hard to estimate, but are likely to run into tens of billions of dollars. 

Markets that respond to climate information will stimulate adaptation among individuals and firms. Risk-based insurance schemes, for example, provide strong signals about the size of climate risks and therefore encourage good risk management. 

Governments have a role in providing a policy framework to guide effective adaptation by individuals and firms in the medium and longer term. There are four key 

areas:

• High-quality climate information and tools for risk management will help to 

drive efficient markets. Improved regional climate predictions will be critical, 

particularly for rainfall and storm patterns. 

• Land-use planning and performance standards should encourage both private 

and public investment in buildings and other long-lived infrastructure to take 

account of climate change. 

• Governments can contribute through long-term polices for climate-sensitive 

public goods, including natural resources protection, coastal protection, and 

emergency preparedness. 

• A financial safety net may be required for the poorest in society, who are likely 

to be the most vulnerable to the impacts and least able to afford protection (including insurance).

Sustainable development itself brings the diversification, flexibility and human 

capital which are crucial components of adaptation. Indeed, much adaptation will 

simply be an extension of good development practice—for example, promoting overall development, better disaster management and emergency response. Adaptation 

action should be integrated into development policy and planning at every level. 

An Effective Response to Climate Change Will Depend on Creating the Conditions 

for International Collective Action. 

This Review has identified many actions that communities and countries can take 

on their own to tackle climate change. 

Indeed, many countries, states and companies are already beginning to act. However, the emissions of most individual countries are small relative to the global 

total, and very large reductions are required to stabilise greenhouse gas concentrations in the atmosphere. Climate change mitigation raises the classic problem of the 

provision of a global public good. It shares key characteristics with other environmental challenges that require the international management of common resources 

to avoid free riding. 

The U.N. Framework Convention on Climate Change (UNFCCC), Kyoto Protocol 

and a range of other informal partnerships and dialogues provide a framework that 

supports co-operation, and a foundation from which to build further collective action. 

A shared global perspective on the urgency of the problem and on the long-term 

goals for climate change policy, and an international approach based on multilateral 

frameworks and co-ordinated action, are essential to respond to the scale of the 

challenge. International frameworks for action on climate change should encourage 

and respond to the leadership shown by different countries in different ways, and 

should facilitate and motivate the involvement of all states. They should build on 

the principles of effectiveness, efficiency and equity that have already provided the 

foundations of the existing multilateral framework. 

The need for action is urgent: demand for energy and transportation is growing 

rapidly in many developing countries, and many developed countries are also due 

to renew a significant proportion of capital stock. The investments made in the next 
25

10-20 years could lock in very high emissions for the next half-century, or present 

an opportunity to move the world onto a more sustainable path. 

International co-operation must cover all aspects of policy to reduce emissions—

pricing, technology and the removal of behavioural barriers, as well as action on 

emissions from land use. And it must promote and support adaptation. There are 

significant opportunities for action now, including in areas with immediate economic 

benefits (such as energy efficiency and reduced gas flaring) and in areas where 

large-scale pilot programmes would generate important experience to guide future 

negotiations. 

Agreement on a broad set of mutual responsibilities across each of the relevant 

dimensions of action would contribute to the overall goal of reducing the risks of 

climate change. These responsibilities should take account of costs and the ability 

to bear them, as well as starting points, prospects for growth and past histories. 

Securing broad-based and sustained co-operation requires an equitable distribution of effort across both developed and developing countries. There is no single formula that captures all dimensions of equity, but calculations based on income, historic responsibility and per capita emissions all point to rich countries taking responsibility for emissions reductions of 60-80% from 1990 levels by 2050. 

Co-operation can be encouraged and sustained by greater transparency and comparability of national action. 

Creating A Broadly Similar Carbon Price Signal Around the World, and Using Carbon Finance To Accelerate Action in Developing Countries, Are Urgent Priorities 

for International Co-Operation. 

A broadly similar price of carbon is necessary to keep down the overall costs of 

making these reductions, and can be created through tax, trading or regulation. The 

transfer of technologies to developing countries by the private sector can be accelerated through national action and international co-operation. 

The Kyoto Protocol has established valuable institutions to underpin international 

emissions trading. There are strong reasons to build on and learn from this approach. There are opportunities to use the UNFCCC dialogue and the review of the 

effectiveness of the Kyoto Protocol, as well as a wide range of informal dialogues, 

to explore ways to move forward. 

Private sector trading schemes are now at the heart of international flows of carbon finance. Linking and expanding regional and sectoral emissions trading 

schemes, including sub-national and voluntary schemes, requires greater international cooperation and the development of appropriate new institutional arrangements. 

Decisions Made Now on the Third Phase of the EU ETS Provide an Opportunity for 

the Scheme To Influence, and Become the Nucleus of, Future Global Carbon 

Markets. 

The EU ETS is the world’s largest carbon market. The structure of the third 

phase of the scheme, beyond 2012, is currently under debate. This is an opportunity 

to set out a clear, long-term vision to place the scheme at the heart of future global 

carbon markets. 

There are a number of elements which will contribute to a credible vision for the 

EU ETS. The overall EU limit on emissions should be set at a level that ensures 

scarcity in the market for emissions allowances, with stringent criteria for allocation 

volumes across all relevant sectors. Clear and frequent information on emissions 

during the trading period would improve transparency in the market, reducing the 

risks of unnecessary price spikes or of unexpected collapses. 

Clear revision rules covering the basis for allocations in future trading periods 

would create greater predictability for investors. The possibility of banking (and perhaps borrowing) emissions allowances between periods could help smooth prices 

over time. 

Broadening participation to other major industrial sectors, and to sectors such as 

aviation, would help deepen the market, and increased use of auctioning would promote efficiency. 

Enabling the EU ETS to link with other emerging trading schemes (including in 

the U.S. and Japan), and maintaining and developing mechanisms to allow the use 

of carbon reductions made in developing countries, could improve liquidity while 

also establishing the nucleus of a global carbon market. 

Scaling Up Flows of Carbon Finance to Developing Countries To Support Effective 

Policies and Programmes for Reducing Emissions Would Accelerate the Transition to a Low-Carbon Economy. 

Developing countries are already taking significant action to decouple their economic growth from the growth in greenhouse gas emissions. For example, China has 
26

adopted very ambitious domestic goals to reduce energy used for each unit of GDP 

by 20% from 2006-2010 and to promote the use of renewable energy. India has created an Integrated Energy Policy for the same period that includes measures to expand access to cleaner energy for poor people and to increase energy efficiency. 

The Clean Development Mechanism, created by the Kyoto Protocol, is currently 

the main formal channel for supporting low-carbon investment in developing countries. It allows both governments and the private sector to invest in projects that 

reduce emissions in fast-growing emerging economies, and provides one way to support links between different regional emissions trading schemes. 

In future, a transformation in the scale of, and institutions for, international carbon finance flows will be required to support cost-effective emissions reductions. The 

incremental costs of low-carbon investments in developing countries are likely to be 

at least $20-30 billion per year. Providing assistance with these costs will require 

a major increase in the level of ambition of trading schemes such as the EU ETS. 

This will also require mechanisms that link private-sector carbon finance to policies 

and programmes rather than to individual projects. And it should work within a 

context of national, regional or sectoral objectives for emissions reductions. These 

flows will be crucial in accelerating private investment and national government action in developing countries. 

There are opportunities now to build trust and to pilot new approaches to creating 

large-scale flows for investment in low-carbon development paths. Early signals 

from existing emissions trading schemes, including the EU ETS, about the extent 

to which they will accept carbon credits from developing countries, would help to 

maintain continuity during this important stage of building markets and demonstrating what is possible. 

The International Financial Institutions have an important role to play in accelerating this process: the establishment of a Clean Energy Investment Framework 

by the World Bank and other multilateral development banks offers significant potential for catalysing and scaling up investment flows. 

Greater International Co-Operation To Accelerate Technological Innovation and Diffusion Will Reduce the Costs of Mitigation. 

The private sector is the major driver of innovation and the diffusion of technologies around the world. But governments can help to promote international collaboration to overcome barriers in this area, including through formal arrangements 

and through arrangements that promote public-private co-operation such as the 

Asia Pacific Partnership. Technology co-operation enables the sharing of risks, rewards and progress of technology development and enables co-ordination of priorities. 

A global portfolio that emerges from individual national R&D priorities and deployment support may not be sufficiently diverse, and is likely to place too little 

weight on some technologies that are particularly important for developing countries, such as biomass. 

International R&D co-operation can take many forms. Coherent, urgent and 

broadly based action requires international understanding and co-operation. These 

may be embodied in formal multilateral agreements that allow countries to pool the 

risks and rewards for major investments in R&D, including demonstration projects 

and dedicated international programmes to accelerate key technologies. But formal 

agreements are only one part of the story—informal arrangements for greater coordination and enhanced linkages between national programmes can also play a 

very prominent role. 

Both informal and formal co-ordination of national policies for deployment support 

can accelerate cost reductions by increasing the scale of new markets across borders. 

Many countries and U.S. states now have specific national objectives and policy 

frameworks to support the deployment of renewable energy technologies. Transparency and information-sharing have already helped to boost interest in these markets. Exploring the scope for making deployment instruments tradable across borders could increase the effectiveness of support, including mobilising the resources 

that will be required to accelerate the widespread deployment of carbon capture and 

storage and the use of technologies that are particularly appropriate for developing 

countries. 

International co-ordination of regulations and product standards can be a powerful way to encourage greater energy efficiency. It can raise their cost effectiveness, 

strengthen the incentives to innovate, improve transparency, and promote international trade. 

The reduction of tariff and non-tariff barriers for low-carbon goods and services, 

including within the Doha Development Round of international trade negotiations, 

could provide further opportunities to accelerate the diffusion of key technologies. 
27

Curbing Deforestation Is a Highly Cost-Effective Way of Reducing Greenhouse Gas 

Emissions. 

Emissions from deforestation are very significant—they are estimated to represent more than 18% of global emissions, a share greater than is produced by the 

global transport sector. 

Action to preserve the remaining areas of natural forest is needed urgently. 

Large-scale pilot schemes are required to explore effective approaches to combining 

national action and international support. 

Policies on deforestation should be shaped and led by the nation where the particular forest stands. But those countries should receive strong help from the international community, which benefits from their actions to reduce deforestation. At 

a national level, defining property rights to forestland, and determining the rights 

and responsibilities of landowners, communities and loggers, is key to effective forest management. This should involve local communities, respect informal rights and 

social structures, work with development goals and reinforce the process of protecting the forests. 

Research carried out for this report indicates that the opportunity cost of forest 

protection in 8 countries responsible for 70 per cent of emissions from land use could 

be around $5 billion per annum initially, although over time marginal costs would 

rise. 

Compensation from the international community should take account of the opportunity costs of alternative uses of the land, the costs of administering and enforcing protection, and the challenges of managing the political transition as established 

interests are displaced. 

Carbon markets could play an important role in providing such incentives in the 

longer term. But there are short-term risks of destabilising the crucial process of 

strengthening existing strong carbon markets if deforestation is integrated without 

agreements that strongly increase demand for emissions reductions. These agreements must be based on an understanding of the scale of transfers likely to be involved. 

Adaptation Efforts in Developing Countries Must Be Accelerated and Supported, Including Through International Development Assistance. 

The poorest developing countries will be hit earliest and hardest by climate 

change, even though they have contributed little to causing the problem. Their low 

incomes make it difficult to finance adaptation. The international community has 

an obligation to support them in adapting to climate change. Without such support 

there is a serious risk that development progress will be undermined. 

It is for the developing countries themselves to determine their approach to adaptation in the context of their own circumstances and aspirations. Rapid growth and 

development will enhance countries’ ability to adapt. The additional costs to developing countries of adapting to climate change could run into tens of billions of dollars. 

The scale of the challenge makes it more urgent than ever for developed countries 

to honour their existing commitments—made in Monterrey in 2002, and strengthened at EU Councils in June 2005 and at the July 2005 G8 Gleneagles Summit—

to double aid flows by 2010. 

Donors and multilateral development institutions should mainstream and support 

adaptation across their assistance to developing countries. The international community should also support adaptation through investment in global public goods, 

including improved monitoring and prediction of climate change, better modelling of 

regional impacts, and the development and deployment of drought-and flood-resistant crops. 

In addition, efforts should be increased to build public-private partnerships for climate-related insurance; and to strengthen mechanisms for improving risk management and preparedness, disaster response and refugee resettlement. 

Strong and early mitigation has a key role to play in limiting the long-run costs 

of adaptation. Without this, the costs of adaptation will rise dramatically. 

Building and Sustaining Collective Action Is Now an Urgent Challenge. 

The key building blocks for any collective action include developing a shared understanding of the long-term goals for climate policy, building effective institutions 

for co-operation, and demonstrating leadership and working to build trust with others. 

Without a clear perspective on the long-term goals for stabilisation of greenhouse 

gas concentrations in the atmosphere, it is unlikely that action will be sufficient to 

meet the objective. 
28

Action must include mitigation, innovation and adaptation. There are many opportunities to start now, including where there are immediate benefits and where 

large-scale pilot programmes will generate valuable experience. And we have already begun to create the institutions to underpin co-operation. 

The challenge is to broaden and deepen participation across all the relevant dimensions of action—including co-operation to create carbon prices and markets, to 

accelerate innovation and deployment of low-carbon technologies, to reverse emissions from land-use change and to help poor countries adapt to the worst impacts 

of climate change. 

There Is Still Time To Avoid the Worst Impacts of Climate Change if Strong Collective Action Starts Now. 

This Review has focused on the economics of risk and uncertainty, using a wide 

range of economic tools to tackle the challenges of a global problem which has profound long-term implications. Much more work is required, by scientists and economists, to tackle the analytical challenges and resolve some of the uncertainties 

across a broad front. But it is already very clear that the economic risks of inaction 

in the face of climate change are very severe. 

There are ways to reduce the risks of climate change. With the right incentives, 

the private sector will respond and can deliver solutions. The stabilisation of greenhouse gas concentrations in the atmosphere is feasible, at significant but manageable costs. 

The policy tools exist to create the incentives required to change investment patterns and move the global economy onto a low-carbon path. This must go hand-inhand with increased action to adapt to the impacts of the climate change that can 

no longer be avoided. 

Above all, reducing the risks of climate change requires collective action. It requires co-operation between countries, through international frameworks that support the achievement of shared goals. It requires a partnership between the public 

and private sector, working with civil society and with individuals. It is still possible 

to avoid the worst impacts of climate change; but it requires strong and urgent collective action. Delay would be costly and dangerous.

The CHAIRMAN. Thank you very much, and as I said we’ll have 

some questions, but before we go to the questions, let me call on 

our other two witnesses. 

Professor Jacoby, why don’t you go ahead? 

STATEMENT OF HENRY JACOBY, PH.D., MASSACHUSETTS 

INSTITUTE OF TECHNOLOGY 

Mr. JACOBY. Thank you, Senator. It’s a privilege to be invited to 

speak to your committee. 

The Stern Review argues that climate change is a challenge of 

risk management akin to other problems in private life and public 

policy, from controlling your cholesterol to defense against epidemic 

disease. Further, it argues that the risks are serious and we ought 

to be doing more to reduce them, importantly including the imposition of financial penalties on greenhouse gas emissions. I agree. 

Now the Review’s application of methods of economic analysis to 

bolster this position has been the subject of controversy among 

economists, as has been its call for urgent action. I’m pleased to 

give my interpretation of the issues raised. First the Review argues 

that failure to control greenhouse gas emissions will impose risks 

of damage that are the equivalent of 5 percent of GDP each year, 

and maybe as high as 20 percent, and that action to greatly reduce 

these risks need cost only about 1 percent of global GDP. These two 

numbers, 20 percent and 1 percent, have been prominent in public 

discussion of the Review. Then I will comment on its main recommendation, which is that we must mount an urgent global response to meet an extremely high capital on the atmospheric concentrations of greenhouse gases. 
29

First, the damage estimate. The 5 and 20 percent loss figures are 

based on cascaded projections, human emissions impact; there is a 

climate which leads to negative and positive effects on market and 

non-market systems which creates gains and losses that are then 

converted into a common monetary measure. These projections extending to the year 2200 and beyond take account of estimates in 

the literature of uncertainty in temperature response and net damage to construct a picture of global risk in economic terms. 

Then to recognize potential events in the extreme upper tail of 

natural climate outcomes, the authors added consideration of major 

changes in the climate system and hypothesized catastrophic damages that are not normally incorporated in formal analysis of climate response, because their likelihood and timing are so poorly 

understood. All these phenomena, both the well-understood and the 

more speculative, and the effects near-term and in the distant future, deserve attention in the discussion of climate change risk. 

They all figure, in my subjective judgment, but to interpret the Review’s monetary damage numbers, three issues need to be sorted 

out. 

The first is the handling of events of high consequence and unknown probability. To account for these effects the Review authors 

simply impose an upward shift in the range of outcomes, and this 

subjective judgment is a key to the expansion from 5 percent to 20 

percent loss. I would have preferred to keep these extreme risks in 

the discussion but out of the formal monetary calculation. 

A second task is to interpret the way the Review weighs up economic loss over time—that is, the discount rate—which has a huge 

effect on the results. The authors apply a standard discounting formula but they choose a set of parameters that, taken together, 

produce a rate substantially below the range judged in the literature to be consistent with the way the economy operates. Now 

because climate change is such a long-term problem, the authors 

justifiably may have wanted to ensure that distant risks were 

taken into account. Moreover, they may have felt that climate 

change should be treated differently from other economic sectors, 

but pushing the standard discounting formula outside of conventional bounds was arguably not the best or the most transparent 

way to accomplish that result. At the very least, the text should 

have made clear what fraction of the 5 percent and 20 percent 

losses are attributable to modeled damages that come 200 or more 

years in the future. 

A third concern is the Review’s application of monetary measures 

to non-market effects like human mortality, species loss, or forced 

migration, the task at which economists lack adequate methods. 

These damage estimates are poorly documented, so the reader has 

a hard time judging whether to accept them as reasonable. My own 

view is that the non-market effects are the heart of the issue. 

Many are described in the Review, but to provide a basis for interpretation, I wish they had presented a few summary indicators in 

natural units (people, hectares, species) alongside a more clear 

statement of the monetary values attached. 

So how to pull all of this together? I believe the first concern implies that an underestimate of uncertainty and the second an 

overweighting of distant events. Opening up the evaluation of non-
30

market damage to closer scrutiny could lead either way, depending 

on what is inevitably a subjective evaluation. However one comes 

out on the specific damage numbers, however the Review does 

present ample justification of a serious global and environmental 

risk. It would be a shame, in my view, if useful insights into these 

risks were clouded by controversy over benefit-cost methods, or by 

charges that the Review goes too far in an effort to raise a sense 

of alarm. 

Now to the mitigation cost: underlying the 1 percent estimate is 

a policy scenario whereby nations take universal collective action 

to reduce greenhouse gases and stop forest destruction. The assumed control regime yields an average price of $100 per ton CO2

in 2015. Analysis recently completed by the U.S. Climate Change 

Science Program indicates that the 2050 cost would be higher than 

1 percent under these conditions, but nonetheless that within intelligent policies and global participation, climate risk can be greatly 

reduced without taking a substantial bite out of GDP. More worrisome is the implied stringency of emissions mitigation within the 

next few years. The emissions price implied by the analysis is at 

least $100 per ton CO2 and likely substantially higher. My own 

view and that of most previous economic studies of climate policy 

is that an emissions penalty substantially below this level is appropriate at the outset, to allow for adjustment of existing capital 

stock, and then a price rising steadily over time. 

Finally, the issue of urgency and the question of, ‘‘What now?’’ 

We don’t live in a world of universal participation, and the first 

step in approaching it is acceptance by 20 or so of the largest 

emitters of an international structure for negotiating equitable levels of national effort. The GATT is an example of such an arrangement. The Architecture for Ozone Destroying Chemicals is another. 

The Kyoto Protocol was the first try for the climate issue, but it 

has now fragmented, as serious research for a workable alternative 

will await further action by the United States. If this judgment is 

correct, then near-term U.S. decisions about new emissions measures have the character of a strategic move in a complicated multiparty game. With no additional U.S. action, the international process will stall. But decisions about new U.S. measures need consider 

not only the urgency of the problem, but also issues of international competitiveness, when trading partners lag behind. 

The Review has made useful recommendations regarding policy 

instruments in this circumstance with a heavy emphasis on market-based measures. Among these, a universal national carbon tax, 

or cap and trade system, can serve the need. Moreover, either approach can provide flexibility to adapt to an evolving level of commitment by other nations. So if we can take a sense of urgency 

from the Stern effort, then I would suggest it is to move ahead with 

a careful consideration of these options and early adoption of one 

or another on a national basis. Thank you. 

[The prepared statement of Dr. Jacoby follows:]
31

1This way of expressing damages can be thought of as an annuity, indexed to GDP, that has 

the same welfare implications over time as the as the projected damages. By this translation 

damage that occurs in particular years gets evened out across all time. 

PREPARED STATEMENT OF HENRY D. JACOBY, PH.D., MASSACHUSETTS INSTITUTE OF

TECHNOLOGY

INTERPRETING THE STERN REVIEW ON THE ECONOMICS OF CLIMATE CHANGE

INTRODUCTION

The Stern Review conveys a number of useful points about the nature of the climate threat on which there is broad agreement among analysts of this issue.

• Human-induced climate change is a problem of risk management. It cannot be 

proved that the outcome will be dire or shown with certainty that it will not. 

As with other problems we face in private life and public policy, from controlling 

your cholesterol level to defense against epidemic disease, uncertain dangers 

can warrant reasonable measures to reduce risk. • Capping the level of greenhouse gas concentrations in the atmosphere at different levels is a useful way to think about long-term objectives in dealing with 

this risk. • Because of the long lives of these gases in the atmosphere, waiting to take action on emission mitigation has the effect of gradually ruling out options for 

controlling the ultimate human influence on the climate system. 

• Economically efficient and effective control will require efforts to develop lowemissions technology and the imposition of direct price and regulatory pressure 

on the emissions themselves. Neither is sufficient to make much difference 

alone. 

• With intelligent policies and global cooperation, climate change risks could be 

limited without taking a substantial bite out of GDP growth.

My conclusion from these points is that the major nations, importantly including 

the United States, should be taking more action to reduce climate change risks. 

The widespread visibility of the Review comes in large part from its two striking 

conclusions about risk and cost and its ultimate recommendation. First, the Review 

holds that if we don’t control greenhouse gas emissions the risks of future climate 

damage will be the equivalent of 5% of GDP each year, beginning now and continuing forever, and maybe as high as 20%.1 And the second main conclusion is that 

greatly reducing these risks need cost only around 1% of global GDP each year. 

These two numbers, 20% and 1%, have dominated public discussion of the Review 

and are used to bolster its main recommendation: we must mount an urgent global 

response to hold an extremely tight cap on the atmospheric concentration of greenhouse gases. 

