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Review of Environmental Economics and Policy Advance Access originally published online on April 23, 2008
Review of Environmental Economics and Policy 2008 2(1):61-76; doi:10.1093/reep/rem024
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© The Author 2008. Published by Oxford University Press on behalf of the Association of Environmental and Resource Economists. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org

An Even Sterner Review: Introducing Relative Prices into the Discounting Debate

Thomas Sterner* and U. Martin Persson**

* Department of Economics, Göteborg University, Sweden
** Physical Resource Theory, Chalmers University of Technology, Sweden

By estimating that the cost of unmitigated climate damages is an order of magnitude higher than most earlier estimates, the Stern Review on the Economics of Climate Change has had a major influence on the policy discussion on climate change. Not surprisingly, severe criticism has been levied against the report, especially by those who claim that the Stern Review's results hinge mainly on a discount rate that is too low. While we have no strong objections to the discounting assumptions adopted in the Stern Review, our main point in this article is that the conclusions reached in the Stern Review can be justified without using a low discount rate. We argue that nonmarket damages from climate change are probably underestimated and that future scarcities caused by the changing composition of the economy and climate change should lead to rising relative prices for certain goods and services. This will raise the estimated damage of climate change and modify as well as counteract the effect of discounting. We illustrate this effect using a slightly modified version of Nordhaus's DICE model and show that taking relative prices into account can have as large an effect on economically warranted abatement levels as a low discount rate.

We would like to thank Martin Weitzman, Claude Henry, Céderic Philibert, Martin Dufwenberg, Olof Johansson-Stenman, Michael Hoel, Christian Azar, Nils Axel Braathen, an anonymous reviewer, and both Rob Stavins and Suzy Leonard for valuable comments that helped improve the quality of the paper. Financial support from FORMAS, the CLIPORE program financed by MISTRA, and the Swedish Energy Agency is gratefully acknowledged.


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