[Senate Hearing 110-52]
[From the U.S. Government Publishing Office]


                                                         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




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                       Printed for the use of the
               Committee on Energy and Natural Resources
               COMMITTEE ON ENERGY AND NATURAL RESOURCES

                  JEFF BINGAMAN, New Mexico, Chairman

DANIEL K. AKAKA, Hawaii              PETE V. DOMENICI, New Mexico
BYRON L. DORGAN, North Dakota        LARRY E. CRAIG, Idaho
RON WYDEN, Oregon                    CRAIG THOMAS, Wyoming
TIM JOHNSON, South Dakota            LISA MURKOWSKI, Alaska
MARY L. LANDRIEU, Louisiana          RICHARD BURR, North Carolina
MARIA CANTWELL, Washington           JIM DeMINT, South Carolina
KEN SALAZAR, Colorado                BOB CORKER, Tennessee
ROBERT MENENDEZ, New Jersey          JEFF SESSIONS, Alabama
BLANCHE L. LINCOLN, Arkansas         GORDON H. SMITH, Oregon
BERNARD SANDERS, Vermont             JIM BUNNING, Kentucky
JON TESTER, Montana                  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










                            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


                      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 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 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 
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.
    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 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 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-as-usual 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:]
   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.
    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 atmospheric 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 low-carbon 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 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.
    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.
    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.
    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.*
---------------------------------------------------------------------------
    * Graphic has been retained in committee files.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \1\ Referred to hereafter as CO2 equivalent, 
CO2e.
---------------------------------------------------------------------------
    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 
high-carbon 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.
    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.
---------------------------------------------------------------------------
    \2\ All changes in global mean temperature are expressed relative 
to pre-industrial levels (1750-1850).
---------------------------------------------------------------------------
    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 Nino 
        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 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.
    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.

    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 probability-weighted 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.
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    * Graphic has been retained in committee files.
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    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 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.
    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 low-carbon 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 fossil-fuel 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.
---------------------------------------------------------------------------
    * Graphic has been retained in committee files.
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    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 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 greenhouse-gas 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 cost-effective. 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 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 high-carbon 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, 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.
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    * Graphic has been retained in committee files.
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    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.
    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 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 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.
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.
    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-in-hand 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.
    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-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 multi-party 
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:]
 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 low-emissions 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.
---------------------------------------------------------------------------
    \1\ This 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.
---------------------------------------------------------------------------
    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 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.
---------------------------------------------------------------------------
    \2\ The 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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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 discussed. 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 economic 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.
    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 policy-making 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 exercise 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 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
   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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
    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.
---------------------------------------------------------------------------
    * Graphic has been retained in committee files.
---------------------------------------------------------------------------
    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 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\
---------------------------------------------------------------------------
    \2\ The 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.
---------------------------------------------------------------------------
    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 short-term 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 long-term 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 long-term 
economic costs of the policies.
    As an example, one might consider investments that are pending to 
replace coal-fire 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 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?
    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.
    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 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 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 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 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.
    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 everyday. 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. 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.
    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 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.
    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.
    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 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 importance 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 investment, 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.
    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 out-years. 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 out-years 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 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 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.]
                                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 cumulatively 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.
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    \1\ When the safety valve was triggered.
    \2\ Much 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.
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    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 co-operation 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.
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    \3\ The price cap when set very low effectively takes the form of a 
tax rather than a trading scheme.
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    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.
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    \4\ For more on the design of emissions trading schemes see Chapter 
15 of the Stern Review and Box 15.2 for price caps and floors.
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    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 engagement. 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\
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    \5\ The issues of public awareness and responsible behavior are 
explored in more detail in Section 21.4 and 17.7 respectively.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \6\ Covering 47% of industrial energy use.
---------------------------------------------------------------------------
    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 policies 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 coal-fired 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.
---------------------------------------------------------------------------
    \7\ In shorter time periods in low lying and poorer areas 
particularly low lying Island states and countries such as Bangladesh.
---------------------------------------------------------------------------
    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.
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \9\ www.sternreview.org.
---------------------------------------------------------------------------
    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 contributing 
scientists to ensure that the Review was based on the best available 
science.
---------------------------------------------------------------------------
    \10\ Inter-governmental Panel on Climate Change www.ipcc.ch/
SPM2feb07.pdf.
---------------------------------------------------------------------------
    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 assessment\11\ 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.
---------------------------------------------------------------------------
    \11\ Chapter 6 of the Review.
    \12\ There is not a comprehensive set of global studies for each 
impact that allows a bottom-up cost estimate from disaggregated 
studies.

    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 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.
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    \13\ For more details and video see http://www.ycsg.yale.edu/
climate/index.htm.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \14\ Lower scenarios are manifestly implausible as assumptions of 
business as usual--they are likely to involve policies of the kind we 
discuss.
---------------------------------------------------------------------------
    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 comparability with 
scientific estimates (which are based on the specific scenarios used by 
the IPCC).
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    \15\ This is explored in the sensitivity analysis on our website 
and further emission scenarios will be the subject of future analysis.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \16\ There 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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \17\ As illustrated in Figures 8.4 and 8.2 and from technology 
approach to modeling Figure 9.3.
---------------------------------------------------------------------------
    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?
    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 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\
---------------------------------------------------------------------------
    \18\ Not necessarily within their own borders.
    \19\ Which is at the top of the range of stabilization goals we 
suggest--between 450 and 550 ppm CO2e.
---------------------------------------------------------------------------
    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.
    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.
---------------------------------------------------------------------------
    \20\ www.iter.orq/.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \23\ Ackerman, F. and Finlayson, I (2007) The Economics of Inaction 
on Climate Change: A Sensitivity Analysis, Climate Policy 6:4.
---------------------------------------------------------------------------
    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 approach 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.
---------------------------------------------------------------------------
    \24\ Such 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.
---------------------------------------------------------------------------
    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 short-term? 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 
business-as-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.
    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 ``non-market 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.
    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 well-designed 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.
---------------------------------------------------------------------------
    \1\ See 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.
---------------------------------------------------------------------------
    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 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 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]
------------------------------------------------------------------------
                                                              Discounted
                        Discount Rate                         Damages\1\
------------------------------------------------------------------------
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.
    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 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 
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 gas-fired 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 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 cost-reducing innovation and fuel switching 
in the transportation, building, and energy supply sectors of our 
economy.\1\
---------------------------------------------------------------------------
    \1\ The 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.
---------------------------------------------------------------------------
    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-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 near-term 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 
climate sensitivities as high as 8 or 9 degrees Centigrade (even though 
the TAR reported an upper bound of 5.5 degrees).
---------------------------------------------------------------------------
    * Graphic has been retained in committee files.
---------------------------------------------------------------------------
    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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