These results and the methods used to reach them have stirred both enthusiastic 

support and controversy. Let’s look at each of these three points in turn—climate 

damage, cost of action and urgent global response—and how they might be interpreted. 

CLIMATE DAMAGE

First the climate damage estimate. The 5% and 20% loss figures result from a policy scenario in which no action is ever taken to limit emissions. Estimates were 

made of the resulting economic loss based on a cascade of projections: human emissions impact the Earth’s climate, which leads to negative and positive effects on 

market and non-market systems, which creates losses and gains that are converted 

to a common monetary measure. These projections, extending to 2200 and beyond, 

take account of uncertain ranges in the temperature response and in the damage 

estimates, in order to construct a picture of global risk in economic terms. Then to 

recognize potential events in the extreme upper tail of potential climate outcomes 

the authors added consideration of major changes in the climate system that are 

not normally incorporated in formal analysis of the range of climate response because their likelihood and timing are poorly understood (e.g., see IPCC, 2007), and 

they applied what were necessarily very rough assumptions about catastrophic social effects beyond those quantified in the current literature. 

All these phenomena—both the well-understood and the more speculative, and effects near-term and in the distant future—deserve attention in a discussion of climate change risk. They all figure in my subjective judgment. But when I come to 

interpret the Review’s specific monetary damage numbers three issues need to be 

sorted out. The first is the handling of events of high consequence but unknown 
32

2The triplet of inputs at issue are the social discount rate or pure rate of time preference, 

set effectively to zero in the calculations, the elasticity of the marginal utility of consumption 

(the social weight attributed to a small increase in an individual’s consumption) set to 1.0, and 

the rate of economic growth. 3 In a study just completed for the U.S. Climate Change Science Program a similar calculation 

was carried out by three U.S. modeling groups (CCSP, 2006). For the case closest to the one 

analyzed in the Review the GDP loss in 2050 ranged from 1.5% to 5% (among modeling groups 

that is; this was not an uncertainty analysis). The CCSP authors are careful to point out that 

these likely are minimum estimates because computer models are very good at identifying mitigation actions of an economic efficiency that political processes rarely match. 

probability. The risk calculation requires estimates of the probabilities of climate 

outcomes and associated social costs, and the Review breaks this into two parts: (1) 

estimates based on the current literature, and (2) extreme events for which likelihood estimates are not available. To account for the latter Review authors simply 

imposed an upward shift in the range of outcomes, and this subjective judgment is 

a key element of the expansion from 5% to 20% loss. I would have preferred to keep 

these extreme risks in the discussion but out of the formal calculation. Also, I will 

note that the analysis was not able to consider uncertainty in the baseline emissions 

forecast. Our MIT analysis of temperature change to 2100 indicates that about half 

the uncertainty originates in the Earth science and half comes from uncertainty in 

projections economic growth, technical change and greenhouse gas emissions (Webster et al., 2003). 

A second task is to interpret the way the Review weighs-up economic loses over 

time—their discount rate. Its selection has a huge effect on the results. The authors 

apply a standard discounting formula but they choose a set of its parameters that, 

taken together, produces a rate that is substantially below the range judged in the 

literature to be consistent with the way the economy operates.2 The result is a low 

discount rate that, if applied to other realms of economic life, would justify increases 

in the savings rate and thus large reductions in current consumption to increase 

that of (much richer) people in the distant future. Because climate change is such 

a long-term problem the authors justifiably may have wanted to insure that distant 

risks were taken into account. Moreover they may feel that climate change should 

be treated differently from other economic choices. But pushing parameters of the 

standard discounting formula outside conventional bounds was arguably not the 

best or a transparent way to accomplish that result. At the very least the text 

should have made clear what fraction of the 5% and 20% losses are attributable to 

modeled damages that come 200 or more years in the future. 

A third concern is the Review’s application of monetary measures to non-market 

effects (e.g., human mortality, species loss, forced migration)—a task for which 

economists lack adequate methods. How these effects were handled is not clearly 

documented, so the reader has a hard time judging whether to accept the estimates 

as reasonable. My own view is that the non-market effects are the heart of the 

issue. Many are described in early chapters of the review, but more effort was needed to develop a few summary indicators in natural units (people, hectares, species), 

to be presented alongside a clearer statement of the monetary values attached (see 

Jacoby, 2004). 

So how to pull all this together? I believe the first concern implies an under-estimate of uncertainty and the second an overweighting of distant events in the GDP 

calculation. Opening up the valuation of market damage to closer scrutiny could 

lead to either higher or lower estimates depending on what is inevitably a subjective 

valuation. However one comes out on the Stern economic analysis there is ample 

evidence in the Review to indicate that we face a serious global economic and environmental risk. It would be a shame if useful insights about the risk were clouded 

by controversy over benefit-cost methods or charges that the authors went too far 

in an effort to convey their level of alarm. 

THE COST OF ACTION

With regarding to mitigation cost, underlying the estimate of a 1% GDP cost of 

mitigation in 2050 is a policy scenario whereby all nations, rich and poor, take universal collective action—reducing fossil and other industrial greenhouse gases and 

stopping forest destruction—by applying same emissions penalty everywhere, beginning now and continuing into the future.3 This cost result estimate assumes a control regime that imposes measures with an average price of $100 per ton CO2 in 

2015, this cost falling over time as assumed technological change kicks in. 

I will make just a couple of points in interpreting this result. First, the modeling 

approach adopted by the Review was capable of analysis only to 2050. What cost 

levels would be if the analysis were extended over a longer time period is not dis-
33

cussed. Whether the cost would rise or fall with time depends on the outcome of 

a race between economic growth and technological change. My expectation is that 

costs would rise. 

A second concern is the implied stringency of emissions mitigation in the early 

years. The Review does not report what marginal cost (and therefore emission price) 

is implied in 2015. Because there are some relatively cheap reductions in the mix 

it is somewhere above $100 per ton CO2 and probably substantially above. This result may be compared with what the futures markets say is the likely price in the 

European Trading System (ETS) in the first Kyoto period, which is $15 per ton. My 

own view, and that of most previous economic studies of climate policy, is that an 

emissions penalty closer to the neighborhood of this ETS level is appropriate at the 

outset, to allow for adjustment of existing capital stock, then a price rising steadily 

over time. 

AN URGENT GLOBAL RESPONSE

Whether or not one accepts the Review’s stabilization target, a judgment that nations should do something more to reduce the risk raises the question ‘‘what now?’’ 

We don’t live in the world of universal participation, and a necessary step in achieving it is acceptance by 20 or so of the largest emitters of an international structure 

for the difficult negotiations over equitable levels of national effort. The trade regime established at the end of World War II was one such arrangement, and the 

architecture for negotiating reductions in ozone destroying chemicals was another. 

The Kyoto Protocol was the first try at such a regime for the climate issue, but it 

has now fragmented. These most important nations will not seriously pursue the 

search for a workable architecture until the U.S. takes additional action on emissions, independent of any international agreement. 

If my judgment about the international prospects is correct, then near-term U.S. 

decisions about new emissions measures have the character of a strategic move in 

a complicated multi-party game. If the U.S. doesn’t take additional mitigation measures the international process will stall. But decisions about how stringent a policy 

to adopt need to consider not only the urgency of the problem and likely domestic 

economic effects but also issues of international competitiveness when trading partners lag behind and the tangle of this issue with our other foreign relations. The 

Review has very useful things to say about policy instruments, with a heavy emphasis on the use of market-based measures to the degree possible, and the fostering 

of more R&D and international technology cooperation. Among the market-based 

approaches a universal national carbon tax is the favorite of many economists. A 

cap-and-trade system, like the ETS or the one we apply to sulfur emissions, can 

serve the same purpose. Moreover either approach can provide flexibility to adapt 

to an evolving level of commitment by other nations. If we can take a sense of urgency from the Stern effort, then, I would suggest it is to move ahead with a careful 

exploration of these options and the adoption of one or the other on a national basis.

The CHAIRMAN. Thank you very much, and now let’s hear from 

Professor Yohe. Thank you very much for being here. 

STATEMENT OF GARY YOHE, PH.D., ECONOMICS PROFESSOR, 

WESLEYAN UNIVERSITY 

Mr. YOHE. Thank you. Mr. Chairman, Senator Domenici, and 

members of the committee, I thank you very much for your invitation to present testimony today. It’s indeed an honor, and I have 

to say it’s a particular honor to be on the same panel with Sir 

Nicholas. His credentials speak for themselves, but I would like to 

emphasize that Sir Nicholas is a world-class economist whose contributions to our knowledge extend well beyond the issues of climate change and the specifics of his service to the World Bank and 

to her majesty’s treasury. 

I also fully recognize as I’m here that this is a hearing on the 

Stern Review, and not climate policy, but as you’ve heard these two 

issues are really quite inseparable, so that my remarks will sort of 

wander back and forth. 

I’d like to begin by expressing appreciation for the Stern team for 

taking on the enormous challenge of constructing convincing eco-
34

nomic argument in support of taking immediate action to reduce 

the emission of greenhouse gases in general and carbon dioxide in 

particular. I think that a case can be made in a variety of different 

ways, as the economics of climate policy do indeed tell us unambiguously that it’s time to act. 

The major messages of the Review’s assessment of the current 

science are sound; indeed, as has been said already, they’re completely consistent with the conclusions presented by Working 

Group 1 of the Intergovernmental Panel on Climate Change in 

Paris. They are consistent, in other words, with the conclusions 

about the underlying science that were unanimously accepted by 

the representatives of the signatory nations of the United Nations 

from a convention on climate change who attended the meeting in 

Paris. 

To my mind the major messages are as follows: climate is changing faster than was anticipated only 5 years ago in the third assessment report of the IPCC; significant climate impacts have been 

calibrated in terms of multiple metrics, some of which are economic 

and some of which are not; and thresholds of associated climate 

risk have been identified in terms of increases in global main temperature. Many of the temperature thresholds of critical impacts 

are now thought to be closer and lower than they were only 5 years 

ago. Achieving any concentration target, however, can not guarantee that any specific temperature threshold can be guaranteed. 

Achieving a concentration target can only reduce the likelihood of 

crossing these thresholds. This is evidence that we need not only 

mitigation in the short term, but also the adaptation that was mentioned earlier. 

Figure two of the executive summary of the Stern Review has 

been reproduced here for the committee and for the audience, and 

in my mind it is a concise portrait of these essential results. If you 

look at it carefully you can see thresholds of critical impacts, you 

can see associations with temperature, and you can see ranges of 

concentration targets that would indicate certain likelihoods. Once 

you take a careful look at that, it follows that the confirmation of 

the IPCC conclusions in the Stern Review makes the case that 

some sort of policy innovation based on the economics of applied 

cost and benefit analysis couched in waste management terms will 

be required. It is important to note, though, that it is impossible 

to write climate policy in 2007 that will be valid for the entire century. Coping with thresholds and uncertainty over the long term 

will require adopting an adaptive risk management approach 

where a series of medium-term policy decisions will be formed by 

the evolutional long-term objectives. Taking medium-term action 

will require political leadership, but it strikes me that framing the 

mechanisms by which the long-term goals can be achieved will take 

political vision. 

The Stern Review’s estimates are—as has been noted by Jake—

quite controversial, in part because they’re difficult to understand, 

and partly because they’re highly dependent on underlying assumptions about discounting, aversion to risk, aversion to inequality and evaluation of non-economic metrics of impacts and other 

significant risks. 
35

In my written testimony I go through and make reference to a 

wide range of papers that have been published. Since the release 

of the Stern Review, it’s actually turned out to be pretty much of 

a full employment act for economists who know a little bit about 

climate. To emphasize just a few, as Jake has mentioned, the damage estimates are difficult to understand, because they’re expressed 

in terms of certain equivalent annuity metrics that convert expected discounted welfare values computed across thousands of 

possible futures into a single number, and those are the single 

numbers that get quoted. The Stern authors are very careful to say 

that these damages are equivalent to a 5.3 percent reduction in per 

capita consumption for now and forever. Unfortunately, a lot of 

times the conditional clause gets left off and people are left wondering where their 5.3 percent reduction of per capita consumption 

that was supposed to happen now actually is. 

The damage estimates have been criticized because they’re based 

on very low discount rates, a rate that virtually guarantees very 

high values. The damage estimates have also been criticized because they seem to be calibrated at the high end of current understanding about impacts and they sometimes miss the opportunity 

for adaptation, especially in the future where incomes become higher around the world. The mitigation cost estimates are expressed 

in terms of percentage losses and GDP, so it’s difficult to make a 

comparison of the sorts that might be appropriate, in terms of expected losses and for mitigation as well as for climate damages. 

So with all of that controversy, I would respectfully ask that the 

members of the Senate, specifically, and the members of the policymaking community in Washington, more generally, not to fall into 

the trap of focusing all of our attention on the controversies that 

surround the specific estimates, because you could easily miss the 

most important messages of the Review. I would urge you to let the 

economics profession continue to work the problems that we have 

identified, while you work on the near-term policy in recognition of 

the important insights of the Stern Review. Focus on the risks of 

climate change, that it identifies. Understand the efficiency 

grounds for buying insurance against the economic consequences of 

climate change and also the economic consequences of rapidly 

ramped-up climate policy in the future that would be required if 

nothing is done now. 

As soon as you recognize that some sort of policy will be required 

in the near term—and I think reference to Figure 1 and the now 

verified science makes that easy—simple economics says that the 

least cost approach always means starting now. 

The conclusion is true in large measure because atmospheric concentrations depend on cumulative emissions over time, so achieving 

a specific concentration target is fundamentally an exhaustible resource problem. The long-standing hotelling result that I teach my 

students in their first course in environmental and resource economics therefore applies: to maximize the discounted value set in 

initial scarcity rent and let it go up at the rate of interest, and it 

is this persistent and predictable increase in price that gives the 

policy attraction. Setting the initial tax can be an exercise in determining the appropriate short-term incentives for carbon saving inventive investments and energy conservation, rather than an exer-
36

cise in solving the climate problem, since no policy created in 2007 

will indeed solve that problem. It is possible and maybe even desirable for this committee to step out from under the burden of trying 

to solve the climate problem, and try to answer the question, 

‘‘What do we do now and how do we make progress toward a future 

that we can all be proud of?’’ 

It’s too early to state with any confidence what the political implications of the Stern Review might be. Initial fears in some circles that the Review’s estimates were so suspect that they could 

only backfire and further polarize the debate have not materialized, but the climate doubters and policy opponents have certainly 

continued their attempts to focus their attention away from the 

fundamental messages. You simply don’t want further evidence to 

be put forward that the climate is changing faster than we previously thought. 

Perhaps most productively the Stern Review does seem to have 

induced a wider appreciation that climate can be approached as an 

economics problem, and that its questions about the appropriateness of emissions reduction can be illuminated with the tools of decision analysis. If that is true, then we ought to be grateful for Sir 

Nicholas and his team for having the courage to deliver his Review 

for us for our review and our consideration. Thank you. 

[The prepared statement of Dr. Yohe follows:]

PREPARED STATEMENT OF GARY W. YOHE, WOODHOUSE/SYSCO PROFESSOR OF

ECONOMICS, WESLEYAN UNIVERSITY

Mr. Chairman, Senator Domenici, and Members of the Committee on Energy and 

Natural Resources, thank you for your invitation to present testimony on the Stern 

Review on the Economics of Climate Change. It is indeed an honor to be here, today. 

It is especially an honor to be on the same panel with Sir Nicholas Stern. His credentials speak for themselves, but I would like to emphasize that Sir Nicholas is 

a world class economist whose contributions to our knowledge extend well beyond 

the issues of climate change and the specifics of his service to the World Bank or 

to Her Majesty’s Treasury. 

With my testimony, I will try to tell a story that supports the fundamental conclusion of the Stern Review that the discipline of economics can play a significant role 

in understanding how we should respond to the risks of climate change even as it 

identifies some of the reasons why the Review has been so controversial. I recognize 

fully that the Stern Review and not climate policy is the topic of this hearing, but 

I submit that the two issues are inseparable. The point of the Review is to make 

an economic case for immediate action to reduce the emission of greenhouse gases; 

and so it is as important to discuss the validity of that claim, based on the evidence 

presented, as it is to examine the validity of the underlying economic estimates. 

Therefore, my story will try to do both. 

Before I start, I would like to acknowledge the contributions of Richard Tol, an 

economist from the University of Hamburg who is currently the Senior Research Officer at the Economic and Social Research Institute in Dublin, Ireland. Richard and 

I have collaborated on many things over the past ten or fifteen years, and we have 

authored a series of papers on the Review over the past three months. I have made 

those papers available to the Committee. 

I begin by expressing our appreciation to the Stern Team for taking on the enormous challenge of constructing a convincing economic argument in support of taking 

immediate action to reduce the emissions of greenhouse gases, in general, and carbon dioxide in particular. 

The Stern Review goes a long way in demonstrating how economics has something 

to say in informing the climate policy debate. Its release amounted to a full employment act for economists who know something about climate (and some who do not). 

Its release also inspired some scientists and others who don’t know much economics 

to enter the fray, but that is fine, too. 

To be honest, Richard and I are not convinced that the Review is the definitive 

word in this regard. Its numerical results are controversial and value-laden, but 
37

that is the nature of the economic science. Please do not interpret the controversy 

over the numerical results as anything more than economists being economists—arguing over every point to make sure that the fundamental conclusions are sound. 

We have participated in that discussion, and I will highlight some of our concerns, 

today. I assure you, though, that we are both convinced that the Review provides 

sufficient evidence to support its fundamental conclusion with very high confidence: 

the economics of climate policy tell us unambiguously that it is time to act. 

The major messages of the Review’s assessment of the current science are sound. 

Indeed, they are completely consistent with the conclusions presented by Working 

Group 1 in its contribution to the Fourth Assessment Report of the Intergovernmental Panel on Climate Change (the IPCC). They are consistent, in other words, 

with the conclusions about the underlying science that were unanimously accepted 

by representatives of the signatory nations of the United Nations Framework Convention on Climate Change who attended the IPCC plenary meeting in Paris two 

weeks ago. They include:

a. Climate is changing faster than was anticipated only 5 years ago (in the 

Third Assessment Report of the IPCC). 

b. Significant climate impacts have been calibrated in terms of multiple 

metrics (some are economic, but many are not), and thresholds of associated climate risk have been identified in terms of changes in global mean temperature. 

c. Many of the temperature thresholds for critical impacts are now thought 

to be lower than anticipated only 5 years ago. It follows that we are approaching them more quickly than we thought, and so we will reach them sooner than 

we thought. 

d. Achieving any concentration threshold cannot guarantee achieving a specific temperature threshold; but achieving a concentration target can reduce the 

likelihood of crossing those thresholds at any point in time. 

e. Achieving any concentration threshold may, however, only delay the inevitable unless the rate of change in temperature is diminished by persistent policy intervention over the entire century and perhaps beyond.

Figure 2 in the Executive Summary of the Stern Review offers a concise portrait 

of the essential results of the most recent science. I attach a version here as Figure 

1. Notice that temperature thresholds are identified for truly dangerous impacts in 

many dimensions in the lower portion of the figure; their location in terms of warming are the basis for believing Senator McCain’s assertion last month that the debate over the science is over. 

The imprecise links between temperature targets and concentration targets are 

meanwhile illustrated in the upper portion of Figure 1. They summarize current understanding to show, for example, that holding concentrations

• below 750 ppm means a greater than 95% chance of exceeding 2 degrees (Centigrade) of warming above current levels and a 70% chance of exceeding 3 degrees 

of additional warming, 

• below 650 ppm means a 95% chance of exceeding 2 degrees and a 60% chance 

of exceeding 3 degrees, 

• below 550 ppm means around a 70%-80% chance of exceeding 2 degrees and a 

50% chance of exceeding 3 degrees, 

• below 450 ppm means a 50% chance of exceeding 2 degrees and a 25% chance 

of exceeding 3 degrees, and 

• below 400 ppm means roughly a 30% chance of exceeding 2 degrees and still 

a 5% chance of exceeding 3 degrees.

Putting the two parts of the figure together allows the reader to judge the sensitivity of our experiencing any specific risk to changes in policy. It is, indeed, a spectacularly powerful portrait of the policy predicament. 

It follows from its confirmation of the IPCC conclusions that the Stern Review 

makes the case that some sort of policy intervention, based on the economics of applied cost-benefit analysis couched in risk management terms, will be required. 

It is important to note that it is impossible to write climate policy in 2007 that 

will be valid for the entire century. Coping with thresholds and uncertainty over the 

long term will require adopting an adaptive risk management approach where series of medium-term policy decisions will be informed by the evolution of long-term 

objectives. Designing such a program will be difficult, because it will need to give 

clear signals of intention over the medium-term even as it maintains flexibility so 

that it can respond to

• changes in scientific understanding, 

• changes in social valuations of impacts, and 
38

1 It strikes me, as an aside, that the Federal Reserve System of the United States (the FED) 

is an example of an institution designed to accomplish all of these tasks. While surely in a different context, the FED confronts the same sorts of short-term versus long-term tensions with 

the same sorts of price or quantity policy tools and protected from political manipulation by 

carefully designed insulation. 

• changes in our expectations of how the policies are working.

In every case, however, this flexibility must somehow be immune to political and/

or economic manipulation, and so designing such a mechanism will require a considerable amount of political leadership.1

The Stern Review’s estimates of economic damages and the cost of mitigation 

have been controversial in part because they are difficult to understand and in part 

because they are highly dependent on underlying assumptions about discounting, 

aversion to risk, aversion to inequality, and the valuation of noneconomic metrics 

of impact and significant risk (abrupt change and extreme events, for example). 

The controversies surrounding the damage estimates are fraught with detailed 

discussions of the technicalities involved in applying economic analysis to a complex 

problem like climate change. I highlight a few, here, but will shortly argue that the 

case for immediate action survives the controversy, especially if one takes a slightly 

different, but nonetheless economically rigorous tact. 

The damage estimates are difficult to understand because they are expressed in 

terms of a ‘‘certainty equivalent and equity equivalent annuity’’ metric that converts 

expected discounted welfare values computed across thousands of possible futures 

into a single number. 

The analysis underlying the computation of this metric is sound, if not brilliant; 

see Mirrlees and Stern (1972) for the details of its development. Its application to 

the climate problem is path-breaking, but it is vulnerable to the sort of misinterpretation that will make people roll their eyes and wonder if any of us know what 

we are talking about. The authors of the Review are careful to say that ‘‘total cost 

over the next two centuries... are equivalent to an average reduction in global 

per capita consumption of at least 5%, now and forever’’. When the results are reported in the popular press, however, the conditional phrase about equivalence is 

usually deleted, and that is a problem. Readers can react by saying ‘‘It’s now, and 

I don’t see my 5.3% reduction in consumption. Where is it? It’s still now! Still not 

here!’’

