By Kenneth J. Arrow (China Daily)
Updated: 2007-12-14 07:51

Last fall, Britain issued a major government report on global climate change directed by Nicholas Stern, a top economist.

The Stern Review Report on the Economics of Climate Change amounts to a call to action: it argues that huge future costs of global warming can be avoided by incurring relatively modest cost today.

Critics of the Stern review do not think serious action to limit CO2 emissions is justified, because there remains substantial uncertainty about the extent of the costs of global climate change, and because these costs will be incurred far in the future.

However, I believe that Stern's fundamental conclusion is justified: we are much better off reducing CO2 emissions substantially than risking the consequences of failing to act, even if, unlike Stern, one heavily discounts uncertainty and the future.

Two factors differentiate global climate change from other environmental problems.

First, whereas most environmental insults - for example, water pollution, acid rain, or sulfur dioxide emissions - are mitigated promptly or in fairly short order when the source is cleaned up, emissions of CO2 and other trace gases remain in the atmosphere for centuries. So reducing emissions today is very valuable to humanity in the distant future.

Second, the externality is truly global in scale, because greenhouse gases travel around the world in a few days.

As a result, the nation-state and its subsidiaries, the typical loci for internalizing externalities, are limited in their remedial capacity. However, since the United States contributes about 25 percent of the world's CO2 emissions, its own policy could make a large difference.

Thus, global climate change is a public good (bad) par excellence.

Cost-benefit analysis is a principal tool for deciding whether altering it through mitigation policy is warranted.

Two aspects of that calculation are critical. First, it has to be assumed that individuals prefer to avoid risk. That is, an uncertain outcome is worth less than the average of the outcomes. Because the possible outcomes of global warming in the absence of mitigation are very uncertain, though surely bad, the uncertain losses should be evaluated as being equivalent to a single loss greater than the expected loss.

The second critical aspect is how one treats future outcomes relative to current ones - an issue that has aroused much attention among philosophers as well as economists. At what rate should future impacts - particularly losses of future consumption - be discounted to the present?

The consumption discount rate should account for the possibility that, as consumption grows, the marginal unit of consumption may be considered to have less social value. This is analogous to the idea of diminishing marginal private utility of private consumption, and is relatively uncontroversial, although researchers disagree on its magnitude.

There is greater disagreement about how much to discount the future simply because it is the future, even if future generations are no better off than us. Whereas the Stern review follows a tradition among British economists and many philosophers against discounting for pure futurity, most economists take pure time preference as obvious.

However, the case for intervention to keep CO2 levels within bounds is sufficiently strong to be insensitive to this dispute. Consider some numbers from the Stern review concerning the future benefits of preventing greenhouse gas concentrations from exceeding 550 ppm, as well as the costs of accomplishing this.

The benefits are the avoided damages, including both market damages and non-market damages that account for health and ecological impacts.

Kenneth J. Arrow, a Nobel laureate in Economics, is professor of Economics Emeritus and professor of Management Science and Engineering Emeritus at Stanford University Project Syndicate

(China Daily 12/14/2007 page11)