Thursday, July 30, 2009

How to discount time for climate change policies

If you ever tried to argue with a biologist about the pros and cons of conservation, of climate change or habitat encroachment, for example, the debate will pretty fast narrow down to whether the future should be discounted or not. For an economist, this is a nonsensical debate, as the present value of anything is infinity if there is no discount rate and a possibly infinite lifetime. But among economists as well, there is a debate about what discount rate to use, in particular after the release of the Stern Review (previous post about this).

David Anthoff, Richard Tol and Gary Yohe now provide a much more rational discussion about how to treat discounting for climate change. Take a standard Ramsey model, and in the Euler equation one needs to take into account time preference, risk aversion and the growth rate of marginal utility. Under fairly standard assumptions, this amounts to figuring out the (pure) discount rate, the curvature of utility and the growth rate of consumption. Obviously, the (pure) discount rate will have a large impact on the discount rate to use, but so will have risk aversion considering the large uncertainties about climate change. The uncertainties are not so much about whether it is happening, but rather how far and fast this change will happen.

Interestingly, Anthoff, Tol and Yohe find that the present value of the social cost of carbon is $61 a metric ton, which is a lot more than the $0 the US Congress seems to be ready to price it for the initial carbon permits...

1 comment:

Stephen Monrad said...

Suppose I have a way of earning a dollar today that will result in the end of the world 10,000 years from now. With a low discount rate of 1 per cent, the present value of the future stream of lost world income is roughly 6.11 x 10^-42 times the annual world income (assuming a stable income).

Discounting would show that earning a dollar today at the cost of the end of the world in 10,000 years was a good deal.

Whoever or whatever is around 10,000 years from now, however, would see things differently.

While discounting is a useful tool in the medium term, I think it leads us astray in the very long term.

The answer, I think, is to use common sense instead of math. It's wrong to create problems that cannot be fixed. Destabilizing the climate is something that should be avoided at all costs. We need a habitable planet, period.