Notwithstanding this presentation problem, it is important to note that the damage estimates include not only the economic ramifications of climate impacts as they 

play out over time, but also a ‘‘risk premium’’ tied to the current level of uncertainty 

about the future as displayed in the simulation model. It is here that aversion to 

risk and aversion to inequality have an effect on the estimates. Weitzman (2007) 

argues that the Stern estimates undervalue these contributions because the tails of 

the distributions of our understanding of the climate impacts are so ‘‘thick’’. in other 

words, the representations of uncertainty upon which the underlying simulations 

are conducted do not adequately consider the likelihood of extreme consequences. 

The damage estimates have been criticized because they are based on a very low 

discount rate—a rate that virtually guarantees high values. 

Dasgupta (2006), Maddison (2006), Nordhaus (2006), Tol (2006), Tol and Yohe 

(2006), Tol and Yohe (2007), Varian (2006), Yohe (2006) and Yohe and Tol (2007) 

all make this point. Some argue that imposing such a low discount rate on investments to mitigate climate change in a world where other investments are required 

to earn higher returns is a prescription for the inefficient allocation of resources 

over time. Others argue that public investments can earn lower than market returns if they complement private investment; see for example, Ogura and Yohe 

(1977). Still others, including the Stern Review itself, make an ethical case for minimizing the rate at which impacts that will be felt by future generations are discounted in current policy deliberations. 

Regardless of how one comes down on this debate, and the choice of a discount 

rate is in the purview of policy-makers, it is important to recognize the sensitivity 

of the damage estimates to that choice. Tol and Yohe (2007) report, on the basis 

of a simply model calibrated to the Stern Review baseline scenario where damages 

create the equivalent of a 5.3% reduction in per capita consumption, that lowering 

the rate further would have very little effect on the estimate while increasing the 

discount rate to 3% would reduce damages to the equivalent of a 1.6% decline in 

equivalent per capita consumption. 

It should finally be noted that Weitzman (2007) expresses concern that the economic profession at large has not yet solved the problem of exactly how to discount 

the distant future when intergenerational transfers of wealth must be considered. 

His point is simple: there is a lot of fundamental work still to be done in this regard. 
39

* Graphic has been retained in committee files. 

The damage estimates have also been criticized because they seem to have been 

calibrated to the high end of current understanding of impacts, because they sometimes miss the opportunity for adaptation especially in a future where incomes will 

be higher, and because they add estimates of catastrophic damages to a baseline 

that already included estimates of the willingness to pay to avoid such calamity. 

Tol (2006), Tol and Yohe (2006) and Yohe and Tol (2007) have made these points, 

but it is important to note that the range of uncertainty reflected in the underlying 

simulations is not tied entirely to these upper-end estimates. Tol and Yohe (2007) 

confront the ‘‘So what?’’ question that we begged in their earlier comments by exploring the implications of simply assuming that the developing world’s capacity to 

adapt will grow toward the current level of the world developed countries as their 

economies grow. The result is a reduction in discounted damages of more than 50%. 

Why so large? Because the small discount rate rewards increases in future adaptive 

capacity as heavily as it punishes future impacts. 

Mitigation costs are estimated in terms of percentage losses in GDP, and so it is 

difficult to compare the costs of policy with its benefits (calibrated in terms of losses 

in equivalent per capita consumption). 

Mendelsohn (2006) has remarked that the mitigation cost estimates are too low. 

Others have noted that they seem to run only through 2050. Tol and Yohe (2006) 

wonder why the conventional 550 ppm concentration target from earlier work persists as a policy target when damage estimates are so much higher than before. Perhaps most importantly, however, the Review never presents the net effect of mitigation in terms of the equivalent per capita consumption metric employed to track 

damages. Tol and Yohe (2007) have attempted to do so for a simple model calibrated, again, to support a 5.3% loss absent any intervention. They find that achieving a 550 ppm concentration target would reduce damages to 2.2%, that a achieving 

a 650 ppm target would reduce damages to 3.0%, and that achieving a 400 ppm target would reduce damages to 0.8%. 

These are not net benefit estimates, of course, because they do not include the 

cost of mitigation. They do show, however, that no amount of mitigation can be expected to eliminate economic harm expressed in terms of per capita consumption 

equivalents even though mitigation does reduce the uncertainty with which we view 

future impacts. 

I would respectfully ask members of the Senate, specifically, and members of the 

policy-making community in Washington more generally not to fall into the trap of 

focusing all of their attention on the controversies that surround the specific estimates because you could easily miss the most important message of the Review. Let 

the economic profession continue to work the problems that we have identified while 

you work to define near-term policy in recognition of the important insights of the 

Stern Review. Focus on the risks of climate change that it identifies. Understand 

the efficiency grounds for ‘‘buying insurance’’ against economic consequences of climate change and the economic consequences of rapidly ramped climate policy in the 

future if nothing is done now. 

As soon as you recognize that some sort of policy will be required (and that recognition follows directly from Figure 1*), simple economics says that taking the 

least cost approach means starting now. 

This conclusion is true in large measure because atmospheric concentrations of 

greenhouse gases depend on cumulative emissions over time, so achieving a targeted 

concentration target (and thus a corresponding range of possible temperature increases and associated climate risks) is fundamentally an exhaustible resource problem. The long-standing Hotelling result that I teach my students in their first 

course on environmental and resource economics therefore applies (at least to a first 

approximation): to maximize the discounted value of welfare derived from an exhaustible resource (that is, to minimize the discounted costs of limiting cumulative 

emissions over the long-term), simply calculate the appropriate initial ‘‘scarcity rent’’ 

(in this case, an initial price for carbon for 2007) and let it increase over time at 

the rate of interest. 

Adjustments over time in the concentration target (borne of uncertainty about the 

climate system specifically and the future more generally) confound the issue, to be 

sure, but I have shown in Yohe, et al. (2004) that some hedging based on the 

Hotelling minimum cost result minimizes expected costs even if there is a chance 

that we will discover sometime in the future that the climate problem fixes itself 

and climate policy initiated now was unnecessary. Why? Not because it generated 

some energy independence for the United States, even though that would be a good 

idea. Rather, because the expected costs of adjusting to more pessimistic climate 

news sometime in the future if we delay taking action are higher than the expected 
40

2The tax should increase, in real terms, at the real rate of interest. If expressed in nominal 

terms downstream, then it should increase at the nominal rate of interest. 

costs of doing too much too soon (even with discounting at the market rate of interest). 

To be more specific, the Hotelling result means that it is enough to specify an initial tax on carbon (or perhaps setting targeted permit price for a cap and trade system). This tax should be designed to get the attention of American business and to 

show political leadership in the face of a serious problem. It need not, however, be 

set so high that it would cause undo economic harm in the short-run. Allowing the 

tax to increase at the rate of interest year after year (following Hotelling) and acknowledging that adjustments for new knowledge about performance and risk will 

have to be accommodated over time will give the policy traction. 

I personally favor a tax because permit markets can be volatile, and because responding to this volatility by building in a ‘‘safety value’’ on the price of permits 

sets up a loophole in the policy that could easily be manipulated. Indeed, it undermines the power of the policy. A tax, increasing at the rate of interest, would 

produce a persistent and predictable increase in the cost of using carbon that would 

inspire cost-reducing innovation and fuel switching in the transportation, building, 

and energy supply sectors of our economy.2

Be assured that providing incentives for American business to prepare for a carbon scarce future will put them in a good position when it comes time to compete 

in world markets, especially if their competitors in China and India do not follow 

suit. This is why 10 major corporations are on record in support of a U.S. (federal) 

climate policy that has some teeth and is predictable. There is money to be made, 

but only if uncertainty about climate policy is reduced. 

Setting the initial tax can be an exercise in determining the appropriate shortterm incentives for carbon-saving investments and energy conservation rather than 

an exercise in ‘‘solving the climate problem’’. 

Since no policy created in 2007 will ‘‘solve the climate problem’’, it is possible and 

even desirable for this Committee to step out from under that burden to confront 

a more manageable problem (while still making progress towards an ultimate solution to the climate problem). You are not trying to ‘‘Solve the climate problem.’’ You 

are trying to ‘‘Acknowledge and confront the climate problem in 2007 with the best 

information available.’’ More specifically, your problem is ‘‘What do we do now?′′ The answer is to design something for the near-term that will discourage longterm investments in energy, transportation, and construction that would lock in 

high carbon intensities for decades to come. Moving decisions in that direction 

would be consistent with long-term programs designed to ‘‘solve’’ the climate problem (however our understanding of it evolves) and with the minimization of longterm economic costs of the policies. 

As an example, one might consider investments that are pending to replace coalfire power plants along the eastern seaboard of the United States. Tens if not hundreds of power plants will be replaced over the next 4 or 5 decades, and new plants 

will be required to meet growing demand. They might be replaced with coal-fired 

plants, because that would be the efficient choice given current expectations of alternative fuel prices (absent any climate policy) over the next few decades. All or some 

of these plants could, however, be replaced by plants that burn natural gas with 

a 60% reduction in carbon emissions per unit of electricity. People who know the business claim that a $30 per ton tax on carbon dioxide (a $110 per ton tax on the carbon content of fossil fuel) would make natural gas the 

more economical choice, but it is not necessary to impose a $30 tax in 2007 to inspire complete conversion to natural gas. Since investment decisions turn on the discounted value of returns over 50 or 60 year time horizons, the price of carbon would 

not have to reach $30 per ton for another 15 or 20 years to make natural gas the 

economical choice this year for investments in power plants that will come on line 

5 or so years hence. Of course, Hotelling tells us to increase the tax by the rate of 

interest, and that helps. 

Assume for the moment that private investors use a 5% discount rate in their present value calculations. So what are the options? The $7 per ton of carbon dioxide charge envisioned in the legislation being considered in this Committee would 

reach $30 per ton in 2036—probably too late to capture plants being designed this 

year, but sufficient to bring most of the plants constructed between now and 2050 

over to a lower carbon technology. A $15 per ton charge in 2007 would reach the 

decision threshold in 2021. 

That would do if the goal were to achieve 100% fuel switching, but what would it cost? A $15 per ton charge would add almost $6 to a barrel of oil. We have seen 

monthly variation in oil prices bigger than that, recently; the difference here is that 
41

it would be predictable, and it would affect different fossil fuels differently. It would 

add 14 cents to a gallon of gasoline. Given current fuel configurations for electricity 

generation in the United States, it would increase electric bills by 10% to 30% depending on location, but that percentage would decline over time. It would generate 

something like $90 billion in tax revenue in 2007 if it were paid on every ton of 

carbon embodied in every gallon of fossil fuel consumed in the United States. This 

is revenue that could be used to offset the regressive nature of an energy tax, invest 

in alternative energy sources that could lower the $30 per ton threshold, and otherwise reduce our dependence on foreign sources of oil without looking to domestic 

sources like the Alaskan wilderness. 

It is too early to state with any confidence what the political implications of the 

Stern Review might be. Initial fears in some circles that the Review’s estimates 

were so suspect that they could only backfire and further polarize the debate have 

not materialized. Climate doubters and policy opponents have certainly continued 

their attempts to focus attention away from the fundamental messages that can be 

drawn from its literature survey if not its economic synthesis. They simply do not 

want further evidence to be put forward that the climate is changing faster than 

previously thought and that no specific temperature target can be guaranteed by 

holding atmospheric concentrations of greenhouse gases below any specific threshold. Despite their attempts, however, the Stern Review has not interrupted a perceptible, sometimes slow, and sometimes noisy march towards meaningful climate 

policy, but neither has it done anything to halt wild exaggeration from all sides. 

Perhaps most productively, the Stern Review does seem to have induced a wider 

appreciation that climate change can be approached as an economic problem, and 

that questions about the appropriateness of emission reduction can be illuminated 

(but perhaps not yet answered) with the tools of decision analysis. If that is true, 

then economists ought to be grateful to Sir Nicholas for having the courage to deliver Stern Review to us for ‘‘review’’ and consideration.

The CHAIRMAN. Thank you very much. Thank all of you. Let me 

start with the questions. We’ll do 6 minute rounds of questions. Let 

me start and ask a few. 

Sir Nicholas, in your statements, you say climate change is the 

greatest market failure that the world has ever seen. What leads 

you to that conclusion? Why is this different than other market 

failures that seem to be all around us? 

Mr. STERN. Thank you, Mr. Chairman. The climate change is the 

greatest market failure the world has seen because of the range of 

the causes and the range of the consequences. Every one of us in 

our actions, every industry is involved in emitting greenhouse 

gases in some shape or form. It’s very hard to think of other kinds 

of externalities—an externality is economist language for when we 

do something which affects directly the consumption or production 

possibilities of other people—that are associated with everybody 

around the world. It’s the greatest market failure in the sense that 

everybody’s involved in producing these damages. Second, it’s the 

greatest market failure the world has seen in terms of consequences. The impact will be on everybody. Third, it’s the greatest 

market failure the world has ever seen because it’s the potential 

scale of the damages, as we tried to describe in the report and as 

is illustrated in the diagrams that Gary Yohe put out there. 

The CHAIRMAN. Let me also ask: I think I heard Professor Yohe 

refer to your Review as advocating an adaptive risk management 

approach to the problem. Is that an accurate statement of what you 

said, Professor Yohe? 

Mr. YOHE. That is an accurate statement of what I said. 

The CHAIRMAN. Is that an accurate description of what you in 

fact have concluded with the recommendations coming out of your 

Review? 
42

Mr. STERN. Yes, it is. It’s understood as being about the economics of risk and reducing greenhouse gases in order to reduce risks, 

looking at the costs and benefits of doing that, and it also emphasizes that in the Review. It also emphasizes, as Gary Yohe and 

Jake Jacoby have, the importance of adaptation. We do know that 

even with strong action the climate will change quite strongly over 

the next 30, 40, 50 years and that means that we’re going to have 

to adapt, so those two parts of the statement—adaptation and economic risk—are absolutely at the heart of what we did. 

The CHAIRMAN. One of the issues that is going to be central to 

our debate here, on how to actually come to grips with this in a 

legislative way, is whether or not a cap and trade system—if we’re 

able to get a consensus to enact a cap and trade system—whether 

there should be something that most to us refer to as a safety 

valve, which would essentially ensure that those who are emitting 

greenhouse gases would not have to pay more than a certain 

amount per year for those emissions, and that amount could then 

rise. This is something that’s contained in the draft legislation that 

I’ve worked on with Senator Specter and others, that’s not in many 

of the other bills that are proposed. 

Sir Nicholas, did you have any thoughts as to whether that kind 

of approach would make any sense? I think Professor Yohe’s testimony indicates that he thinks that would defeat the purpose of a 

cap and trade system, as I understand his comments. 

Mr. STERN. I think the answer to that question, Senator, has to 

depend on the other parts of the story in which a cap is situated. 

I do think that it could have a role to play, to help with the transition—to give a certain amount of certainty in a new departure in 

a new kind of policy instrument. But I think the context is crucial, 

and in that I would emphasize that strong ambition in terms of 

carbon reduction is crucial to the whole story. So that means that 

one should not set any cap too low, and you judge ‘‘too low’’ in relation to the kind of quantity reductions you would expect, or that 

you find along the way. 

Second, I think it’s important to look at other possible ways of 

giving the kind of stability, the kind of ability to make decisions 

in the stable environment, that is behind the idea of a cap. There 

I think the importance not only is the ambition in the production 

but also in the size of the market and the openness of the market. 

If you have big markets and open markets, then you’re more likely 

to get stability than when you have narrow and closed markets, so 

that route to stability in terms of ambition, openness and long-term 

nature of the challenge is also very important. 

A third element to bear in mind when you think of caps is the 

ability to link up with other trading schemes. Linking up with 

other trading schemes will allow not only more stability, but also 

an efficiency in the allocation worldwide and an ability to start to 

produce carbon finance flows to developing countries that could 

help bring them along and establish the kind of coalition that Senator Domenici was describing. So within that broader context, I do 

think that in terms of stability and in helping people to adjust to 

a new regime, that safety valves could have a role to play, but it 

would be a problem if they were set too low. 

The CHAIRMAN. Thank you very much. Senator Domenici. 
43

Senator DOMENICI. I’m going to let Senator Thomas take my 

place for one round. 

The CHAIRMAN. Alright, Senator Thomas. 

Senator THOMAS. Ok, thank you. Well, thank you gentlemen. I 

appreciate that very much. 

Mr. Stern, you mentioned the United Nations report in your testimony, the IPCC. That panel predicted a rise of 3 feet by 2100. 

Your new study cuts that figure to 17; how do you explain the variation in prediction from the same route within 5 years in their report? 

Mr. STERN. Of course I’m not a member of the IPCC, so I’m not 

here to answer for them. But the IPCC is quite cautious in including different forms of evidence, and when it feels that there’s some 

indications, but it’s not sure or it doesn’t feel the evidence is strong 

enough, then it can revise on that basis. Some of the impacts it revised upwards and some of the impacts it revised downwards. For 

example, it revised upwards its estimate of the frequency of intense 

tornadoes. It did some adjustment downwards—you’re right—in 

the sea level story, but that’s based on a group of scientists simulating and looking carefully at different forms of evidence. It’s not 

for me to answer for them. 

Senator THOMAS. I see. I guess it’s one of the questions we ask 

ourselves as we get different kinds of reports from scientific studies 

with respect to this. Eighty percent of the world’s energy comes 

from fossil fuels: this number is projected to be up to 40 billion tons 

by 2030. Your report says international cooperation is necessary, 

yet the Kyoto Protocol has been a failure. How do you have an alternative proposal with enough detail to accurately implement it? 

Mr. STERN. The story that we emphasize in the Review is to for 

rich countries around the world particularly to take strong action 

through their own ambitions. So the European Union has got 

strong ambitions for its third phase of the European Union Emissions training scheme, ambitions being discussed now to cut greenhouse gases emissions by 20 or 30 percent by 2020. That’s an ambition which it has taken on itself. Within that context France has 

taken on a 75 percent ambition for its reduction by 2050, UK over 

60 percent. I do appreciate that California is not a country but it 

has its own ambitions of 80 percent reductions. 

Senator THOMAS. But the Kyoto agreement has not had much of 

an impact. 

Mr. STERN. Well what I’m saying is that the Review itself points 

to the importance of strong action and strong ambitions, country by 

country, which can then be linked up by trading schemes. If that 

can be fitted into a broader protocol internationally, then that 

would be very good. But what I’m saying is that we do not depend 

on the particularities of the Kyoto Protocol for making strong 

progress in this. What is does depend on is the strong ambitions 

of the rich countries, working in a way that is likely to bring in 

the poorer countries, and in that sense the international community can move strongly forward without necessarily getting all the 

details of an international agreement right. 

In thinking about Kyoto, of course, we have to think that it is 

a very short-term agreement and it was something that set us 

along a path. I believe if you look at it in that context and ask if 
44

the kinds of issues that it raised, the kinds of ambitions it set 

itself, initially—are those right? I think they are. They’re the right 

kind of level of ambition because they were short-term ambitions, 

but you could fit them in the longer one. So I think the kinds of 

ambitions it set were right and the kind of mechanisms it pointed 

to, of trading, is right also. I think that is underlined in the discussions, if I understand correctly, that are taking place now on cap 

and trade, so I think a lot of the principles and ambitions of Kyoto 

were sound. We have to think how things will move forward after 

2012. 

Senator THOMAS. None of you mentioned particularly what some 

of the things are that we’re doing now. We have a coal plant in my 

State that’s going to eliminate CO2. We’re going to move more toward nuclear. We’re doing quite a little bit, moving toward automobiles and so on. Do you think we’re making progress at this 

point? 

Mr. STERN. Yes, I do. If I might return to the issue of China in 

that context that Senator Domenici raised: we’ve traveled a great 

deal since the publication of the Review, and indeed prior to publication of the Review we did visit the biggest countries around the 

world from this perspective—including the United States, India 

and China—and we went back there after the Review. We spent a 

lot of time in China explaining and underlining and emphasizing 

that the United States is taking strong action. We pointed to the 

examples of California. We pointed to examples of the Northeastern 

States. We pointed to the importance of the technology investment 

and research that the United States is taking, and that is a big 

part of our argument in China. But also when we come here to the 

United States we emphasize just how much China is doing. If I 

could give you just a few examples, it’s a very important context 

for the whole story. They’re building collaboration. 

China is no longer deforesting. It is now reforesting. China has, 

as I mentioned in my testimony, a 20 percent reduction in the energy intensity target within 5 years. Their eleventh 5-year plan 

started last year and they’re implementing and working on that in 

a very strong way—for example, through direct targets for the 

1,000 biggest firms in China, recently extended considerably to 

below our tier terms. You cannot sell an American car in China because it doesn’t meet the emissions standards, which are pretty 

high. Beijing has made $8,000 tax on SUVs. China in late November, early December instituted an export tax on energy-intensive 

goods, such as aluminum, steel and cement. So China is grappling 

with this problem. There’s a tremendous amount more that many 

of us believe it should be doing but I think it’s not correct to say 

that China is doing nothing, and we try to explain through the examples I’ve just given how China is beginning to get its arms 

around this problem. Just as when we are in China, we emphasize 

very strongly what the United States is doing. 

Senator THOMAS. Thank you. 

The CHAIRMAN. Senator Domenici wanted to go next, so you go 

right ahead. 

Senator DOMENICI. Thank you. Sir Nicholas, I did not know that 

you shared with China the information that you have gathered 

about what the United States is doing. I personally appreciate that 
45

you’re doing that. You are probably doing more and better at it 

than we are, so we thank you for it. We only wish that we could 

get with it and I think that they would listen. They sell us an 

awful lot of merchandise, for which they build many of those power 

plants, so they build the capacity for that. 

I had some questions which were going to be critical of your report but let me just say I’ll submit them in writing. I understand 

that from this discussion what the criticism is, and applaud you for 

your report in spite of the fact that there is some room for arguing 

with some of the economics that you use. I think that probably 

would have been there with any report like this, but I found that 

to be rather credible from some who submitted it. 

Now I’m going to suggest this and ask for you, any of you to help 

us. I look at this and am very pleased to see that you have talked 

about adaptation, because now after 2 months or so of reading 

what I can, it is obvious that the capture of carbon or the capacity 

to get the world to greatly diminish its use is almost impossible. 

We can do some, but we can’t do the big job, and part of that is 

because we cannot find a way to invest sufficient capital in the research for new equipment that will solve the problem of sequestration. We are spending money, but I ask that we check how much. 

It really won’t get the job done. 

There has to be some way to get all of the countries of the world 

to put in, literally billions of dollars in some major research effort 

and decide whether sequestration and return of that carbon is doable. If it is, it becomes a major undertaking and I’m not selling 

that short. If you could do it we don’t know that you would find 

the money to do it, it’s so expensive. We don’t even know if we can 

do it and that has to take place. 

Having said that, I believe that an adaptation policy is in order 

and that we ought to start thinking about it up here because States 

and others ought to be looking at what they might do. I thank you 

for bringing that subject up with a little more clarity. I wonder if 

you would agree about the need for more research money from the 

world and the areas that are contributing to this problem, and if 

you have any ideas on how we might get that done: any of you? 

