STERN REVIEW: The Economics of Climate Change

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 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:

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;

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;

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

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 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.

The current level or stock of greenhouse gases in the atmosphere is equivalent to

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.

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

annual flow of emissions is accelerating, as fast-growing economies invest in highcarbon

infrastructure and as demand for energy and transport increases around the

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°C.

1 Referred to hereafter as CO2 equivalent, CO2e

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°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°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.

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°C within the next

emissions continue to grow.

Warming will have many severe impacts, often mediated through 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.

without the ability to produce or purchase sufficient food. At mid to high

latitudes, crop yields may increase for moderate temperature rises (2 - 3°C),

but then decline with greater amounts of warming. At 4°C and above, global

food production is likely to be seriously affected.

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.

flooded each year with warming of 3 or 4°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.

40% of species potentially facing extinction after only 2°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.

5 All changes in global mean temperature are expressed relative to pre-industrial levels (1750 - 1850).

Higher temperatures will increase the chance of triggering abrupt and large-scale

changes.

monsoon rains in South Asia or the El Niño phenomenon - changes that

would have severe consequences for water availability and flooding in tropical

regions and threaten the livelihoods of millions of people.

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°C.

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.

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

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 1m

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.

In higher latitude regions, such as Canada, Russia and Scandinavia, climate change

may lead to net benefits for temperature increases of 2 or 3°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°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.

temperatures, is predicted approximately to double annual damage costs, in

the USA.

to 0.2 - 0.4% of GDP once the increase in global average temperatures

reaches 3 or 4°C.

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.

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°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°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°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 peerreviewed

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:

(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.

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.

regions of the world. If we weight this unequal burden appropriately, the

estimated global cost of climate change at 5-6°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.

result, since 1850, North America and Europe have produced around 70% of all the

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

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

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.

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.

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:

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

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.

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%,

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

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 lowcarbon

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

1% of global GDP by 2050, with a range from –1% (net gains) to +3.5% of GDP.

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

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.

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.

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

associated with significant risks.

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

$500bn 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.

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.

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

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 costeffective.

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

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-

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.

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.

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.

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.

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 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, an