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Report n° 7: The Stern review

Influence of a seemingly abstruse debate on the choice of coefficients

Stern measures damage in terms of 2005-equivalent per capita consumption, the logic of which should be understood. It implies drawing readers into developments which may appear to be a modern form of the debate on how many angels can dance on the head of a pin, but which expresses in learned terms very real arguments and visions of the world.

  • The strong point of the Stern indicator (Annex 1 of the Stern Review) is that it puts forward a permanent cost, a simple figure which summarizes loss profiles over a century: i.e. a sequence of damage occurring between 2050 and 2150 which lowers the level of household well-being (for example 2% in 2050, 5% in 2080) compared to a given reference (1.3% growth per annum). Stern aggregates the losses over two centuries and calculates which drop in consumption today (following a hypothetical shock) would produce the same aggregate loss in well-being if it was followed by a 1.3% growth rate. It is as if n% of consumption was lost "now and forever" (see box below).

  • The calculation depends on the long-term discount rate "r" which allows evaluating future well-being gains or losses at equivalent current values. They are the consumption drop or surplus needed today to achieve that gain or loss following on the change in investment which would ensue. The r value derives from the equation r = r + h.g which represents in a very abstract way interactions between preferences and technological progress: r is the pure present preference rate (ppp), and h.g the well-being gain from the investment.
    That in turn is the product of g, surplus consumption, and h which describes how marginal utility decreases with income (if future generations are richer, one euro will be of less utility).
    Hence the importance of r (the value assigned to the future) in view of the time lag between emission abatement and avoided damage: if the now and forever cost of damage in 2100 is assessed at 5% of present consumption with r = 0.1% as chosen by Stern, it rises to 0.75% with r =2 %, a value often retained for growth models.