Mr. JACOBY. I’ll respond to that. 

Mr. STERN. Jake Jacoby will respond after me, if that’s okay with 

you, Mr. Chairman. Jake knows a great deal about research and 

development in these areas. 

On the various questions that economists around the world have 

raised on the report, let me first say that the report was never intended to be the last word. That would have been foolish and I 

hope that we didn’t make that mistake. We welcome the discussions that have taken place. I believe that we have sound answers 

to all the questions that have been raised, including on the treatment of discounting. We did put three papers up on the web at the 

beginning of this week which deal with the some of the discussions 

that have taken place. We will be discussing them with academic 

colleagues at Yale later this week, so we absolutely welcome that 

public discussion. I would offer a fairly cheerful and robust response to the various points that have been raised and look forward to discussing these in detail with my academic colleagues. I 

was 30 years in academic life before I went into the service in 
46

international institutions and her majesty, and I will go back to 

academic life in the near future, and those are exactly the kinds 

of discussions that I welcome. But as I say, we stand by what we’ve 

done and we give the reasons for that. 

The emphasis you place on research and development and deployment I think is absolutely fundamental, and I do believe that 

the world taken together has been remiss in funding expenditures—public expenditures in our research and development declined by a factor of 2 over this last 25 or 30 years. Collectively, 

we made a big mistake. Now you can look at the reasons why we 

did that, and no country is alone in this story. It’s a pattern around 

the world. But that’s something I think we must act very quickly 

to correct. 

Most economists, and we would be amongst them would say, 

‘‘Let’s see a price to carbon, let’s correct this market failure, let’s 

invest in research and development, both public and private.’’ 

They’re very highly correlated, public and private expenditures now 

are indeed. Let’s do those things and let’s see which technologies 

come forward. We’re seeing pretty rapid change in solar technologies as we find ways to do photovoltaics which are different 

from silicon and using plastics and other materials for the photovoltaic effect. We could well see quite strong progress in cellulosic 

sources of bio-fuels, not just sugar and corn but switch grasses and 

rough grasses and other kinds of residue which could be grown on 

the marginal lands around the world. If we did find progress there, 

it would open up opportunities for bio-fuels far greater than if we 

keep it narrowly to sugar and to corn. So there are margins wherever you look on these technologies where we have strong progress, 

and I hope that we can be reasonably optimistic. But it will require 

a kind of effort on the scale which you so eloquently described. 

There’s one technology which we did emphasize and which you 

have emphasized, I believe rightly so, and that’s carbon capture 

and storage for coal. The reason for that is because it’s so widely 

used, around 50 percent of electricity consumption around the 

world. It will be over 70 percent in India and China for the foreseeable future. Why? Because they’ve got lots of coal, it’s under their 

ground, they don’t have to import it, and it can be done quickly. 

You can get those fire stations up quickly and they’re there in a 

hurry because their economies are growing, and lots of their people 

and industries don’t have electricity supplies. So it’s pretty obvious 

that they’re going to be using coal over electricity-powered generation for quite a long period of time. So, too, Poland and Germany 

and United States; it’s not just India and China. But particularly 

in India and China, there’s an issue there on coal. 

What’s the answer to that? In the short term, to use coal much 

more efficiently than they do, move to super critical, ultra super 

critical burners. That’s the kind of technology which the rich countries can help with in terms of ordinary, private investment activities. But we have to have an open view and encourage the transfer 

of those kinds of technologies, and as soon as we can, we have to 

move to the carbon capture and storage for coal. We have to learn 

to do that well. 

I have lived and worked in India for more than 30 years now, 

in various places. I’ve lived and worked in China for nearly 20 
47

years. I’ve seen those two countries change quite remarkably in the 

last year or so in their attitudes toward energy efficiency and their 

attitudes to the environment. There is some way to go, but I believe that there is a partnership there of the kind you describe that 

can be forged. Friends say to us: you’re emphasizing carbon capture 

and storage for coal, sounds like a good idea. It will be more expensive so we’ll need some help with the carbon finance. It will require 

changes in technology and in development and deployment of these 

technologies. We’d like some help with that, too; in particular, show 

it works in your own countries. So I think if Europeans argue that 

carbon capture and storage is a good thing for India and China, 

they ought to show it works in Europe. I think it’s a fair challenge, 

my friends in India and China, but I believe that we can rise to 

that challenge. That is a particular area where I think the United 

States and its ingenuity and creativity in technologies right across 

the board can not only have a big role in creating these technologies, but can also show how they can be deployed and indeed, 

get business from so doing. 

So I think your emphasis is absolutely right. I would certainly 

share it. I don’t believe that any one country should carry all the 

burden of the R&D. It should be shared around. One thing that we 

can do, or one thing that you can do as leaders of your nations, is 

to try to work out with your counterparts in other parts of the 

world just how those R&D—and deployment, of course—efforts can 

be built and shared. 

Mr. JACOBY. May I respond? 

The CHAIRMAN. Yes, if you can make a reasonably short response, we’d appreciate it. 

Mr. JACOBY. Let me second, Senator, your comment about coal. 

It’s located all over the world. It’s cheap. It’s not located in places 

that are security problems and it’s hard to imagine we’re not going 

to burn it over the next century, so carbon capture and storage is 

one of the essential technologies. If we can’t make that work, we’re 

in deep trouble. So I would just say that we’re near the completion 

of a study in which I participated at MIT, on the future of coal. 

That study, which should be out within a month, is going to argue 

that we should be spending a lot more effort on the development 

of coal capture and storage technology, doing studies at commercial 

scale. 

We are spending a lot of money in the United States. We do have 

the FutureGen program, but the argument is that is not enough. 

We don’t know which is the right technology. We need more experimentation with the joint operation of these complicated chemical 

technologies that remove the CO2 and generate electric power jointly with the storage process itself. We need more experience with 

that. There’s an argument that we should not have one, but five 

or six of these, and that given the magnitude of the problem that’s 

a small expenditure. You’re going to hear a blast from the north 

on this topic in a few weeks. I think you’re exactly right; I would 

second you with great enthusiasm. 

The CHAIRMAN. Senator Dorgan was ready to go with his questions. Did you have a comment you just have to make, Professor? 

Mr. YOHE. Yes, I’m just going to be very brief about the other 

part of the question about adaptation. 
48

It’s absolutely essential that we think about adaptation. We are 

committed to warming even if we stopped emissions of greenhouse 

gases tomorrow. There was, as you know, in Paris the release of 

the Working Group One report from the IPCC. There will be a second one, Working Group Two, released in April. I am on the writing team for that; its topic is adaptation vulnerability and sustainable development. It works to the nexus of the development and 

adaptation issues, as well as related to mitigative capacity of various countries, so stay tuned for that, please. 

The CHAIRMAN. Well, thank you very much. 

Senator Dorgan. 

Senator DORGAN. Mr. Chairman, thank you very much. Let me 

say that I agree with Senator Domenici in respect to the use of 

coal. Mr. Jacoby we are going to use coal, the question just isn’t 

‘‘whether’’, the question is ‘‘how’’ do we use coal and I think these 

projects are very important to find ways for the development of 

zero emission coal-fired appliances, for example. We have in my 

State of North Dakota the only plant in America that produces synthetic gas from lignite coal. 

About three decades ago we were going to produce a lot of those, 

build a lot of those plants. Only one was completed. We now 

produce synthetic natural gas from lignite coal. We have the largest application of sequestration of CO2 at that plant. We take the 

CO2 from this plant that turns lignite coal into synthetic natural 

gas. We pipe the CO2 to the oil fields in Alberta, Canada, and invest that CO2 back into the marginal oil wells to increase the productivity of oil wells. We sequester the CO2 from the synthetic gas 

plant. You dramatically increase the marginal capability of these 

marginal oil wells. It is exactly the kind of thing we ought to look 

to do as we produce all of these bio-fuels. We ought to take a look 

at location, with respect to using and capturing CO2, to further enhance the productivity of oil development. 

But having said all that, Mr. Stern, first of all, thanks for your 

work, thanks to all of you for participating today. When I hear your 

description of China, India, I mutter under my breath, ‘‘I hope so.’’ 

It sure does sound optimistic to me, but I hope so. I hope you’re 

right about this. It appears to me that there is a natural tension 

and conflict with respect to the global economy and this issue of 

global participation with respect to climate change. 

When we take a look at the jobs from the U.S. or England migrating to China or India in search of cheap labor, those jobs are 

also in search of not just cheap labor, but also less regulation and 

lower costs. One of the aspects of that has nothing to do with laws 

on the books of China or the laws on the books of other countries. 

Many countries have really strong laws dealing with the environment or minimum wages, but they are never enforced, in a number 

of circumstances that I have pointed out previously. 

So my question is this: isn’t there a natural tension with respect 

to the agents of production and the global economy’s searching for 

the lowest labor cost and the lowest production cost, therefore less 

environmental regulation? Search around the world where they 

have those opportunities and the opportunity even in those countries, less developed countries, to oppose the kind of regulatory 

structure we have already imposed upon ourselves. We see it every-
49

day. We see it all the time; see it in China and in India. If that’s 

the case, if there is this natural tension and I believe there is, what 

makes you so optimistic with respect to both China and India? 

Then if I might make one other comment. 

Mr. STERN. I’m sorry. 

Senator DORGAN. You say climate change is the greatest market 

failure the world has ever seen. I think there’s probably a germ of 

an idea in my question about this issue of market failure, and I’d 

like to have you describe what you meant by that. 

Mr. STERN. Just on that second question, it is an important one 

and I did try to answer it a little earlier. 

Senator DORGAN. Senator Bingaman just told me, go ahead and 

skip that, if you’d answer the first question. 

Mr. STERN. Thank you. What I said about China and India, I 

should say emphasized a bit more strongly for China than for 

India. I think that China’s moving a bit faster than India was 

about direction of movement. I think that those countries, those 

two countries are changing very rapidly in their attitude to energy 

efficiency and the environment. They both realize that global 

warming really matters to them. Just for example, from the point 

of view of the receding snow and glaciers in the Himalayas: that 

would increase water stress in much of the year for both countries, 

both India and China which rely to a very large extent on water 

that originates in the Himalayas. Of course the glaciers and the 

snow act as sponges, and they spread it out over the year. Without 

that, you’ll have torrents and floods in the rainy season and dry 

rivers in the dry season, so they really do understand increasingly 

strongly, how much it matters to them. They also realize their increasing weight in the world economy and their responsibilities as 

key players in the world economy. It’s movement in the right direction. 

I’m optimistic about movement in the right direction, but not 

necessarily about whether it will be fast enough and a big enough 

scale to deal with this problem. That’s why I think collaboration 

and participation, as Senator Domenici was describing, is so important. But in order to do that, to collaborate effectively with other 

people, I think you do have to recognize what they are trying to 

do. 

Just as I explained a little earlier, when we’re in China we go 

to great lengths to emphasize just what the United States is doing. 

Because in China, you’ll be told that the United States is doing 

nothing about this, and they’re not going to move much more 

strongly unless the United States does. We try to show that that 

argument is not well-founded, that actually there’s intense discussion and a lot of action in the United States on those issues; for 

example, the kind of plant that you described in your own State as 

well as the ambitions of California, the trading in the Northeast 

States, many cities in the United States, and so on. So we do emphasize that very strongly and it’s vital to build the collaboration 

to have that mutual understanding. 

On the migration of jobs we try to take that issue on directly in 

Chapter 11 of the report, to review the evidence that there is on 

the mobility in response to environmental regulations, and to think 

that through in relation to the increased costs. It could be an effect. 
50

The question is how big that effect is likely to be, and we have to 

get quantitative about that. If we’re right that the extra cost to 

production costs to getting serious about climate change, it is at the 

order of 1 percent of GDP. That’s like a 1 percent one-off increase 

of costs. That’s significant but in very few cases, I think would it 

be the kind that would trigger a big movement. That is small in 

relation to difference in wage rates at 5, 10, 15 a factor of, 5, 10, 

or 15. 

So I think if you look at it carefully and empirically and look at 

the numbers and see how things move, that that particular aspect 

of the story, the extra costs in trying to do things differently in 

terms of energy, would be a very small part of that story and by 

itself, I think unlikely to trigger a massive movement. It could be 

different in a few industries, and in those few industries I think 

it’s important to try to look for international agreement—steel, aluminum, cement—and we discuss those kinds of agreements in 

Japan and in China, and I think in those few industries which are 

very energy-intensive, it would be possible to build sectoral agreements. But that would involve governments and private sector 

working together. 

Senator DORGAN. Well, Mr. Stern, thank you and I certainly hope 

you’re right. I understand what you’re saying now. This is about 

direction rather than progress. If you feel that the Chinese have at 

least started to think in terms of moving in a constructive direction, that’s different then quantum progress, so I understand what 

you’re now saying. 

I would only observe—I don’t mean to be either an optimist or 

a pessimist about this—that the agents of production, particularly 

those that have become much, much larger than they were decades 

ago, have always resisted additional regulations. When they move 

to find the lowest cost unit of production capability in China or 

India or the Philippines, they will similarly resist regulation just 

as they did here for many decades. Most of what we have achieved 

through regulation has been over the objection of some very substantial interests in this country. 

This doesn’t relate to the environmental issue but it relates to 

the same thing I’m talking about. The president of the Philippines, 

some while ago said, ‘‘I think we need to increase the minimum 

wage in the Philippines.’’ One of our corporations that’s in the Philippines, the very next day said, ‘‘You do that, we leave.’’ 

The same approach with respect to trying to retain low-cost production in these areas: I just ask the question, is there tension with 

respect to the global economy and the agents of production searching for the lowest cost? Is there a need for not only regulatory capability but enforcement that would produce real progress rather 

than just a positive direction in some of these countries? 

So let me thank you all for being here. I apologize that I was 

late—I have three committee hearings going on at the same time—

but I do think this is a very constructive opportunity for us, and 

I hope for you to exchange views on something that is very important to this country and to the world. 

The CHAIRMAN. Senator Corker. 

Senator CORKER. Yes, sir. Well, thank you for the testimony and 

for your leadership on the committee. 
51

As you look at the various tensions that do take place and you 

look at the fact that any kind of legislation that may take place 

here in America—and I know there’s going to be a lot of legislation 

introduced to deal with this—really drives investment by entrepreneurs and therefore ends up being something that both large 

companies that are investing large capital, small entities that are 

seeking capital need to count on in order to move in a certain direction. Based on the experiences that you’ve had in the European 

Union, where I suppose the cap and trade legislation over there 

has been not perfect, if you will, as it relates to trying to meet the 

guidelines that have been laid out—what are the components in 

your opinion of the perfect piece of legislation for a country like 

America? 

Seriously, what would be those components that you would lay 

out knowing that again you look at discount rates? I was a former 

finance commissioner. I understand you can just with a small, 

small change make huge differences in outcomes. What would be 

the type of legislation that you would propose be put in place, that 

allows for changes that will take place, that we all know will take 

place? Our assumptions will not be correct, to allow a dynamic 

market, if you will, to adjust and take into account proper legislation. 

Mr. STERN. Perfection’s a tough ask. I think you need a combination of measures. In the report we argue that regulation and standards can play an important role in giving confidence in the direction of a market. If you require unleaded gasoline, and you state 

that that’s going to come in, and it’s definitely going to come in, 

people can plan clearly on that basis. Similarly with catalytic converters or the Star schemes that you have for electrical appliances. 

Those kinds of regulations, either direct regulations or regulation 

on transparent information can, I think, develop markets. The 

United States has shown the way in many cases on that. So partly 

I think regulation will have a role to play. 

Second, cap and trade policies have a powerful role to play. They 

will have a role to play in different areas from tax policies. Cap and 

trade in Europe covers about half of Europe’s emissions; I mean, 

it’s a big scope of the scheme. It’s been going for 2 years and we’ve 

learned a lot along the way and what we’ve learned is beginning 

to get embodied in our plans for the next stage. 

One thing we learned, which may come in the category of the 

blindingly obvious, but it is that if you give away too many permits, you’re going to have a very low price for a permit. That’s economics 101, I guess, and that’s something which did happen in the 

early stages and which we’ve taken lessons from now. In the second stage of the scheme which runs from 2008 to 2012, the plans 

for the permits around Europe are coming in now and the environment commissioner has to deal with them. He’s taking a much 

more robust line than was the case the first time around, so the 

scheme itself is a good scheme, but the way it’s operated, and the 

kinds of ways in which permits are issued, will of course make a 

very big difference. 

So I think your emphasis on learning as you go, both of how the 

scheme operates and about how the technologies are coming forward to give you more opportunities, those kinds of ways have to 
52

be enshrined and embodied in the schemes. So you have to be 

strong on the ambition. You have to have scarcity otherwise markets don’t work. 

You also have to in this case, look long. Our third phase in Europe will be 2012 to 2020. The current periods of up to 2012 are 

far too short for people to make investment decisions in these kinds 

of industries. So going long is an important part of the design of 

a scheme. Being open to other trading schemes, being open to the 

possibilities of linking up with Northeastern States, with California, with Australia as it comes through, with India and China 

as they start to develop; openness, I think will be important part 

of that story. 

So within cap and trade, I’d emphasize scarcity, long-time horizons and openness with the ability to adjust along the way as information comes in. In Europe, taxation on gasoline is a very important part of the policy, and I think that has a role to play as well. 

So I would look across regulation, cap and trade, taxation, and 

we’ve already—with Senator Domenici—laid strong emphasis on 

research and development, and deployment, so I wouldn’t cover 

that again. I think the cap and trade is going to be crucial, but as 

part of the suites of measures, the suites that policies, that look 

across the board in the way I just tried to describe. 

Senator CORKER. Comments from any other? 

Mr. JACOBY. I think a suite is correct. I realize this is perhaps 

an economist moving out of his area to talk about politics, but I’m 

sorry we don’t have more discussion of the possible choice of taxes 

or cap and trade. You don’t seem to be able to talk about a carbon 

tax as a possible mechanism. That would be worth some consideration, I believe. I think that cap and trade, as I indicated in my 

testimony, could do the same thing. Thank you. 

Mr. YOHE. I would just like to agree with what Jake just said. 

It would be nice if taxes weren’t so taboo, because they do all sorts 

of good things and could generate revenue with which you could 

fund adaptation, equity considerations, and R and D, as well as 

looking into carbon sequestration and a variety of things like that. 

Of course, Senator I’m sure you realize that the converse of your 

question, that uncertainty about the regulatory environment and 

uncertainty about where carbon policy or climate policy is going to 

go, leads to uncertainty in the investment world. It has the potential of locked indecisions in very high carbon intensity technologies 

with which we will be dealing for 30, 40, 50 years, perhaps, and 

that increases the economic costs of making adjustments in climate 

policies as the future unfolds. 

Senator CORKER. Thank you. Mr. Chairman. 

The CHAIRMAN. Thank you. 

Senator Salazar. 

Senator SALAZAR. Thank you very much, Chairman Bingaman, 

for holding this hearing on this very important subject. Thank you 

for assembling this stellar panel that you have here today. 

I have a question to you, Dr. Jacoby, and then a general question 

and I’d appreciate it if each of you would respond. Again we’re 

under a time limitation, so I’d appreciate it if your responses are 

short. 
53

First with you, Dr. Jacoby, a question on carbon sequestration: 

the work that you are currently doing, would it be beneficial for us 

here in the U.S. Congress to move forward with conducting a national assessment of where we can geologically move forward with 

respect to carbon sequestration opportunities here in our own Nation? So if you will respond to that question. Then second, for the 

entire panel: we started getting into a conversation here about 

emissions trading approaches versus putting a tax on carbon emissions—would you amplify which one of those two approaches, a few 

of you already spoke to it, but would each of you take a minute and 

give us some guidance as to the policy choice between moving forward with the cap and trade system versus putting a tax on carbon 

emissions? What you would pursue if you happen to be king for a 

day? So, Mr. Jacoby, and then why don’t we just move across the 

rest of the panel? 

Mr. JACOBY. I’m not familiar with the details, but I believe under 

the DOE programs there already is substantial effort on a set of 

regional studies to identify potential areas, particularly saline 

aquifers where you could do this storage. A lot of that work also 

went on in the competition that went on among various regions of 

the country to get the FutureGen project, which is the major DOE 

activity to bid your R&D commercial demonstration. So I think 

there’s quite a bit going on here. I’m not really confident to say 

whether it’s enough, but there is a lot already going on to identify 

these geological areas. 

Senator SALAZAR. And my second question: why don’t we start 

with you, Gary, and move across. 

Mr. YOHE. Okay, thank you. I do favor a tax approach, and I describe that a little bit in some of my testimony that’s written before 

you: an idea that would start somewhere around say $15 a ton of 

CO2 go up at the rate of interest to inspire the appropriate decision-making in investments decisions, then avoid locked-in investments, as I spoke before. 

Fundamentally, one of the reasons that I worry so much about 

the cap and trade is that volatility in the price that could obscure 

the signal. It is not where you set the initial tax that gives this policy or the carbon price its traction. It is its predictable, persistent 

increase, year after year after year, in ways that don’t damage the 

economy but send a signal that carbon will be more expensive tomorrow than it is today, and it will be more expensive next year 

than it is tomorrow. Those inspire the appropriate decisions at 

times when they can be made at least cost. When they get buried 

inside signals of variability, it’s a little bit harder to see that happening, so that the $15 that I’m talking about is $6 a barrel of oil. 

Senator SALAZAR. That would be your preferred approach——

Mr. YOHE. It would be, yes. 

Senator SALAZAR [continuing]. In dealing with this issue? Dr. 

Jacoby. 

Mr. JACOBY. I would prefer a tax system, but not terribly strongly. I don’t want to lose the good in fighting for the perfect here. So 

I think the cap and trade system can be quite satisfactory. I regret 

we don’t spend more time thinking about the details of the two approaches. 
54

On the volatility issue, two potential corrections can be built into 

these systems. One is the safety valve; now we can have more discussion if you want about the level of the safety valve, but that is 

what that’s about and how it’s set is important in terms of influencing volatility. The other thing that gets built into the current 

bills that are before you is banking, where you can do more now 

and save it to do more in the future. Banking also has an influence 

on reducing volatility, and if I may take off on Sir Nick’s comment, 

on what’s happened in the European trading system. One of the 

reasons that the European trading system’s current price is so low 

is that there is so much restrictions on the banking into the next 

period. So banking has a big effect on this. 

Senator SALAZAR. Thank you. 

Mr. JACOBY [continuing]. So there are ways to moderate the volatility problem. 

Senator SALAZAR. Thank you. Why don’t we go to Ms. Peters and 

then come back to you for the final comment on this question, Mr. 

Stern? 

