61Symposium:The Economics of Climate Change: The Stern Review and Its CriticsAn Even Sterner Review: IntroducingRelative Prices into the DiscountingDebateThomas Sterner∗and U. Martin Persson∗∗IntroductionThe Stern Review (2006) has come to symbolize something of a dividing line in the evolution ofthe common appreciation of the climate problem. It is fair to say that during the last decade,there has been a gradual but uneven increase in the perceived gravity of anthropogenicclimate change, among scientists and, with some time lag, the general public. However, savethe United Nations’ Intergovernmental Panel on Climate Change (IPCC) assessments (seefor example, IPCC, 2001, 2007a, b), the Stern Review is the first major, official economicreport to give climate change a really prominent place among global problems. The politicalbacking of the Stern Review in the UK—at its first presentation, Sir Nicholas Stern was flankedby both Prime Minister Tony Blair and Chancellor Gordon Brown—has been impressiveand one of the factors commanding attention.Still, the Stern Review has been criticized on a number of accounts. The criticism hasregarded both the manner in which the results are presented and the methodology underlyingthem, especially when it comes to the discount rate used when analyzing the future economicbenefits and costs of climate change.The reason for the preoccupation with the discount rate, a seemingly trivial parameter, issimple: since the impacts of climate change will mostly be felt in the future (because emissionsof greenhouse gases are rising and because of the inertia of the climate system), the rate atwhich we discount the future will have a huge impact on the level of emissions reduction that∗Department of Economics, G¨oteborg University, Sweden∗∗Physical Resource Theory, Chalmers University of Technology, SwedenWe would like to thank Martin Weitzman, Claude Henry, C´ederic Philibert, Martin Dufwenberg, OlofJohansson-Stenman, Michael Hoel, Christian Azar, Nils Axel Braathen, an anonymous reviewer, and bothRob Stavins and Suzy Leonard for valuable comments that helped improve the quality of the paper. Financialsupport from FORMAS, the CLIPORE program financed by MISTRA, and the Swedish Energy Agency isgratefully acknowledged.Review of Environmental Economics and Policy, volume 2, issue 1, winter 2008, pp. 61–76doi: 10.1093/reep/rem024Advance Access publication on April 23, 2008CThe Author 2008. Published by Oxford University Press on behalf of the Association of Environmental and ResourceEconomists. All rights reserved. For permissions, please email: [email protected] T. Sterner and U. M. Perssonis economically warranted today. A simple example illustrates this point. If we use a discountrate of 1 percent, the discounted value of $1 million 300 years hence is around $50,000 today.But if we use a discount rate of 5 percent, the discounted value is less than 50 cents! Notehow this difference is strongly nonlinear—in this example, the discounted value is changedby a factor of 100,000 when the discount rate is changed by a factor of five.Although a relatively simple concept in economics, the discount rate debate cuts to the coreof many fundamental questions regarding global environmental change: how much weightshould we put on the welfare of future versus current generations? Will growth continue sothat future generations are all richer than we are today? How important is the distributionof impacts (i.e., how should we value costs that disproportionately fall upon the poor or therich)? Consequently, when it comes to analyzing climate change policy, we are far from aconsensus in the economics literature on which value to choose for the discount rate.The main argument of this article is that results similar to the Stern Review can be obtained,even without making the assumptions concerning the discount rate that have been so stronglycriticized, by taking into account the neglected but important fact that relative price changesare an inherent aspect of economic growth. More specifically, we show that rising relativeprices can have important implications for the efficient level of climate change mitigation.Briefly, because the rate of growth is uneven across sectors of the economy, the compositionof economic output will inevitably change over time. If output of some material goods (e.g.,mobile phones) increases, but access to environmental goods and services (e.g., access to cleanwater, rain-fed agricultural production, or biodiversity) declines, then the relative price ofthese environmental amenities should rise over time. The result will be augmented economicdamages from climate change, which means that higher levels of climate change mitigationwould be warranted today. We conclude by arguing that even more restrictive stabilizationscenarios than those discussed in the Stern Review can be justified on economic grounds.The article is structured as follows. In the second section, we discuss the metric used bythe Stern Review to present future costs. In the third section, we make some observationsconcerning the rate of discounting and its determinants, both in the Stern Review and inthe broader literature. Further, we introduce our main contributions: the effect of highernonmarket damages and unbalanced growth on relative prices and the importance of thesefactors for the value of future climate damage. Using a well-established climate model, theDynamic Integrated Model of Climate and the Economy, or DICE (Nordhaus 1994), inthe subsequent section, we illustrate the effect of making different assumptions regardingdiscount rates and incorporating relative price changes on efficient levels of emission abate-ment. In the sixth section, we discuss the estimates of the economic impacts of climate changeon precisely those nonmarket goods and services whose prices we expect to rise over time.Finally, in the last section, we discusse our findings and conclude.The Stern Review’s Presentation of Damage EstimatesOne of the features of the Stern Review that has stirred controversy concerns the way itpresents the estimated damages from climate change. While earlier studies (e.g., Nordhaus1994) have estimated costs of climate change impacts on the order of 1 percent of futureGDP, the Stern Review boldly asserts that business-as-usual (BAU) emissions of greenhouseAn Even Sterner Review: Relative Prices and Discounting 63gases will lead to a