Ms. PETERS. Just also picking up on volatility and other ways of 

managing it, using offset mechanisms to make any scheme which 

is open to trade with others is another very helpful way to manage 

volatility in emissions trading scheme, once it is established, once 

the rules of the game are established, and once there are clear 

guidelines to how to recognize emissions reductions evading across 

other schemes. So the cap and trade in its early stages is likely to 

be quite volatile, but I’ve seen some more established—you can do 

that rising long-term predictable price signal, which I highly agree 

is appropriate. 

Senator SALAZAR. Sir Nick. 

Mr. STERN. I think the controls on volatility that Jake on my left 

and Siobhan on my right have described are very important parts 

of the design mechanism, and can be taken forward in a way that 

does give you reasonable stability. 

I would use cap and trade in some parts of the economy and taxation in other parts of the economy. In the European Union electricity generation and the big industries are particularly appropriate for cap and trade, but it’s reasonably easy to observe what’s 

happening in just a few plants. It does have the advantage, emissions trading, of allowing interaction with other countries. It allows 

you, through your own actions, to help build the international coalition that’s going to have to be part of a whole story. So I think it’s 

a great advantage in terms of international exchange and cooperation associated with emissions, trading. Also it gives you a take on 

the total quantity of the action. You have a take on just how much 

you’re trying to reduce emissions which isn’t so easy with a tax instrument. 

Tax on the other hand can be more appropriate where you have 

lots of small firms where everybody uses gasoline in some shape or 

form. I would have a tax on gasoline rather than cap and trade on 

gasoline. So I would look at different parts of the economy. Look 

at what they offer, look at the advantages, and I think you get to 

some pointers as to where you’d want to use emissions trading and 

where you’d want to use taxation. But I would use them both, not 
55

at the same time or in the same place, in different parts of the 

economy. 

Senator SALAZAR. Thank you very much. 

The CHAIRMAN. Senator Murkowski. 

Senator MURKOWSKI. Thank you, Mr. Chairman and thank you 

to the very distinguished panel here this morning. You probably 

didn’t notice since your back was to them, but earlier this morning 

there was probably 25 or 30 young people who were standing in the 

back. I’d like to think that the reason that they’re still not here 

after almost 2 hours of hearing is that they had to move off to their 

classes, but I think it demonstrates the significance of the issue 

here before us. It’s particularly important that our young people 

are part of the discussion as well. 

I appreciate the focus that all of you have had in the discussion 

that has been had to this point on the adaptation. Dr. Yohe, you 

mentioned the term ‘‘adaptive risk management approach’’ and in 

your report, Sir Stern, you focus to a fair degree on the adaptation. 

Just reading my Alaska clips from home this morning, I’m reading 

about a new initiative at our university which is an endeavor at 

the university to get the research information into the hands of the 

policy-makers. So it’s not just the scientists that are taking advantage of the research and then not moving forward further with it. 

They’re using the example that if you’re a shipping company, it’s 

going to be helpful to know what the ice conditions might be over 

the period of the next decade or so. This is important as we move 

forward and recognize that we are dealing with climate change, 

and certainly in my State we know it, because we can see it, but 

we also know that we have got to figure out how we can be adaptive, how we can be responsive, so I do appreciate that discussion. 

Sir Stern, I want to ask you: in your report, you state that the 

removal of barriers to behavioral change is the third essential element, and you say particularly as it relates to cost-effective energy 

efficiency measures. We had a hearing in this committee yesterday, 

in our subcommittee on energy efficiency. It was very interesting. 

You recognize how much more we can do in that area. Can you develop further how we can attempt to remove these barriers to energy efficiency that we are currently facing? 

Mr. STERN. Thank you. I would share with the others on this 

panel, and it’s emphasized very strongly in the report, the importance of adaptation. What you’re seeing and what we’re all seeing 

is the effects of the temperature increase of 0.7 centigrade relative 

to pre-industrial times. I think it’s clear that however strong we 

are, and we hope we’re very strong on reducing emissions, we’ll 

probably see something like 2 to 3 degrees centigrade all together. 

So we’ve got another probably 2 degrees centigrade or close to 2 degrees centigrade coming, and we’re only seeing at the moment the 

consequences of 0.7 degrees centigrade. So a lot of climate change 

will be there and even if we act very strongly. I think the adaptation story is fundamental, and information of course is fundamental, to people being able to adapt intelligently. I would certainly share that. 

The removal of barriers to behavioral change in energy efficiency, 

they come in a number of ways, but one of them I think is just people’s appreciation of the magnitude of the problem and the impor-
56

tance of their own personal actions. That I think comes with sharing of ideas, hearings of this kind, and education in schools, so that 

people understand what the consequences of their actions are. I do 

think they’re influenced by more than simply the prices and taxes 

and subsidies and incentives that they face. They’re also influenced 

by their understanding of the problem, so that itself is one part of 

the story, and the schools, of course, have a very important role to 

play in that. 

There are problems in capital markets. How easy is it to borrow 

against the returns that you get from energy efficiency? The European Bank for Reconstruction and Development, which lends to 

eastern Europe and the former Soviet Union, has been quite innovative in coming forward with various kinds of loans which recoup, 

or which get their repayments, through energy efficiency. But I 

think capital markets are not well structured around that issue. 

Regulation of new buildings: often people who are putting a 

building together might feel that the extra cost of the extra insulation wouldn’t be too understood, wouldn’t be too known by buyers, 

and they wouldn’t get their full returns. So I think regulation on 

new buildings is one way forward as well. 

Senator MURKOWSKI. Let me ask, because I just have a minute 

left here. I wanted to pose a question to you, Dr. Jacoby and to Dr. 

Yohe. It’s been suggested, I think it was you, Dr. Yohe, that said 

that we needed to be flexible in developing whether it’s a cap and 

trade system or a carbon tax, so that it can change with the scientific understanding and perhaps the changing expectations. Recognizing that you’re suggesting we’ve got to be flexible, does this 

send perhaps a conflicting or inconsistent message? We’ve indicated, and Dr. Jacoby you’ve said, we need to send a strong signal 

on the importance of climate policy. Can we do both? Can we be 

flexible and still send a consistent message to other nations? 

Mr. YOHE. That’s fundamentally one of the questions. We will 

learn more about the climate. We will learn more about the drivers 

of climate change as the century progresses, but investment decisions need to be taken in an environment where there’s predictable 

and persistent policies for the short- to medium-term. It’s a matter 

of timing and it’s a matter of being very creative in constructing 

the institutions by which new science and new understanding can 

be brought to bear long-term policy objectives while short-term 

policies are being set. The only example that I can refer you to off 

the top of my head that does something like that is the Federal Reserve system of the United States. They have long-term economic 

growth as a major objective but they set monetary policy at least 

quarterly and occasionally every month. 

Senator MURKOWSKI. Dr. Jacoby, can we be flexible? 

Mr. JACOBY. I think you’ve hit on one of the big problems that 

Congress has: how to do this in a way that provides flexibility? 

I think it should start with some sort of scheme that puts a price 

on emissions, like a cap and trade system, with a plan for 5 or 10 

years as to what you’re going to do and to commit to that. It’s not 

as if, with the schemes that we’re likely to do, we’re going to do 

significant damage or go very wrong in terms of cost in relation to 

what the rest of the world does. So the trick is to get something 

on the tracks with enough horizons so it has an influence on in-
57

vestment, on investment incentives, on expectations, for 5 to 10 

years. We’re never going to at any one time set a policy for a century. What you want is a policy that’s long enough to have that influence, but is not so long that you give away the flexibility that 

you would need to adapt to what the rest of the world does, or 

adapt to what we learn about the problem. 

Senator MURKOWSKI. Thank you, Mr. Chairman. 

The CHAIRMAN. Thank you very much. 

Senator Menendez. 

Senator MENENDEZ. Thank you, Mr. Chairman. I want to thank 

you for assembling a very distinguished panel here on a critical 

issue and I appreciate all of their testimony. Sir Nicholas, I appreciate your report, which I think creates an added sense of urgency 

that some have not adapted to this view. I think it’s very important 

to look at this with a greater sense of urgency. Time flies quickly 

and I’m afraid that there are many who are still not of the belief 

that we need to move forward. While this is certainly a global 

issue, I sometimes think when we think locally, we may act differently. 

In my home State of New Jersey, I look at the consequences of 

an action and I think of the tremendous cost of unmitigated climate change that you describe in your report. We have fragile barrier islands that provide homes and jobs for hundreds of thousands 

of residents, support a $26 billion tourist economy, and protects the 

rest of the State from storm surges, just to name a few things. So 

rising sea levels would either drown out these islands or they’d require expensive levees or sea walls or other protective measures, 

and I think about that in a way in which the residents of my State 

can think about their stake in a meaningful way. So one of the 

things I’d like to explore with you is that here in the Senate I’ve 

heard a lot of my colleagues—and rightfully so—be concerned 

about the impact of any carbon reduction proposals. I think some 

of the discussion that has been going on here is along that line on 

the U.S. economy. The Energy Information Administration has 

done a number of analyses on a series of legislative proposals that 

are out there, and I was wondering if you, Sir Nicholas or any of 

the panelists, are familiar with any of that work? 

Mr. STERN. I’ve seen some of that analysis, Senator, but I’m not 

sufficiently close to it to answer in any detail. 

I would like to emphasize what I think is the right approach to 

the problem of urgency because we are already at 430 parts per 

million. We’re adding 2.5 parts per million a year, and that’s rising 

as a world, so if we do nothing in 30 or 40 years time we’ll be pretty close to the 550 parts per million that I suggested was the upper 

level of where we want to be. Because that level of stabilization 

would involve eventually a 50 percent chance of being above 3 degrees centigrade relative to pre-industrial times, hugely more than 

0.7 degrees we’ve seen already. I think the urgency part of the 

story points strongly to a joint understanding around the world of 

a stabilization target that we argued in the Review should be no 

higher than 550 parts per million. 

On the costs to economists, we do our own calculations in the Review and we come up with roughly 1 percent of GDP; that’s like 

a one-off 1 percent increase in cost. 
58

Senator MENENDEZ. I don’t know any of the other panelists’ 

views, but it seems to me from what I can gather from the information that there’s no analysis of the costs of inaction. While we seem 

to be focused on the costs of any particular course of action, what 

I’m concerned about is, shouldn’t we also be looking at the costs of 

inaction? Shouldn’t there be an accounting for the benefits that 

we’ll get by implementing these proposals, and for stalling a rise 

in temperature? 

Mr. STERN. That is the kind of calculation, sir, we tried to do in 

the Review. And we came to the conclusion that the costs of inaction were much bigger than the cost of action, and the cost of acting strongly and urgently was very good economics. 

Mr. JACOBY. The one thing that’s going on is that under the climate change science program there’s a set of synthesis and assessment products. One of them is out, one of them is about to come 

out. Those are a sequence of studies that are due to come out in 

coming months which draw together the information that’s available in the climate science world, to answer questions like that. So 

there is work like that going on. 

It will not go all the way that Sir Stern meant to, in monetary 

numbers, because the climate science program is not going to do 

that. But going down to the levels of changes in climate variables 

and then on to what might be some of the regional implications, 

that work is being drawn together. I don’t know exactly the horizon 

of it, but those synthesis assessment products are one of the major 

activities within the U.S. Government. Of course, out in the academic world people are doing this all the time, not really official 

studies. 

Senator MENENDEZ. It seems to me it’s an incredibly important 

part of the ledger——

Mr. JACOBY. Yes. 

Senator MENENDEZ [continuing]. That isn’t necessarily being considered. We can look at how we fine-tune a strategy so that it has 

a minimum impact in the economy, but if we don’t consider the 

consequences in the out-years just as we’re having a great debate—

I just left the budget committee before I was able to come here, 

having a great debate about entitlements and the costs in the outyears. Well, if we don’t look at the out-years we certainly can’t form 

policy now as a way in which to deal with the costs of rising entitlements. Similarly, it seems to me if we’re not looking at the outyears of an action, the consequences in the long term are somewhat 

exponential. Doctor? 

Mr. YOHE. Yeah, there are a couple of points. The second and 

third working groups of the IPCC will be issuing their reports later 

this year and both of them will have comments about such things. 

In particular, Working Group Two will be able to, not only for New 

Jersey in the United States, but for all of the continents and major 

sectors, have information from which you can glean answers to 

questions about the cost of inaction. 

I would also, though, like to suggest that the cost of inaction is 

in some ways a simpler problem. Because if you look at these figures here, you see that it’s quite likely that some sort of climate 

policy will be required. So you could say, ‘‘Well, what if we delay 

for 10 or 15 years?’’ Then the cost of inaction is the cost of ramping 
59

up the policy much more quickly than otherwise would have been 

required. 

I did a paper with some colleagues a couple of years ago and 

asked the question, ‘‘What if we don’t do anything for 30 years?’’ 

Waiting for the next batch of new science, but we had sort of an 

equal likelihood of certain temperature targets, 2 degrees, 2.5, 3 degrees or whatever, and one of the possibilities was this climate 

business turns out to be a hoax and in 2035 we found out that we 

shouldn’t have been doing anything at all. The least-cost solution, 

which was the least minimum adjustment cost solution and expected value over that, was $10 a ton of CO2. 

For sure if our climate turns out not to be a problem, we overdid 

it early. But because of the possibility that 2 degrees was the target, we wanted the cost of inaction to be No. 1, a huge amount of 

ramping up that cost a lot of money, even discounted at 5 percent 

back to the future. No. 2, there were temperature targets that were 

now precluded; we just couldn’t get there from here, because we 

had thrown so much up into the atmosphere, the warming was already there. We were committed by our inaction to temperature increases that were above what might be reasonable targets, according to certain definitions of what’s dangerous. 

Senator MENENDEZ. I appreciate that. I mean there’s other values here too, including the cost of the value to public health and 

some of these issues as well, that we haven’t even equated. 

Mr. Chairman, if I could just make one very last question, since 

I see that no one else is here. I appreciate your courtesy. 

Part of what you say in the report as a key finding is action required to address deforestation, which is estimated to represent 

more than 18 percent of global emissions—more than the entire 

global transport sector. I sit on the Senate Foreign Relations committee, on the committee that deals with international environmental issues as well as foreign assistance, and wonder if you have 

any suggestions as to how we stem the tide of deforestation in the 

report? 

Mr. STERN. I think it’s crucial to work very closely with the countries in which the trees stand—in Brazil, Indonesia, Malaysia, 

Papua New Guinea, and so on. The vast majority of the deforestation occurs in seven or eight countries, so I think it’s a question 

of building collaboration with those countries and indicating to 

them that if they come up with good plans for dealing with deforestation—plans that only they themselves can produce, because 

only they understand the environments, the communities, and social structures in which they live—if they come up with strong 

plans, they’ll get very powerful international support. I think that’s 

something which the World Bank could do a great deal on. I believe 

they are moving in that direction, and I think strong support from 

the shareholders at the World Bank, will be absolutely fundamental. But as you say, Senator, this is very much about foreign 

relations and building collaboration. I think building collaboration 

with developing countries in the ways that you describe—on deforestation, and in other ways—that we discussed earlier on carbon 

trading and sharing technology, will be fundamental. I also believe 

that a strong alliance between the European Union and the United 
60

States on these issues could have an enormous influence on the 

speed and scale on which we tackle this problem. 

Senator MENENDEZ. We’ll look forward to exploring it with the 

World Bank at one of our hearings. Thank you, Mr. Chairman. 

The CHAIRMAN. Thank you very much. Let me just ask one additional question. I believe Senator Domenici is trying to get back to 

the hearing and he may before the answer is completed, in which 

case he may have a question. 

Sir Nicholas, you indicated, as I understood your testimony, that 

one of the things we need to work on long-term is getting to a global price for carbon. Could you just briefly describe how you see us 

going from where we are today to a global price for carbon? That 

seems to me to involve some fairly major hurdles that need to be 

overcome. 

Mr. STERN. The key element in that would be building an international trading scheme, so that when you design your cap and 

trade scheme, sir, for the United States, you should bear in mind 

that the technicalities of linking it with European Union trading 

schemes should be a big part of the story, so it’s trading schemes 

that can speak to each other. The two biggest will be the European 

Union, which is on the way, and that of the United States, which 

is already in its early forms. I think with your leadership it will 

grow so the building of an international price depends on the linking of those schemes, and then the further linking as time goes by 

with India, China and the other main countries. I think that will 

be the main method. 

Another method, of course, is if we go the tax route. We have to 

look at the taxes that other people are charging and try to do what 

you can to bring them into line. I don’t think a formal structure 

in that case would be likely to get very far, but awareness of what 

others are doing and linking your tax prices to your cap and trade 

prices would, I think, bring that kind of harmony in a way that 

wouldn’t be formal or heavy, that could actually create it. 

The CHAIRMAN. Well, thank you very much. You’ve all been very 

generous with your time and it’s very useful testimony. I think obviously a lot of the questions have demonstrated the interest the 

committee has on this subject, so thank you all very much for being 

here. 

If there are additional questions, if Senator Domenici has any additional questions, or anyone else, we may submit those to you and 

ask you to respond if you could for the record, but again thank you 

for being here and we will adjourn the hearing. 

[Whereupon, at 11:56 a.m., the hearing was adjourned.] 
(61)

APPENDIX 

RESPONSES TO ADDITIONAL QUESTIONS

RESPONSES OF SIR NICHOLAS STERN TO QUESTIONS FROM CHAIRMAN BINGAMAN

Question 1. In your testimony, you say that ‘‘Climate change is the greatest market failure the world has ever seen.’’ Can you explain what you mean by this? Why 

is this different from other market failures? 

Answer. Economic activities which emit greenhouse gases directly affect, via climate change, the consumption and production decisions of others. They are thus, 

in the language of economics, an externality. Climate change is a market failure 

since, without climate change policy, the costs of these impacts are not considered 

by consumers or producers when they make decisions that lead to greenhouse gas 

emissions. 

There are two reasons why I believe that it is the greatest market failure the 

world has ever seen. First is the breadth of human activities that are involved. Most 

production and consumption actions have some greenhouse gas emissions associated 

with them (though a large proportion of emissions come from a limited number of 

activities). The sources of greenhouse gas emissions are diverse in their nature and 

motivation. As greenhouse gas emissions add to a global stock, it does not matter 

where the emission comes from—the impact is global. Each emission affects everyone on the planet albeit in a very small way. The actions of everyone have an impact on everyone. This is in contrast with other externalities such as road congestion and acid rain where the sources of the externality are fewer and the impacts 

are generally felt locally. 

The second reason is the scale of the potential impacts. Other market failures 

may lead to under-provision of particular goods or higher prices for consumers 

whereas this market failure has the potential to seriously threaten the way we can 

live our lives in the future. If emissions continue to rise, following business-as-usual, 

by the end of the century there is a very real possibility of atmospheric concentrations such that, next century, we will see increases of 5 degrees C temperature 

change from pre-industrial levels. This is equivalent to the change between now and 

the last ice age and it is inevitable that this would have a profound effect on the 

physical and thus the human geography of the world. Some of these impacts are 

highlighted in Figure 2 of the Executive Summary that Professor Yohe brought to 

the Committee’s attention and outlined in more detail in Chapters 3-5 of the Review. 

Question 2. Dr. Yohe says in his testimony that building in a ‘‘safety valve’’ to 

a cap and trade program sets a loophole in the policy that could easily be manipulated. We are considering such a mechanism in the legislation that I have circulated 

and I would like to ask your thoughts on whether or not it makes sense to use such 

a thing. 

Answer. Introducing a safety valve—some sort of cap on the price of allowances 

in an emissions trading scheme—is thought to have two potential advantages—one 

economic and one political. The supposed economic advantage is that it can reduce 

price volatility in the market by reducing the risk of any price spike, and also minimize uncertainty on the upper limit of prices by capping it. When prices reach the 

cap level, emissions are allowed to increase without a consequent increase in prices. 

If such a cap on prices or ‘safety valve’ were in place for a short duration of time, 

then there are minimal risks to the environment, as it the total stock of emissions 

in the atmosphere that cause warming, rather than the timing of those emissions. 

In particular, if a safety valve were to operate over a long period of time, this could 

put the environmental credibility of the scheme at risk. Although it is the total 

stock of emissions in the atmosphere that cause warning, rather than the timing 

of those emissions, over a long period of time, the flow of emissions would cumula-
62

1When the safety valve was triggered. 

2Much of the same reasoning can also apply to a price floor (a minimum price for permits) 

since when prices are very low it is efficient to take advantage of low cost abatement. This can 

provide security to those investing in low-carbon infrastructure and thus potentially reduce the 

trading price. It does, however, suffer many of the same potential problems and as also a major 

risk to public finances. 3The price cap when set very low effectively takes the form of a tax rather than a trading 

scheme. 4For more on the design of emissions trading schemes see Chapter 15 of the Stern Review 

and Box 15.2 for price caps and floors. 

tively increase,1 and the environmental risks would therefore increase. Over short 

time periods, it may be efficient to avoid high abatement costs or price peaks, because adjustments are more difficult to make in the short-term.2 This leads to the 

political advantage of price caps; they can be used to avoid price spikes that may 

undermine support for emission reductions policy. 

I am however skeptical of the merits of the price cap via a ‘safety valve’ and believe there are better ways to manage the risks of price volatility. First of all, it 

is difficult to ascertain how much a safety valve can contribute to minimizing uncertainty for investors. The price at which it is set would be a political decision, that 

is therefore subject to political risk in terms of when and at what level it would be 

set, what and how changes would be made to its level. Investors may not find the 

safety valve itself much more certain than estimating where the free market price 

of carbon could peak during a particular time frame. 

Secondly, policy makers can use good market design to overcome some of the risks 

of peaking prices. There are a few design features that can help this. One is to have 

long trading periods (say at least 10 years), allowing banking of allowances between 

periods of trading. Allowing firms the flexibility in compliance options over time reduces risks of forcing abatement in short time periods and the subsequent peaks in 

abatement costs. A second is broadening trading schemes to include more diverse 

economic sectors that have different abatement costs and that are subject to different influences will tend to deepen markets and help to stabilize carbon prices. 

A third design feature is to expand trading schemes to allow them to link to purchases of emission reductions from the developing world (for example via Clean Development Mechanism credits or a revised equivalent) thus reducing overall compliance costs and therefore limiting the level of any price peaks. Unlike a safety valve 

mechanism where firms have unlimited emission rights once prices exceed the safety valve, using a link to reduction-credits in the developing world maintains the environmental credibility of the policy as it involves buying emission reductions from 

elsewhere. Importantly, linking to the CDM or similar mechanisms also builds cooperation with developing countries and provides options for them to benefit from 

investment in lower carbon technologies. 

Thirdly, any price cap, by setting an upper limit on future prices, will reduce 

firm’s central expectation of future prices. This is particularly the case if the cap 

is set too low and the price is expected to ‘‘hug the ceiling’’.3 The safety valve reduces the incentive to invest in mitigation and increases the likelihood that the cap 

will be triggered. It also impacts on the incentive to innovate and adopt technologies 

that are currently higher in price but may fall. This means that either these technologies will not be adopted or that much greater support through other policies is 

required. 

Finally, and crucially in terms of the benefits of moving towards a more efficient, 

least cost global carbon market, price caps form a potential obstacle to linking with 

other trading schemes. Linking schemes is efficient as it allows a given target to 

be met through reducing emissions wherever it is cheapest. It also reduces price volatility by increasing market liquidity. Countries will be reluctant to join another 

scheme with a low safety valve, as it will reduce the environmental credibility of 

their scheme, as their firms will pay the low price of the safety valve in another 

scheme. It also increases the risk of manipulation by firms operating across borders. 

Technical fixes to these problems are available but increase the complexity of the 

scheme. 

In summary a well designed safety valve does have some potential advantages but 

these advantages can be enjoyed through other features of the scheme and a badly 

designed or very low safety valve will limit the effectiveness of any scheme.4 The 

potential disadvantages of a cap are significant and so they should such an approach should be avoided if possible. 

Question 3. You say that the three elements of policy required for an effective 

global response are: a carbon price, implemented through tax, trading, or regulation; 

support for innovation and the deployment of low carbon technologies; and action 

to remove barriers to energy efficiency, and to increase public awareness and en-
63

5The issues of public awareness and responsible behavior are explored in more detail in Section 21.4 and 17.7 respectively. 6 Covering 47% of industrial energy use. 

gagement. I think we are familiar with some of the mechanisms needed to accomplish the first two, but what can we do to remove the barriers to energy efficiency 

and to increase public awareness and engagement, especially in places like China 

and India? 

Answer. Action to remove further barriers, particularly relating to energy efficiency, is explored in more detail in Chapter 17 of the Stern Review. The choice of 

policy depends on the issue that is being addressed. We split the policy response 

to address these barriers into 3 categories:

• Regulation.—Regulation has an important role, for example in product and 

building markets by: communicating policy intentions to global audiences; reducing uncertainty, complexity and transaction costs; inducing technological innovation; and avoiding technology lock-in, for example where the credibility of 

carbon markets is still being established. • Information.—Policies to promote: performance labels, certificates and endorsements; more informative energy bills; wider adoption of energy use displays and 

meters; the dissemination of best practice; or wider carbon disclosure, can all 

help consumers and firms make sounder decisions and stimulate more competitive markets for more energy efficient goods and services. • Investment/Finance.—Private investment is key to raising energy efficiency but 

there may be market distortions (for example in property markets) or problems 

in obtaining finance for good investments. Generally, policy should seek to address the source of market failures and barriers. Investment in public sector energy conservation can reduce emissions, improve public services, fostering innovation and change across the supply chain and set an example to wider society.

Public discussion and awareness can have an important effect on individual behavior. It can also lead to society to act as an enforcement mechanism, ensuring 

that their national government sets policy and acts internationally in a manner that 

they consider responsible. How this can occur throughout the world was highlighted 

in Box 21.6 in the report.5

Both China and India have a significant emphasis on energy efficiency in their 

respective 11th 5 year plans. More can be done to support this. While not always 

the case, developing countries often install less efficient plant as they do not have 

access to or the capacity to adopt technologies with higher efficiency that are cost 

effective. Developed countries can do more to support the transfer of technologies 

to developing countries particularly by helping to build the capacity to adopt new 

technologies. This is explored in Section 23.4 of the Review. 

Question 4. We talked quite a bit about China at the hearing. Can you expand 

on some of the points you made about what is going on in China right now? 

Answer. During my travels in preparation of the review and since its release it 

was clear that there was often little understanding of the action undertaken by 

other countries. There is a tendency to underestimate action by others and falsely 

assume that in acting to reduce emissions any country would be acting in isolation. 

We outlined the goals of the 10 largest countries in Table 21.1 of the Review. Building a shared understanding of what other countries are doing helps encourage international co-operation and strengthen national action. 

Turning specifically to China—as I outlined in the hearing—I have experience of 

working in living in China over the past twenty years and am pleasantly surprised 

by the huge shift in attitudes towards the environment that began in the early 

1990s and accelerated rapidly in the past two years. The 11th 5 year plan has two 

headline targets—the growth target and a national objective to reduce energy intensity of GDP by 20% from 2005 to 2010. This includes a 10% reduction in air pollutants and 15% of energy from renewables within the next ten years. China has an 

impressive track record at meeting its targets. 

China already has the world’s largest renewable sector and is reforesting not 

deforesting. To achieve the efficiency targets the government announced its intention to give targets to the largest 1,000 enterprises 6 for which their chief executive 

is accountable. Enthusiastic local implementation has seen targets extended to the 

largest 8,000 enterprises. China is also seeking to close the ‘dirtiest’ sources of emissions. Efficiency standards for cars are higher than the U.S. and SUVs face an 

$8,000 tax in Beijing. 

Such strong policy objectives are justified by the three inter-related objectives of 

local environment, climate change and energy security. There is much concern in 

rich countries about a shift of carbon activities to jurisdictions with less active poli-
64

7 In shorter time periods in low lying and poorer areas particularly low lying Island states 

and countries such as Bangladesh. 

cies but China, for example, has introduced export duties on energy intensive products (iron, steel, cement, aluminum, coal and copper) ranging between 5% and 15%. 

In most cases this is a larger price effect than would have been the case if Chinese 

firms had been subject to the carbon price from throughout the first trading period 

of the EU emissions trading scheme. I interpret this as a clear desire to avoid China 

becoming the locus of the world’s pollution and energy intensive products. 

That said, there is currently a rapid growth in the Chinese energy sector to sustain economic growth, giving rise to oft quoted statistics of the number of new coalfired power stations that are produced each week. Lifting more of the population 

out of poverty through economic growth is an understandable priority in China (and 

India). Consideration of cost, local availability and speed dictates that coal will be 

the major fuel for energy growth and is forecast to remain at least 75% of electricity 

production for the coming decades. This emphasizes the importance of developing 

carbon capture and storage technologies and the transfer of efficient generation 

technology. It must be remembered when evaluating China’s green credentials that 

even when China overtakes the U.S. as the leading emitter of greenhouse gases in 

the coming years the difference in population means that China will have a less 

than a quarter of the emissions per head of population. 

RESPONSES OF SIR NICHOLAS STERN TO QUESTIONS FROM SENATOR DOMENICI

Question 1. Your review concludes, ‘‘the overall costs and risks of climate change 

will be equivalent to losing at least 5 percent of global GDP, now and forever.’’ Economist Richard Tol calls this claim ‘‘preposterous,’’ pointing out that society could adjust to higher temperatures and higher sea levels by developing technologies to 

adapt. 

Isn’t it possible that adapting to climate change might be best for the world economy? 

Answer. Adapting to climate change is indeed wise for the world economy—it 

makes little sense to act as if there is no climate change when we are already seeing 

it and more is on the way. As set out in my written testimony—we strongly argue 

that adaptation is a crucial and central part of the response to the challenges of 

climate change. Without adaptation the costs of climate change will be significantly 

higher. Even with strong mitigation, adaptation will be required to address the impacts of climate change. Adaptation is discussed in more detail in the three chapters 

in Part V of the Review. 

Adaptation can mute impacts, but cannot solve the problem of climate change. 

There are residual costs and limits to what adaptation can achieve particularly in 

the case of natural systems and due to sea level rise in the longer-term.7 Adaptation 

can, at a cost, reduce the impacts of climate change but cannot be a substitute for 

mitigation. Adaptation does not address the issue of risk, which is at the heart of 

the story. The impacts at higher levels of temperature change are potentially very 

large. It is obvious that if these were borne out assuming that we could adapt would 

prove reckless. Local benefits ensure that much action will be autonomous but this 

is dependent on good information on future impacts and is difficult for poorer members of society. 

When discussing the aggregated modeling of climate change impacts it is important to remember their role in assessing the risks of climate change. Modeling is 

inevitably dependent on aggregating much information and replacing much with 

simplistic assumptions. It loses much of the important detail and is dependent on 

often value-laden assumptions and what is included in the models. As was clearly 

expressed by Professor Yohe, the simplest way to look at the problem is to look at 

the disaggregated impacts alongside the cost of reducing emissions and consider 

whether it is worth paying for mitigation to avoid the risks associated with higher 

temperatures. That was the main argument of the review. Only Chapter 6 (30 pages 

of 700) embodies this type of modeling. The modeling supplements this approach 

and helps tell us what is important in terms of economic modeling approaches, scientific variables and ethical considerations. 

The modeling in the Stern Review, using Professor Chris Hope’s PAGE model, has 

produced cost of damage estimates that are higher than the existing literature for 

what I believe to be justifiable reasons. The major changes are, (i) the incorporation 

of the latest scientific information (ii), including the economics of risk and (iii) a full 

consideration of the economic and ethical implications of how we treat costs and 

benefits over time. 
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8 Adaptation costs are convex—see Box 3.1. As an intuitive example consider the following illustrative escalation of costs relative to temperature: at between zero and two degrees warming, 

agricultural output can be adapted and crops can change; some regions will see higher yields 

and longer growing seasons, levies can be strengthened and irrigation projects enhanced; between two and four degrees warming, new agricultural plant and processes may be required, 

levies and barriers must be rebuilt and new irrigation sources found; between four and six degrees some coastal areas must be abandoned and populations moved and former agricultural 

land must be abandoned. It is clear that the costs and impact of residual effects and adaptation 

costs are highly disproportionate—convex—to the linear change in temperature. Five degrees C 

temperature change would redraw the physical geography of the world and thus the human geography. It would ultimately lead to population movements on a massive scale that would inevitably entail great costs. 9www.sternreview.org. 

10 Inter-governmental Panel on Climate Change www.ipcc.ch/SPM2feb07.pdf. 

The model we used included a wide range of impacts and allows policy-makers 

to measure much of what counts rather than just counting what can be measured 

but many risks and potential costs are still excluded. In its construction it is based 

on the existing impacts literature and is thus in line with the cost estimates relative 

to temperature change in the literature. Many approaches do not include important 

impacts and effectively assume they are zero. Our estimates still exclude social contingent impacts such as the impacts of large-scale migration and conflict so is likely 

to be an under-estimate as so much is left out. Incorporating the latest science and 

the economics of risk does mean that the impacts at higher temperature are more 

likely to be triggered increasing average cost estimates. 

Responding to developments in the science the Review, I believe, added considerable value to the economics of climate change by incorporating the economics of risk. 

Understanding risk and incorporating the full range of risk when making decisions 

is desirable when making sound policy decisions. Rather than using point estimates 

the Review incorporates probabilities and thus the worst- and best-case scenarios, 

and has explicitly built in aversion to risk. Risks and uncertainties should be the 

heart climate change modeling. It is this that concerns many people and it is important that economics reflects the distribution of potential impacts as otherwise the 

numbers are biased downwards. 

Probabilities of temperature change from the science allowed outcomes to be 

weighted by their likelihood to ensure they are included in a balanced fashion. For 

climate change the damages increase more rapidly as temperatures rise. The distribution has a long tail so there are low probability high impact effects and these 

pull the average upwards. This is preferable to using a point estimate that does not 

include the full range of risk. The review also includes an aversion to large losses, 

as people routinely do in their daily lives, for example, in buying insurance. People 

are risk averse about a low probability of their house being destroyed and hence 

purchase insurance. 

The modeling in the Review, using the PAGE model, assumed adaptation to 90% 

of the impacts of climate change in developed countries, but only adaptation to 50% 

of the impacts in developing countries where capacity to adapt is lower. Some have 

criticized this as being too optimistic (i.e. overstate the degree of adaptation and this 

underestimates damages). It is important to recognize that adaptation is not costless 

and that adapting to the impacts becomes increasingly difficult and more expensive 

as temperatures rise.8 Our modeling does include the costs of adaptation though we 

do assume it is relatively cheap. Other approaches do this implicitly with lower impacts. Unless added later this removes the cost of adaptation from comparisons between costs and benefits of action. 

Further sensitivity analysis on assumptions and modeling is available in the postscript and subsequent papers.9 This shows that our main conclusions from this exercise—that the costs of strong action are less than the costs of damage avoided—are 

robust to a range of input assumptions. The question should be as to why the earlier 

estimates are so low. The main answer is that they ignored risks that we now know 

to be real and underestimated emissions. 

Question 2. Notable economists have written that the Stern Review drew selectively from studies of the impacts of climate change, emphasizing those with high 

damage estimates—even when the studies were highly speculative. 

Did the Stern Review intentionally seek studies that supported the worst-case scenario? If so, is this accepted practice among economists? 

Answer. The Stern Review did not select the studies with worse case scenarios. 

It used only peer reviewed science and all key scientific assumptions have since 

been endorsed by the Working Group 1 report by IPCC 10 released in February 2007. 

The Stern Review only summarized the science. The IPCC remains the most comprehensive summary of the science and the Review team took advice from its con-
66

11 Chapter 6 of the Review. 12There is not a comprehensive set of global studies for each impact that allows a bottomup cost estimate from disaggregated studies. 13For more details and video see http://www.ycsg.yale.edu/climate/index.htm. 

tributing scientists to ensure that the Review was based on the best available 

science. 

The Stern Review presented the impacts in two general forms, firstly through a 

disaggregated analysis based on peer-reviewed literature and secondly, through integrated assessment modeling. Neither of these approaches focused on worst-case 

scenarios.

• The disaggregated analysis presented estimated ranges of damages at different 

temperature levels for several key indicators, such as water availability and 

population at risk from coastal flooding. This analysis demonstrated the dependence of impacts on temperature, showing clearly that the impacts of climate change become more negative, severe and widespread as temperatures increase. The analysis also illustrated that the risk of surprise climate events, 

such as loss of the ice sheets, and large-scale socially contingent effects, such 

as mass migration and conflict, increase as temperatures rise. • The integrated assessment11 made the treatment of risk explicit. It used a 

model that explores probabilistically the range of possible outcomes. The model 

is based on the existing impacts literature and is not an outlier in any sense. 

The task requires considerable aggregation to make it feasible.12 This loses the 

important detail of the disaggregated impacts that are set out in the early part 

of the Review. Many costs and risks are left out (such as weakened carbon cycles) or not treated formally (such as intra-generation distribution) in this approach. Had these been included the damage estimates would have been higher. 

Economic and ethical assumptions do have a significant role to play. Economic assumptions such as the emissions path were based on the latest economic forecasts 

(using the International Energy Agency’s World Energy Outlook 2006). Ethical factors are not related to best/worse case scenarios but rather the ethics and values 

that underpin them. We made these assumptions explicit. 

On the costs of mitigation we present the full range and are central within the 

literature. The subsequent analysis in the IEA’s World Energy Outlook 2006 released after the report found costs to be lower than our central estimate. Any claim 

that the Review always using worse case scenarios is absolutely untrue. 

Question 3. Why did the British Government fail to subject the Stern Review to 

a peer review process before it officially released the document? 

Answer. The Stern Review was an independent review that was commissioned by 

and reported to the UK Chancellor and Prime Minister. UK Government does not 

undertake peer review on commissioned reviews so this was not an option. We did 

hold a full call for evidence that provided some significant contributions (available 

on our website). We published papers outlining our approach as it developed and 

gave many presentations around the world that made our emerging thinking clear. 

Stakeholders were engaged throughout the Review and drew from the vast wealth 

of peer-reviewed literature, as the IPCC does in its own process. In an area such 

as climate change where it is subject to the media spotlight there are risks of early 

confused coverage if the reports contents were somehow leaked. The review also had 

a set timetable, which would have constrained the scope for peer-review given the 

time needed for review of a document of this size. 

While the Review did seek to build on the foundations of the academic literature 

on the economics of climate change its target audience was not only academics but 

also policymakers, business and individuals. This diverse audience means that reviewing the document from only an academic perspective may have reduced the impact on other audiences. One of the things that has pleased me most since the release of the report, is the diverse range of people from around the world that have 

engaged with the report. 

In many ways some peer review has been carried out since the Review’s release 

in the public domain. Immediately following the Senate Hearing I had a public seminar on the review in Yale alongside Professors Nordhaus, Yohe, Sachs, Barrett, 

Cline and Mendelsohn.13 The Review has been given the attention of many critiques, which we have responded to. I believe that process showed that our analysis 

and conclusions were very robust. Most of the attention was focused on ethical valuations on which reasonable people can differ, but we give powerful arguments for 

the ranges selected. Many of the other comments are based on misconceptions and 

false assumptions about what the Review did or failure to read the whole report. 

So, fortunately, there is nothing significant that I would change if this peer review 
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14Lower scenarios are manifestly implausible as assumptions of business as usual—they are 

likely to involve policies of the kind we discuss. 15This is explored in the sensitivity analysis on our website and further emission scenarios 

will be the subject of future analysis. 

had been conducted before the release of the Review, other than to include the sensitivity analysis for Chapter 6 (contained in a Postscript) in the main body of the 

Review. 

Question 4. In your written testimony, you referred to the Fourth Assessment report of the Intergovernmental Panel on Climate Change (IPCC), stating that ‘‘the 

panel’s central estimate of further warming for the end of this century is 4 degrees 

C. This would also give a greater than 50% probability of increases over 5 degrees 

C in the next century beyond 2100—exactly in line with the analysis presented in 

the Stern Review last year.’’

I understand that the IPCC has a longstanding policy not to attach probabilities 

to its distinct emissions scenarios, and moreover does not identify any one scenario 

as a ‘‘central estimate.’’ The Summary for Policy Makers of the Working Group I 

report does include ‘‘best estimates’’ of temperature change for the six scenarios 

range from 1.8 degrees C to 4.0 degrees C. The mean of 2.8 degrees C is clearly 

presented in table SPM-3 on page 13. 

Can you explain the apparent discrepancy between your testimony and the IPCC 

report? 

Answer. You are correct that the IPCC does not attach probabilities to emissions 

scenarios. 

Your quote from my testimony is missing the first part of the initial sentence, 

which is ‘‘If emissions continue to rise’’. This introduction to my statement was critical to its meaning. The Stern Review, in line with estimates from the International 

Energy Agency, concludes that in the absence of abatement policies, emissions of 

greenhouse gases will likely continue to rise at a rapid rate, roughly doubling by 

the middle of the century (see Chapter 7). This puts us in the range of the three 

higher SRES marker scenarios: A1B, A2 and A1Fl. 

The average of the IPCC’s ‘best estimate’ temperature increases for these scenarios is 4 degrees C in 2100 (adding on 0.6 degrees C to change the baseline from 

1990 to pre-industrial). However, the world would see a further warming after 2100, 

even if emissions fell to zero in 2100. This is called the commitment to warming: 

the inertia in the climate system means that the world would be committed to 

warming for decades after atmospheric concentrations are stabilized. It is this 

warming that I referred to in my statement. 

The Stern Review states that if emissions continue to rise, by the end of the century we would be committed to at least 50% chance a warming of 5 degrees C above 

pre-industrial levels. This is consistent with the findings of the new IPCC report. 

For example, the A1B scenario, the lowest of the three discussed above, reaches a 

greenhouse gas level of 850ppm CO2e in 2100 and applying the IPCC’s ‘likely’ climate sensitivity range, this equates to a warming of between 3.2 and 7.2 degrees 

C above pre-industrial at stabilization, or a best estimate of 4.8 degrees C (i.e. 

around 50% chance of greater or less than 4.8 degrees C). The A2 and A1Fl scenarios reach well over 1,000ppm CO2e, giving an even greater warming. Thus, my 

statement of ‘‘greater than 50% probability’’ was consistent. 

The question of probabilities associated with different emissions scenarios is an 

important one and is now being discussed extensively within both the science and 

economics communities. Our analyses, alongside others, suggest that the lower 

emissions scenarios of the IPCC may be optimistic, including either low levels of 

economic growth or some sort of exogenous technological progress that allows emissions to fall autonomously.14 Technological progress that substantially reduces the 

carbon intensity of economic growth seems unlikely without a pull from mitigation 

policies. Lower emission scenarios also mean that the cost of abatement is far 

cheaper than we estimated. Since emissions fall anyway reductions would be cheap 

and to a large extent free. The emissions scenario we chose did mean relatively 

higher temperature change but also implied that more mitigation was required. 

The scenario we chose has a plausible emissions path and thus impact estimates 

but does incorporate questionable population assumptions that can have an effect 

on the impacts calculus if they were brought in line with latest U.N. estimates.15

Estimating emissions scenarios is an unenviable task that may be re-visited before 

the next IPCC report. The IPCC scenarios were developed in 1997 and subsequent 

growth in energy demand in rapidly growing developing countries since then is one 

of the reasons why the higher scenarios look more plausible. We did not create a 

new scenario for our modeling, as it is important to ensure that there is com-
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16There is also a cautious estimate that we will not be around in the future that is included 

and assumptions on attitude to risks and inequality (the Elasticity of Social Marginal Utility 

of Consumption) also have an impact and along with other issues on discounting are explored 

in far more detail in Annex A of Chapter 2, the postscript and subsequent papers available on 

the internet. 17 As illustrated in Figures 8.4 and 8.2 and from technology approach to modeling Figure 9.3. 

parability with scientific estimates (which are based on the specific scenarios used 

by the IPCC). 

Question 5. If the world economy continues to grow, then future generations will 

be far wealthier than people are today. Future generations will also have more technology options for responding to climate change. 

Doesn’t it make sense to share the burden with future generations who in many 

ways will be better equipped to address it? 

Answer. The modeling in the review does share the burden with future generations. All modeling in the Review incorporates the fact that future generations are 

expected to be richer: economic growth implies discounting precisely to take account 

of the higher incomes of future generations. The extent to which future generations 

are better off controls the extent to which we discount costs and benefits in the future.16

Climate change has a non-marginal impact on growth as it can affect future 

growth rates. To reflect this correctly when estimating costs in the future we discounted each of the thousands of the model runs on the basis of the growth rate 

in that run. This is a more accurate approach, but it is more complicated and has 

led to some false assumptions from commentators over discounting in the Review’s 

modeling. 

The cost of mitigation is expected to remain at around 1% of GDP so it remains 

a relatively constant share of GDP as people get richer, spreading the burden across 

generations. The mitigation paths 17 generally assume a slowing of emissions growth 

before increasing reductions before leveling off in the future. This path spreads 

costs: Initial reductions are smaller while mitigation technologies are developed but 

subsequent steady declines place pressure on future generations as low hanging 

fruit are taken earlier so it becomes harder and potentially more costly to get the 

final reductions requiring advanced technologies in the future. 

The cost of mitigation may be shared between generations but the cost of climate 

change impacts are not. The long-term nature of the impacts of greenhouse gases 

in the atmosphere ensures that the cost of actions now will be felt for more than 

the next two centuries. So we are asking to share the burden of mitigation but ensuring future generations bear the burden of emissions we release in terms of impacts and adaptation costs. 

There are many legitimate differences between climate change and traditional 

project appraisal involving an investment marginal to a growth path. As discussed, 

the outcomes with climate change are non-marginal as it can affect growth. Many 

impacts are also irreversible and the costs of overcoming many others will be very 

high. There are a number of reasons why a smaller scale project such as a new road 

may not be as valuable, or indeed relevant at all, in several years time as circumstances change. However, avoiding the impacts of climate change (the value of 

a stable climate, human life and ecosystems) are likely to continue to be relevant. 

The planet is unlikely to vanish (abstracting from climate change itself here). Further, as people become richer and environmental goods become scarcer it seems likely that, rather than fall, their value will rise very rapidly. Thus investing elsewhere 

and using the resources to compensate any later environmental damage may be 

very costly. This is not yet reflected in the modeling but is likely to be important 

in determining the value of impacts over time. 

Though experts may differ over the initial pace and scale of emissions reductions, 

all economists agree that for any given target it is cheapest to start now. Failure 

to act strongly enough eliminates options we may retrospectively have preferred. 

RESPONSES OF SIR NICHOLAS STERN TO QUESTIONS FROM SENATOR MARTINEZ

Question 1. I am concerned about the impacts of climate change. I believe it is 

happening and that humans at some point play a part in its exacerbation. I think 

you will find a lot of members on this Committee who share that opinion, but like 

me are confronted with a variety of proposals about what to do about it. Given the 

large amounts of legislation that have proposed cap and trade programs, how would 

you go about creating a carbon regulatory program that would not negatively impact 

the U.S. economy? 
69

Answer. While mitigation will have some costs, only extremely badly designed or 

drastic and rushed policy action could have a major negative impact at a macroeconomic level. The effect will be modest rise in costs but not enough to have an 

effect on growth of any magnitude across the economy. It would be more pronounced 

in a very limited number of ‘carbon intensive’ sectors. This cost is a good investment 

against the potential impacts of climate change. Having explored the costs of mitigation we concluded that the costs are likely to be in the region of 1% of GDP in 2050. 

This is equivalent to a 1% increase in a cost index: that is the sort of thing economies react to all the time such as a result of exchange rate fluctuations. This is not 

the sort of effect that can derail growth. There is some uncertainty around this figure of around ∂/¥3% but the extremes of this range are unlikely. Successful innovation could lead to a negative cost (boost growth due to a ‘Schumpetarian’ burst 

of innovation) but conversely a lack of progress could increase costs. 

Some policy actions may lead to rapid positive returns such as through improved 

energy efficiency. It is also important to consider the long run as well as short-run 

impact on growth and competitiveness. Failure to address the cost of emissions now 

will allow investments that lock-in a high carbon infrastructure, that would not be 

competitive in a move to a low-carbon world and risk costly premature retirement 

of investments. It would also fail to spur the innovation and expertise in sectors and 

products that are would dominate these sectors in such a world. 

If policy-makers are specifically concerned about competitiveness it is important 

to get quantitative. Many ‘‘competition’’ claims are without numbers and refer to 

very narrow sectors of the economy. The 1% additional cost is very small compared 

to wage differentials between rich and poor countries. There are only a limited number of traded sectors where energy costs have a significant impact on prices. Even 

in these sectors studies show that environmental legislation has not traditionally 

played a major role in site location. Concern over competitiveness impacts should 

be harnessed in the push for international policy mechanisms, as this is the easiest 

way to avoid distortions and provide suitable incentives. It is possible to achieve this 

in the absence of over-arching carbon constraints such as through sectoral agreements (explored in Section 23.5). These can help prevent distortions and encourage 

participation of developing countries for this limited section of their economy. This 

is made more feasible by the prevalence of large multinational firms in these sectors. Alternatively it is possible to consider the allocation or tax treatment of vulnerable sectors, but this must be set against the long-run implications in these sectors 

of shielding them from the environmental cost. 

Mitigation policy should look to address emissions from all sources and ensure 

that instruments gain benefits from scale but, where appropriate, are also tailored 

to the idiosyncrasies of individual sectors. Effective design of policy structures outlined in Part IV of the report. They include pricing the carbon, spurring technological innovation and removing barriers and changing behavior to reduce deforestation and improve energy efficiency. Within this framework it is important to look 

to make instruments international in the future to reduce costs and reinforce international action. This is explored in Chapters 22-24 of the Review. 

Question 2. The Stern Report has received criticism from the Economist, the Copenhagen Consensus headed by Bjorn Lomborg, as well as other economists for either putting too much of the emphasis of climate change abatement on rich Western 

nations or not enough focus on the developing world. How would you respond to that 

assertion? 

Answer. I had thought that Bjorn Lomborg’s critique was more focused on his belief that climate change is less important to tackle immediately than many other 

world problems such as aids and malaria. I am not aware of specific criticism from 

these sources concerning the balance between rich Western nations and the developing world but I will address this shortly. But let me begin by stating why I think 

Lomborg’s analysis, under the guise of the Copenhagen Consensus, was deeply 

flawed in many ways. 

Many of the economists that participated in that process said afterwards that climate change should not have been on the list of issues considered—it is incomparable in so many ways with the other issues. His approach asks the wrong question. Correcting an externality is not like spending public money and does not come 

from a limited pot of finance. Requiring decision makers to reflect their impact on 

others is basic market economics. 

The techniques used in the analysis are badly applied. They fail to deal with 

many dimensions of the problem such as the economics of risk (possibility of large 

temperature change and severe impacts we now know are possible) and the urgency 

of the reductions to achieve stabilization (costs of action for any stabilization level 

rise rapidly and ultimately become impossible if action is delayed). Indeed 

Lomborg’s analysis truncates the kinds of spending that could be made; on aids and 
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18 Not necessarily within their own borders. 19Which is at the top of the range of stabilization goals we suggest—between 450 and 550 

ppm CO2e. 

malaria it was only preventing the spread of the disease not eliminating it. More 

importantly, the analysis did not take account of the fact that dealing with climate 

change itself can help deal with many of these problems in the future. The impacts 

of unmitigated climate change on health could be very severe, particularly in developing countries. It is not a discrete choice between competing options—tackling climate change has many, varied co-benefits. 

Your question raises the issue of equity of effort between rich and developing nations. Several ethical perspectives have been advocated at international discussions—historical responsibility, per capita rights, ability to pay. All of these endorse 

the notion of ‘‘common but differentiated responsibility’’ recognized in the United 

Nations Framework Convention on Climate Change (UNFCCC). This discussed in 

Part VI of the Review—Chapter 22 in particular. The different ethical perspectives 

all point in a similar quantitative direction: Developed countries should take responsibility for reductions of around 60-90% 18 in 2050 as art of a global reduction of 20-

30% to achieve 550ppm CO2e.19

Asking poorer people to pay a proportionally larger share of the cost of avoiding 

a problem others played a larger role in would seem unethical to many. However, 

the equity split advocated above does includes significant reductions from these 

countries relative to business-as-usual. Developing countries have an active stake in 

a desirable stabilization outcome and should be prepared to contribute subject to an 

equitable allocation of costs. Much of the review addresses the challenges faced by 

developing countries (e.g. Chapter 20) and how to reduce emissions in these countries (e.g. Chapter 23). 

Developing countries give priority to securing the economic growth to lift their 

people out of poverty: their efforts should be supported. Strong targets and carbon 

trading in richer countries can generate private flows of capital that can support 

emissions savings and investment in low-carbon infrastructure in developing countries. The scope for countries free-riding on a global problem means that it is important to create the conditions where all countries will be moved to participate. Equity 

considerations will be crucial given the history of rich country emissions. 

Question 3. It is my understanding that the basic premise of the Stern Report is 

that our international response should act similarly to an insurance policy—pay 

some now to avoid big problems later. Considering that its recommendations urge 

spending 1 percent of global GDP per year (roughly $450 billion) to prevent climate 

change, how would nations be forced to comply? How would nations respond during 

economic downturns or recessions? Would other nations be required to pick up the 

difference if another country experiences severe economic circumstances? 

Answer. Answered in combination with [sic.] 

Question 4. Who would control the collection and allocation of funds to combat climate change under the Stern Report model? 

Answer. It is important to be clear the 1% of global GDP is not a bill to be paid 

but rather an incremental cost that is spread throughout the market. It is not a 

measure of government spending but rather the additional cost of a low-carbon 

economy which affects people largely through price, tax and regulatory system. 

Taxes, trading and regulation all encourage firms and individuals to chose low-carbon approaches at an additional cost (though as discussed earlier this may prove 

to be at negative cost through innovation or energy efficiency savings). This also applies to deployment support for low-carbon technologies for which the costs are usually passed directly onto the consumer. These funds are not collected but allocated 

through the power of the market (if using market instruments). Depending of the 

choice and design of the carbon pricing policy tool, this can lead to transfers to governments in the form of revenue, but these are not a cost and are assumed to offset 

costs or taxation elsewhere. 

One of the advantages of international emissions trading is that the market helps 

reduce emissions wherever it is cheapest, allowing flows to developing countries to 

be managed by the market minimizing total costs. Using tax instruments requires 

politically sensitive transfers to achieve this and recipients to use these funds effectively. 

Furthermore, mitigation policy is likely to be counter-cyclical in that it does not 

exacerbate economic upturns or downturns but serves to moderate them slightly. At 

times of recession, the reductions in economic activity and reduced consumption ensure that emissions target are easier to meet and may provide a resource in trading 

schemes. In times of boom the targets are more stringent, but there is extra resources available to cover any additional costs. 
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20www.iter.orq/. 21 In his comment on the Stern Review he outlines the optimal carbon prices in the DICE- 2006 model as being $17.12 in 2005 $84 in 2050 and $270 in 2100 (all per ton of carbon). 22 Equivalent to £4.67 per ton of carbon dioxide. 23 Ackerman, F. and Finlayson, I (2007) The Economics of Inaction on Climate Change: A Sensitivity Analysis, Climate Policy 6:4. 24Such as problems in quantifying many of the expected impacts of climate change. Other factors that suggest that the social cost of carbon cannot be assumed to be a suitable level of taxation. See section A7 of Paper A: The case for action to reduce the risks of climate change. 

There are some areas where direct public support is required to support the introduction of public goods such as at the R&D stage of innovation and adaptation. As 

outlined in Chapters 23 to 26 there is an international element to these public goods 

that can be supported by international co-operation. This can generally be done 

through existing multilateral organizations. This may involve expanding their role 

and capacity and there may be some cases where separate agreements and institutions may be preferable. In the case of developing fusion technology 20 the scale of 

the costs ensured an international approach was preferable and the EU, U.S., Russia, China, India, Japan and the Republic of Korea agreed terms to split the costs. 

International agreement can reduce duplication, reduce costs and increase the scale 

of action by spreading the risk. 

International agreements on emissions reductions are useful in building a shared 

understanding of appropriate action and building confidence in markets on the future direction of policy. Building a powerful enforcement mechanism is likely to be 

very difficult in the medium term. Formal compliance mechanisms are likely to only 

be effective for specific and limited infractions. However, we argue that such a 

mechanism is not necessary since the will of the domestic population and the desire 

to behave in a responsible manner is the most effective enforcement mechanism. 

Global public concern and awareness about climate change are growing rapidly. 

They both influence and sustain international co-operation, national aspirations and 

private sector leadership on climate change. Countries failing to act in a responsible 

manner will be pressured by their population and may damage international relationships elsewhere. California, France, the EU and China are all examples of countries or regions taking on stringent targets or policies without international agreements underpinning them. 

Question 5. One figure that is often quoted by some critical of the Stern Report is the ‘‘social cost’’ of carbon dioxide. Under the Stern Report, that comes to $85 dollars a ton while the Yale economist William Nordhaus has determined that cost to 

be $2.50 per ton. Why is there such a large difference in these approaches? 

Answer. It is very important to be clear exactly what the social cost of carbon relate to. The estimate you quote from our report relates to the business-as-usual social cost of carbon (the cost if we do nothing to reduce carbon emissions) for a more 

‘‘sensible’’ path of emissions, stabilization at 550 ppm CO2e, we estimate the cost 

to be around $30 per ton of carbon dioxide. Figures from Professor Nordhaus relate 

to an ‘‘optimal carbon price’’ which is the damage cost under what the model estimates to be the most efficient mitigation path. The comparison is not life-to-like and 

business as usual (no policy) estimates of the social cost of carbon will always be 

higher than under a policy path since the aim of the policy is to reduce the damages. More recent estimates from an updated model by Professor Nordhaus are 

higher than $2.50 21 per ton of carbon dioxide at $4.67 per ton of carbon.22

The reason our estimates are higher than much of the existing literature have 

been outlined earlier and are, I believe, for good reasons. Estimates of the social cost 

of carbon are heavily dependent on the modeling approach. Previous low estimates 

reflect high discount rates, omitted impacts and significant benefits from warming 

in the early decades. 

Recently Professor Ackerman published a paper 23 using different variables in 

Professor Nordhaus’ model and produced much higher estimates. Professor Sachs 

added what he believes are more plausible and up to date variables in the same 

model and reached figures much closer to our own. This highlights the importance 

of using models as a tool highlighting potential scale and what the important variables are. The ethical and structural parameters both have a significant impact on 

estimates of impacts. It is important to consider carefully the variables used, whether they are accurate or uncertain, and the implicit ethics of different approaches. 

The social cost of carbon is a useful indicator but using it for policy is subject to 

a number of further considerations.24 Our approach to pricing policies was different 

because of the constraints and uncertainties in estimating a social cost of carbon. 

We advocated the approach of picking a stabilization goal, which leads to a quantitative target and using the power of the market to determine the prices to meet 

this target. Market instruments determine the cost of reaching the target, an ap-
72

proach that bypasses the social cost of carbon. Comparison with estimates of the social cost of carbon is one of the ways of considering whether the goal is too stringent 

or not ambitious enough when this goal is under periodic review. 

Question 6. When conducting economic analysis of the future impacts on climate 

change, what type of prognostications are usually given for hurricanes and other unforeseen weather disasters? 

Answer. Basic science and climate modeling points towards an increase in the 

prevalence of many types of extreme events as the world warms. This includes intense hurricanes (and tropical storms in general), heat waves, heavy rainfall events 

and droughts. It remains unclear how the numbers and paths of hurricanes will be 

affected. 

There has been significant debate over current trends in hurricanes. The IPCC 

concludes that there is evidence for an increase in intense tropical cyclone activity 

in the North Atlantic since about 1970, in line with rising tropical sea surface temperatures, but no clear trend in the number of hurricanes. 

The economic impact of hurricanes is very sensitive to even small increases in intensity. This is well understood from studying past events. One study found that 

an increase in intensity of 5-10% leads to costs doubling. Thus, future warming 

could cause significant effects. One study found that a doubling of CO2 levels would 

lead a 6% increase in the intensity of hurricanes, but this remains highly uncertain. 

Based on current knowledge, the cost of extreme weather events, including hurricanes and many other weather events, could rise to 0.5% to 1% of global GDP by 

the middle of this century. It should be noted that adaptation is a key factor in predicting future hurricane risks. For example, much of the current increase in damages from hurricanes is thought to be associated with the increase in population in 

hurricane risk areas. 

RESPONSES OF HENRY D. JACOBY TO QUESTIONS FROM CHAIRMAN BINGAMAN

Question 1. You say that capping greenhouse gas emissions is a useful way to 

think about long-term objectives in dealing with this risk. What about in the shortterm? Is it feasible, or economical to make some of the drastic reductions that are 

being called for within the next decade? 

Answer. It is not feasible or economical, or indeed even necessary, to make drastic 

reductions within a period as short as a decade. Climate change is a century-scale 

problem and the urgent need in the current decade is to get started on policies that 

will raise the price of emissions and augment efforts to develop low-emitting technologies. These early efforts can then lead to drastic reductions below a businessas-usual path over coming decades. 

Question 2. Do you have any thoughts on how the developing countries are weighing the risks of climate change against the need for rapid economic growth? 

Answer. In most developing countries there is a growing cadre of environmentalists and public officials who are concerned about the climate change issue, and who 

argue for national policy to reduce emissions. At the level of national policy, however, the risks of climate change still rank below concern with the short-term economic well being of their citizens. This observation would apply most importantly 

to big countries like China, India, Brazil, and Indonesia. Others, like Singapore or 

South Korea, may be closer to taking action because their per-capita incomes are 

at a level where the issue can rise higher among social and political priorities. 

RESPONSES OF HENRY D. JACOBY TO QUESTIONS FROM SENATOR DOMENICI

Question 1. A paper co-authored by Dr. Yohe criticized the Stern Report for failing 

to include a proper cost-benefit analysis. In particular, it notes that the analysis 

should compare marginal costs to marginal benefits. Instead the Stern Review compares total costs to total benefits. 

If the cost-benefit analysis was done improperly, isn’t the Stern review fatally 

flawed? 

Answer. Chapter 13 of the Review contains an analysis of the benefits of moving 

from one level of atmospheric stabilization such as 650 ppmv to a tighter one like 

550 ppmv. This calculation yields a rough estimate of marginal benefits of tighter 

long-term targets. The benefits of this tightening are then argued to be larger than 

the estimate of the cost of achieving the tighter target. This is a first step toward 

a benefit-cost analysis, but the Review does not carry this idea through to a complete marginal analysis. Most important, this component of the Review is confined 

to Chapter 13 and is not prominent in either the Review summary or in press coverage. 
73

Whether because of this crude benefit-cost approach the Review as a whole is ‘‘fatally’’ flawed is quite another question. Its intent, in my view, was to raise the public visibility of the issue and argue that corrective actions would not be economically 

disastrous. In that sense the report can be argued to have achieved its objective. 

Question 2. Could you please explain why it is difficult to calculate the economic 

cost of extreme, but highly unlikely, events? 

Answer. Two types of information are required to support a monetary valuation 

of some possible extreme climate event. First, there is a need to define in a meaningful way what the event is. And second, an estimate is needed of how likely it 

is to occur: it makes a big difference whether it is a chance of one in 10 or one in 

1,000. For some of the more troublesome potential outcomes of climate change, e.g., 

a rapid loss of Greenland or Antarctic ice sheets, the nature of the event and its 

likelihood are poorly known. In such a case these potential consequences should be 

prominent in any discussion of the climate change treat, but in my view their inclusion in the formal economic analysis tends to dilute the value of calculations for 

those parts of the problem that are well defined. 

The fact that poorly understood but extreme outcomes are left outside the dollar 

valuation does not mean they are unimportant in climate decision-making, and here 

an analogy may help. The potential economic cost of the mutation to human transmissible form of the Avian flu virus is not well known: we do not know precisely 

how infectious the virus might become or how deadly, or how effective medicines 

might prove to be. Also, epidemiologists cannot give a confident estimate of how 

likely this mutation is to occur. This lack of specific information does not imply, 

however, we should be any less concerned with the threat, or less active in seeking 

ways to lower the risk. 

Question 3. In your written testimony, you raise concerns over the methods used 

in the Review to monetary measures to ‘‘non-market effects.’’

What is accepted practice among economists for estimating the values of ‘‘nonmarket effects’’? 

Can you give us some examples, and contrast them with the methods used in the 

Stern Review? 

Answer. The methods used to try to put dollar values on non-market effects of 

environmental change fall into three rough categories.

• Methods that apply indirect information from related markets, as when real estate values are seen to incorporate the value of cleaner air that may be found 

in some neighborhoods compared to others. Statistical methods are applied to 

sort out the value of clean air from the larger mix of influences that determine 

the market value of a house. • The construction of surrogate markets, often using data on consumer activity 

that can be used to impute value to a non-market resource. Examples in this 

area include the use of information on the transportation expenses that people 

undergo to use a public park as an indication of its value to them and by extension to society, or the application of data from aspects of personal behavior regarding risk-taking and insurance to estimate a value for human life. 

• The construction of hypothetical markets, through a methodology that has come 

to be known as ‘‘contingent valuation’’. Here two approaches are applied. In one, 

survey techniques are used to estimate what people would pay (perhaps in increased taxes) to achieve a particular environmental value, or to avoid its destruction. In a second method subjects are put into an experimental setting, 

trading small amounts of money in a ‘‘make-believe’’ market in which the environmental assets can be bought and sold. Contingent valuation methods came 

to prominence in the wake of the Exxon Valdez incident, when they were applied to the valuation of lost amenities and damage to native species.

These methods can be informative in application to non-market changes that are 

well understood and of relatively small scale (e.g., local air quality or the destruction of animal life in an oil spill). However, I question their adequacy when applied 

to large-scale, poorly-understood effects that may attend climate change (e.g., the 

loss of all arctic tundra). 

The Stern Review did not itself do any analysis of this type but rather quoted results from a number of other studies, some of which used these methods and some 

which simply made rough guesses about the damage of climate change. Also, the 

non-market valuations included in the PAGE2000 model from which many of the 

Review’s results were drawn is not sufficiently well documented to support an evaluation of the procedure employed. 

Question 4. If the world economy continues to grow, then future generations will 

be far wealthier than people are today. Future generations will also have more technology options for responding to climate change. 
74

1See U.S. CCSP [Climate Change Science Program], 2006: U.S. Climate Change Science Program, Synthesis and Assessment Product 2.1, Part A: Scenarios of Greenhouse Gas Emissions 

and Atmospheric Concentrations (L. Clark, J. Edmonds, H. Jacoby, H. Pitcher, J. Reilly, R. 

Richels). http://www.climatescience.gov/Library/sap/sap2-1/sap2-1a-draft3-all.pdf. 

Doesn’t it make sense to share the burden with future generations who in many 

ways will be better equipped to address it? 

Answer. Our generation will without doubt share the burden of any emissions 

mitigation with future generations as most studies show that the cost of reducing 

emissions continues into the future, with the magnitude of the task increased by 

growing population and rising incomes. Also, future generations will not have an opportunity to share the costs of climate damages in our current one. The question, 

rather, is how long our generation should wait before taking substantial action to 

reduce risks for future generations—which of course include our current children 

and grandchildren among those to come later. Because of the stock of long-lived 

greenhouse gases we are building in the atmosphere the longer we wait to begin 

emissions mitigation the more difficult the task we pass on. Also, although we hope 

our R&D our investments will yield much cheaper mitigation technologies we cannot know for sure that this form of technical fix will appear. Finally, although future generations probably will be wealthier than ours, and better able to deal with 

market-based effects of climate change, there likely will be effects on the natural 

environment which they will have no ability to correct or to compensate by their 

greater wealth. 

RESPONSES OF HENRY D. JACOBY TO QUESTIONS FROM SENATOR MARTINEZ

Question 1. I am concerned about the impacts of climate change. I believe it is 

happening and that humans at some point play a part in its exacerbation. I think 

you will find a lot of members on this Committee who share that opinion, but like 

me are confronted with a variety of proposals about what to do about it. Given the 

large amounts of legislation that have proposed cap and trade programs, how would 

you go about creating a carbon regulatory program that would not negatively impact 

the U.S. economy? 

Answer. Any carbon regulatory program will have impacts, both negative and 

positive, on particular sectors of the economy and regions of the country. But a welldesigned policy need not have a substantial impact on the economy as a whole. A 

study carried out for the U.S. Climate Change Science Program indicates that the 

U.S. would continue to experience healthy economic growth even under ambitious 

targets for emissions mitigation.1 If the policy is well designed the concern need not 

be with risk to the national economy but rather the compensation of those who may 

be hurt as the economy adjusts. A national policy that would minimize economic 

cost but achieve environmental objectives would start with a relatively low price on 

emissions, say in the neighborhood of $10 per ton CO2-equivalent, and establish a 

procedure for this price to grow steadily and predictably over time. This pattern of 

increasing stringency would allow time for the natural turnover of the capital stock 

and adjustments in the labor market. Complementing the imposition of a price on 

emissions should be an aggressive program of government-supported R&D and commercial demonstration of emissions-avoiding technologies. 

Question 2. The Stern Report has received criticism from the Economist, the Copenhagen Consensus headed by Bjorn Lomborg, as well as other economists for either putting too much of the emphasis of climate change abatement on rich Western 

nations or not enough focus on the developing world. How would you respond to that 

assertion? 

Answer. The Stern Review calls for universal participation in greenhouse gas 

mitigation and attempts to show the advantages to the global economy if it can be 

achieved. Like almost everyone else dealing with this issue, however, the Stern Review authors do not have a clear plan of activities that will bring all nations to take 

mitigation commitments in the short term, although they do suggest that direct aid 

to developing countries may be useful, and that nations may be brought to control 

emissions through participation in a global emissions trading mechanism. Rather, 

the focus of the Review is on the essential first step in achieving some sort of global 

response, which is for the rich countries to take greater action than now. Clearly, 

developed countries like the U.S. can be expected to go only so far down the path 

the Review recommends without a substantial response by major developing countries, but without such leadership universal participation likely is impossible. 

Question 3. It is my understanding that the basic premise of the Stern Report is 

that our international response should act similarly to an insurance policy—pay 

some now to avoid big problems later. Considering that its recommendations urge 
75

spending 1 percent of global GDP per year (roughly $450 billion) to prevent climate 

change, how would nations be forced to comply? How would nations respond during 

economic downturns or recessions? Would other nations be required to pick up the 

difference if another country experiences severe economic circumstances? 

Answer. As with all international agreements there is no global institution that 

can force sovereign nations to comply. Incentives can be given through diplomat 

pressures or threats of trade restriction, but the participation in an international 

effort by any individual country ultimately will be determined by its perception of 

the effect of climate change on its own national interest. This is the core of the climate change problem. Nations have found it to be in their interest to participate 

in community responses to environmental issues that are similar to the climate 

threat, such as the Montreal Protocol, the Whaling Convention, etc., but the greenhouse gas control problem is a larger and more complicated challenge. 

Regarding the response during recessions: over the past fifty years these types of 

economic fluctuations have been relatively short term in duration, lasting from a 

few months to a year whereas greenhouse gas control policies are longer-term measures, gathering in intensity over decades. In a recession pressure might arise to 

relax some aspects of greenhouse gas control policy, but we would not likely see a 

frontal assault on the whole campaign. Similarly, I would not expect provisions of 

an international regime to change in the face of one or more of its parties experiencing short-term economic difficulty, or that other nations would be expected to 

take additional effort while one was in difficulty. Indeed, during a recession emissions tend to decline, so it likely the troubled economy would likely over-comply during such a period. 

Question 4. Who would control the collection and allocation of funds to combat climate change under the Stern Report model? 

Answer. The Stern Review does not recommend a new international institution 

that would collect funds to fight climate change. It does support a continuation and 

augmentation of the existing Global Environmental Fund to which countries make 

voluntary contributions, and it calls for increases in bilateral aid and technology 

transfer. The proceeds of an emissions tax, or revenue from a cap-and-trade system 

with auctioning of permits, would accrue into the treasury of the implementing 

country. Proposals have been put forth of an international agency funded by mandatory taxes on individual countries, or their international emissions trades, but these 

ideas have not gotten serious attention in international discussions and the Review 

does not argue for this approach. 

Question 5. One figure that is often quoted by some critical of the Stern Report 

is the ‘‘social cost’’ of carbon dioxide. Under the Stern Report, that comes to $85 dollars a ton while the Yale economist William Nordhaus has determined that cost to 

be $2.50 per ton. Why is there such a large difference in these approaches? 

Answer. Several differences among these two studies, including the estimates of 

future damages, contribute to this variation in the estimate of the social cost. But 

the overwhelming source of the difference is the discount rate. The Stern Review 

applies a much lower discount rate than does the Nordhaus study, and Stern discounts damages that are occurring over many future centuries, leading to a much 

larger marginal cost for an additional unit of emissions today. 

Question 6. When conducting economic analysis of the future impacts on climate 

change, what type of prognostications are usually given for hurricanes and other unforeseen weather disasters? 

Answer. Only preliminary analysis is available of the potential increase in damage from severe storms caused by climate change. There is evidence of increasing 

intensity of hurricanes in response to rising sea surface temperatures, but no indication of increasing frequency or knowledge of potential changes in storm tracks and 

likelihood of landfall. Ultimately research on this topic may produce meaningful 

monetary estimates of the potential damage from these consequences of a changing 

climate, but as of now this threat is mainly treated as a risk to be kept in mind, 

yet difficult to quantify. To my knowledge there is no evidence of increasing frequency or intensity of tornadoes. Attempts have been made to calculate potential 

effects of increased frequency of floods and droughts, although these threats also are 

difficult to quantify in monetary terms because of uncertainty in projections of climate change at regional scale. 

RESPONSES OF GARY YOHE TO QUESTIONS FROM SENATOR DOMENICI

Question 1. The value of the ‘‘social discount rate’’ is clearly important in estimating damages that occur in the distant future. We’ve heard that the Stern Review 

made a controversial choice for this value. Should the Stern Review have included 
76

a discussion of how sensitive the cost estimates were to the choice of the discount 

rate? 

Answer. I think that it was almost irresponsible not to do so. Tjalling Koopmans, 

a Noble laureate economist who was expert in optimal growth and discounting often 

remarked that reporting the results of a discounting exercise should always include 

a sensitivity analysis because the answers to any discounting question were so highly dependent on the underlying discount rate. Indeed, the relative valuations of alternative investment projects can be altered by the choice of a discount rate. 

As indicated in my testimony, many economists have highlighted this issue in the 

Stern Review. In our own deconstruction of the underlying model—a simpler version 

calibrated to a 5.3% discounted damage estimate for a discount rate of 0.1%, Richard Tol and I have shown the following correlation:

[Amounts in percent] 

Discount Rate 

Discounted 

Damages1

0.01 .................................................................................................................. 5.4

0.1 .................................................................................................................... 5.3

1.0 .................................................................................................................... 3.6

3.0 .................................................................................................................... 1.6

1 Calibrated in lost ‘‘certainty equivalent per capita consumption’’. 

It is clear from these calculations that the rate used by the Stern authors was 

so low that it was nearly impossible to produce bigger damage estimates. Moroever, 

assuming the more conventional 3% would reduce damages even given the Stern 

calibration by almost 70%. A postscript to the Review does report the results of a 

sensitivity analysis; their results are entirely consistent with the ones quoted above. 

Question 2. The Stern Review authors claim on their website that their damage 

estimates are higher than other studies because the Review uses more recent literature from the science. But a leading expert, William Nordhaus, contends that 

their higher damages are based on their choice of discount rate—not on new scientific findings. Which do you believe to be true? 

Answer. I have known William Nordhaus for more than 30 years, and we have 

had several discussions about the Review. We were on the same panel discussing 

the Review at Yale University of February 15, 2007—the academic exercise about 

which Sir Nicholas spoke during his testimony. Truth in advertising—Professor 

Nordhaus and I have done a lot of work together over the years. He was a reader 

of my PhD dissertation at Yale; and I am in the climate field because he phoned 

in 1982 to invite my participation in the preparation of Changing Climate—one of 

the National Academy’s first analyses of the climate problem. 

I am convinced that the choice of discount rate is the primary reason why the Review’s estimates are so high. There is, though, some merit to its authors’ claim, especially given the way they tended to choose high-end impacts analyses when they 

calibrated their model. Much of the new science is high-end, of course, but not all. 

Figure 1 below shows where the Stern Review’s estimates fit in a survey of results 

published over the last 10 years (mostly over the last 5 years). Stern’s $310 per 

tonne of carbon ($85 per tonne of carbon dioxide) estimate is at the 95th percentile 

among all estimates, but it is well above the 95th percentile for estimates reported 

in the peer-reviewed literature. Notice, though, that it is around the 80th percentile 

for estimates derived using a discount rate (pure rate of time preference or ‘‘PRTP’’) 

of approximately 0%. Even though none of the studies from which higher damages 

estimates were gleaned, this suggests that the low discount rate alone cannot explain fully why the estimate is so high. 

Question 3. Should the Stern Review have been the subject of peer review before 

its release by the British Government? 

Answer. Absolutely. Figure 1 shows clearly that its damage estimates lie outside 

the range of comparable estimates reported in the peer-reviewed literature. Sir 

Nicholas, himself, expressed interest in an ex post peer review; that is why he 

agreed to participate in the Yale event on the 15th of February. In his response to 

criticism that the Review had not been subject to peer review, he spoke of a concern 

about leaks to the press; but that response does not ring true to most of us. The 

press had copies of the Review well before the academic community was allowed access; indeed, many of us who were denied pre-release copies by the author team 

were able to obtain copies from friends in the media. 
77

Question 4. If the world economy continues to grow, then future generations will 

be far wealthier than people are today. Future generations will also have more technology options for responding to climate change. Doesn’t it make sense to share the 

burden with future generations who in many ways will be better equipped to address it? 

Answer. Absolutely, but the critical word here is ‘‘share’’. Sharing does not mean 

postponing all expense, even if future generations will be better off. It means making prudent investments now so that the discounted cost of achieving a climate policy target is minimized across all generations. It means beginning now to minimize 

the risk that climate impacts that could overwhelm even future generations’ capacities to adapt. It means not foreclosing the possibility of holding critical climate variables below thresholds that may trigger these overwhelming impacts. Of course, it 

does not mean imposing an excessive burden on present generations, either. 

RESPONSES OF GARY YOHE TO QUESTIONS FROM SENATOR MARTINEZ

Question 1. I am concerned about the impacts of climate change. I believe it is 

happening and that humans at some point play a part in its exacerbation. I think 

you will find a lot of members on this Committee who share that opinion, but like 

me are confronted with a variety of proposals about what to do about it. Given the 

large amounts of legislation that have proposed cap and trade programs, how would 

you go about creating a carbon regulatory program that would not negatively impact 

the U.S. economy? 

Answer. I argued in my testimony that setting the initial price of carbon in 2007 

can be an exercise in determining the appropriate short-term incentives for carbonsaving investments and energy conservation rather than an exercise in ‘‘solving the 

climate problem’’. Since no policy created in 2007 will ‘‘solve the climate problem’’, 

it is perhaps even desirable to step out from under that burden to confront a more 

manageable near-term problem while still making progress towards an ultimate response to an evolving understanding of climate risk. 

The answer to the ‘‘What do we do in the near-term?’’ question is to design something that will (1) discourage long-term investments in energy, transportation, and 

construction that would lock in high carbon intensities for decades to come and (2) 

encourage development of alternative energy sources, carbon sequestration technologies and efficiency. 

As an example of how the first goal might be achieved, consider what it would 

take to make it economic to run existing natural gas-fired electric generators more, 

and run coal-fired generators correspondingly less (gas-fired generators emit only 

about half as much CO2 per unit of electricity). Because natural gas is a considerably more expensive fuel than coal, it takes a substantial CO2 cost to overcome this 

fuel cost disadvantage—about $30/tonne, on current fuel price expectations in the 

U.S. 

On the other hand, consider pending investments to add new generating capacity 

in the United States over the next few decades. Much of this capacity is currently 

planned as conventional coal-fired technology. What would it take, in terms of a 

price for CO2, to make it economic to install new gas-fired capacity instead, thereby 

cutting by half the carbon emissions from this new capacity? On current gas price 

expectations, a CO2 price of only $5 per tonne would be sufficient to make new gasfired generators as economical as new coal-fired plants, based on the present value 

of fixed and variable costs. 

This number is much lower for new plants than the $30/tonne seen above for existing plants because the lower cost of building a new gas plant compensates for 

some of its higher fuel cost. Several factors may necessitate a somewhat higher CO2

price to achieve this economic equivalence, however—e.g., greater fuel price volatility makes gas capacity relatively less attractive and increased gas demand might 

push up gas prices beyond current expectations. Even so, only a modest CO2 price 

is needed to make lower-carbon gas-fired technologies attractive. 

To make the full step to near zero carbon technologies (e.g., carbon capture and 

sequestration) would require a somewhat higher CO2 price—estimated at around 

$25/tonne CO2 by several sources. Since power generators last 30 to 40 years, if the 

CO2 price increases over time, adding some cost for CO2 emissions would make sequestration technologies attractive in the near term even if the price does not reach 

this ‘‘tipping point’’ until some years after the new plant starts operating. 

The $7 per tonne of carbon dioxide charge envisioned in the legislation being considered by this Committee, if it were to climb at the rate of interest, would reach 

$30 per tonne after 2035—probably too late to inspire fuel switching in existing 

plants over the foreseeable future or much investment in carbon sequestration. It 

would, though, likely be sufficient to bring most of the plants constructed between 
78

1The tax should increase, in real terms, at the real rate of interest. If expressed in nominal 

terms, then it should increase at the nominal rate of interest. 

now and 2050 over to a lower carbon technology. A $15 per tonne charge in 2007 

would reach the $30 threshold around 2020, and that could be sufficient to affect 

the retrofitting switch in most places in the very near future and inspire appropriate development of enhanced sequestration techniques. 

Cap and trade systems have become the stock in trade of many who try to advocate climate policy, but this preference may be based on little more than an allergic 

reaction to the use of the word ‘‘tax’’. Since concentrations depend on cumulative 

emissions over long periods of time, there is no economic reason to favor a policy 

that would fix annual emissions in a way that otherwise minimizes the cost of hitting such a target. Fixing total emissions of any pollutant in any year of short-term 

period of time only makes sense if variability around a targeted average (that would 

improve economic efficiency) would unnecessarily increase expected damages over 

the long term, and this is clearly not the case for carbon emissions. 

In addition, many have expressed concerns that the prices which clear cap and 

trade permit markets can be volatile. Volatility has certainly been the hallmark of 

the sulfur permit markets in the United States and the nascent carbon markets of 

the European Union. This Committee’s proposed legislation has responded to threat 

of incapacitating volatility by proposing ‘‘safety valve’’ limits on the price of permits. 

Others have argued that volatility can be diminished by appropriate banking provisions. The fundamental problem with either solution, however, is that appropriate 

climate policy requires a clear signal that carbon will always be more expensive 

next year than it is today. Even a modest amount of volatility can obscure that signal. 

On other hand, a tax, increasing at the rate of interest, would produce a persistent and predictable increase in the cost of using carbon that would inspire costreducing innovation and fuel switching in the transportation, building, and energy 

supply sectors of our economy.1

If carbon were taxed at the point it entered an economy (a couple thousand 

sources for the United States as opposed to millions of end-users), then it would be 

dispersed appropriately throughout the economy with relative prices of thousands 

of goods changing in proportion to the underlying carbon intensities. 

Moreover, a carbon tax would generate revenue. The $15 per tonne of carbon dioxide tax noted above would, for example, generate something like $90 billion in tax 

revenue in the United States in 2007 if it were paid on every tonne of carbon embodied in every unit of fossil fuel consumed. This is revenue that could be used to 

offset the regressive nature of the carbon tax itself, by underwriting tax credits for 

citizens with taxable incomes below a specified level. Revenue could even be used 

to fund research into alternative energy sources. 

A carbon tax would not, of course, provide any incentive to sequester carbon, but 

that can also be accomplished by appropriate use of some of the tax revenue. It 

should be possible to use some of the revenue to ‘‘buy back’’ carbon that was removed from the end of the effluent stream at a price that equals the tax applied 

at the beginning. Doing so would mean that the marginal cost of bringing in the 

last tonne would equal the marginal cost of taking it out—an efficiency criterion 

that ‘‘closes the loop’’. Interestingly, a $25-30 per tonne of carbon dioxide has been 

identified as the level for which current sequestration technologies might become 

economically efficient. Bringing these technologies up to scale would take more than 

a decade, of course, and large investment would be based on the same type of 

present value calculation outlined above. It follows that the same tax trajectory that 

starts at $15 per tonne in 2007 and reaches the $30 threshold around 2021 would 

also serve well in this context. 

Question 2. The Stern Review has received criticism from The Economist, the Copenhagen Consensus headed by Bjorn Lomborg, as well as other economists for either putting too much of the emphasis of climate change abatement on rich Western 

nations and not enough focus on the developing world. How would you respond to 

that assertion? 

Answer. The developing world must and will do its part, but it need not take the 

lead in 2007. Leadership has to be provided by the developed world, in general, and 

by the United States, in particular. The ideas outlined above would not do much 

harm over the near term, would improve our own energy security, and would show 

the world that we are willing to accept our leadership responsibilities. They will not 

solve the climate problem, though, unless they are accompanied by negotiations 

with and investments in developing countries designed to (1) promote improved capacities to adapt and to mitigate and (2) allow an effective ‘‘leap-frogging’’ of carbon-
79

* Graphic has been retained in committee files. 

intensive technologies that characterized economic activity at the end of the last 

century. 

It should be noted in passing that Bjorn Lomborg’s criticism of the Stern Review 

stopped with his concern that the damage estimates were inflated. He expressed admiration for the assessment of the underlying science and assessment of climate 

risk (just as he did when he commented on the Working Group 1 report to the 

Fourth Assessment of the Intergovernmental Panel on Climate Change (IPCC) released in Paris last month). My argument before you was that this science was the 

basis for a case for near-term climate policy and that a least cost approach to such 

a policy would involve starting immediately. His concerns, therefore, do not apply 

to points outlined above or in my testimony. 

Question 3. It is my understanding that the basic premise of the Stern Review 

is that our international response should act similarly to an insurance policy—pay 

some now to avoid big problems later. Considering that its recommendations usrge 

spending 1% of global GDP to prevent climate change, how would nations be forced 

to comply? 

Answer. This question is beyond my expertise, and I have made it a practice not 

to respond to questions about which I am no more expert than the next person. 

I have, though, used the insurance metaphor in trying to motivate the need for 

modest near-term policy. In those statements, the ‘‘insurance’’ purchased by nearterm climate policy is not against the risk of climate change, per se; rather it is 

against the risk of costly adjustments in policy sometime in the medium term future 

and against the chance of rendering a policy target infeasible that might turn out 

to be critical. In a paper that I published in Science in 2004 (attached to this response), the near policy that minimized expected adjustment cost in Nordhaus’s 

DICE model across 5 possible temperature targets that would be identified in 2035 

(one of which was deciding that no restriction at all is required on greenhouse gas 

emissions) for a current distribution of climate sensitivity turned out to be $10 per 

tonne of carbon dioxide. 

Question 4. Who would control the collection and allocation of funds to combat climate change under the Stern Review model? 

Answer. To my knowledge, the Stern Review model does not presume any specific 

allocation mechanism; and if it does, the validity of its fundamental conclusion that 

there is an economic reason for near-term climate policy is independent of that 

mechanism. Of course, I think that the Stern Review is right for the wrong reasons, 

but allocation mechanisms are not part of my reasons for concern. 

Question 5. One figure that is often quoted by some critical of the Stern Review 

is the ‘‘social cost’’ of carbon dioxide. Under the Stern Review, that comes to $85 

dollars a tonne (of carbon dioxide) while the Yale economist William Nordhaus has 

determined that cost to be $2.50 per tonne. Why is there such a large difference in 

these approaches? 

Answer. As noted in my answer to the second question from Senator Domenici, 

Figure 1 below displays the range of more than 100 estimates currently available 

in the published literature. I note above that the Stern estimate ($85 per tonne of 

carbon dioxide or $310 per tonne of carbon) is an outlier on the high side, especially 

when compared with peer reviewed estimates. The Nordhaus estimate ($2.50 per 

tonne of carbon dioxide or $9 per tonne of carbon) is much lower, but not as low 

as some (older estimates). 

Why the disparity? The choice of discount rate and the incorporation of equity 

weights are extremely important, and both lie within the purview of decision-makers. High discount rates sustain low estimates because future damages become insignificant. Conversely, low discount rates produce high estimates because future 

damages are important. Meanwhile, strong equity weighting across the globe support high estimates because poor developing countries are most vulnerable. Conversely, weak or no equity weighting can produce low estimates because poor developing countries do not factor heavily in the overall calculation. 

It turns out, however, that several scientific parameters that decision-makers cannot choose are even more important in explaining the variability depicted in Figure 

1.* Indeed, climate sensitivity (i.e., the increase in global mean temperature that 

would result from a doubling of greenhouse gas concentrations from pre-industrial 

levels) is the largest source of variation. It is possible to derive high estimates for 

the social cost of carbon even if you assume low discount rates and almost no equity 

weighting. All that is required is the assumption that the climate sensitivity lies 

at the high range of the latest range of estimates. Andronova and Schlesinger 

(2001), for example, find that the historical record could easily be explained with 
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climate sensitivities as high as 8 or 9 degrees Centigrade (even though the TAR reported an upper bound of 5.5 degrees). 

How could one get an estimate below Nordhaus’s? By assuming a high discount 

rate (decision-maker choice), low damages over the medium term (and even some 

benefits in the short term—the result of effective, timely and pervasive adaptation 

in developed and developing countries), and a low climate sensitivity (Mother Nature’s choice, and she hasn’t told us yet that this is so). 

Question 6. When conducting economic analysis of the future impacts on climate 

change, what type of prognostications are usually given for hurricanes and other unforeseen weather disasters? 

Answer. The answer here depends on the type of analysis. If it is a detailed impact analysis at a specific location over a specific period of time, then sea level rise 

is a driving force for climate stress. Exposure is magnified by coastal storms, and 

sensitivity depends on development patterns. Vulnerability analyses try to account 

for possible adaptations (good ones like set-back rules and bad ones like the withdrawal of properly priced insurance coverage). In these analyses, probabilistic representations of storm frequency and intensity are usually employed. With the current state of scientific debate, increases in either are usually included in sensitivity 

analyses around baselines that assume no change. It is important to note, however, 

that coastal storms become more threatening as seas rise regardless of whether or 

not climate change is influencing their likelihoods or intensities; a 10 foot storm 

surge is automatically an 11 foot surge after 1 foot of sea level rise. 

Large integrated assessment like PAGE2002 (employed by the Stern Review author team) or RICE (William Nordhaus’s regional model) include far less detail because they use aggregate measures of damage. There, unforeseen weather events 

are treated stochastically, and damages include estimates of what people would be 

willing to pay to have the risk eliminated—an economic construction of the sort employed by Stern in the calculation of equivalent per capita consumption.

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