Discounting a future of global warming

It’s safe to assume that when Theresa May decided to announce yet another freeze in fuel duty last week she was thinking of her own political survival rather than the survival of the white lemuroid ringtail possum, or the thousands of other animal species on the planet which are facing extinction due to fossil-fuel driven global warming.

It seems reasonable to speculate that her own political welfare loomed somewhat larger in her calculations than the economic welfare of as yet unborn generations of Britons. Depressing it may be but such shorttermism is hardly unusual. It’s innate to our species. As humans we place a higher value on jam today than jam tomorrow. We generally value our own welfare more highly than that of generations to come. We “discount” the future.

The more mature among us moderate our discounting, understanding that we will, probably, be around to live with the consequences of spending like Liberace in 2018. Most of us care about the living standards of our children and their children. But the reality is that we all discount.

Should we expect something different from policymakers? Shouldn’t we expect them to take the long view, or at least to give the impression of doing so? The answer is yes, but not an unqualified one.

In 2006 a landmark UK government-commissioned report into the economics of climate change by Nicholas Stern used a (virtually) zero discount rate to put a price on the future economic damage threatened by a warming planet. Stern’s cost-benefit analysis yielded the firm conclusion that urgent action to reduce emissions was warranted, even if it entailed a sizeable short-term economic cost in terms of investment in low-carbon technology and taxes on fossil-fuel pollution.

Yet William Nordhaus, who was awarded the Nobel economic gong by the Swedish Academy of Sciences on Monday for his pioneering modelling of climate feedback effects on the global economy, was unhappy with Stern’s discount rates. He suggested that using a zero discount rate implied that we would take vastly expensive action today to forestall a negative economic event in 200 years’ time – even though, assuming humanity survives that long, our descendants will probably be far wealthier than us.

Stern, said Nordhaus, “would justify reducing per capita consumption for one year today from $10,000 (£7,600) to $4,400 in order to prevent a reduction of consumption from $130,000 to $129,870 starting two centuries hence and continuing at that rate forever after.” Which sounds like lunacy. But two can play that game of using assumptions to yield ridiculous-sounding conclusions. As Stern has countered, if one uses a discount rate of just 2 per cent “a life starting 35 years later, but otherwise the same, would have half the value of a life starting now”.

Economics can’t tell us the answer of what discount rate to choose when setting up a cost-benefit analysis of a policy like climate change mitigation. How highly we should value the welfare of future generations is a philosophical question.

So are we stuck? Thankfully, no. Since the Stern review was published 12 years ago the estimates of the potential economic damage of climate change have been revised upwards. We know more about potential “tipping points”, after which things get very bad very quickly. The costs of action have also fallen as the cost of renewable energy generation, particular solar power, have come down. Even applying somewhat higher discount rates does not undermine the case for action today. Nordhaus has revised up his estimates of the damage from carbon pollution significantly in recent years.

Nordhaus recommends a straightforward uniform global carbon tax to curb emissions. Other economists prefer a cap and trade system of pollution permits. But provided the cap is set at an appropriately low level – and provided its coverage is sufficiently global – this should have the same impact as a tax. The key is action to make sure that businesses and households internalise the cost of pollution and change their behaviour. Think about the Conservatives’ irresponsible nine years of frozen fuel duty in this context.

The climate science points in one direction, as this week’s updated warning from the United Nations’ Intergovernmental Panel on Climate Change. So does the economics, thanks to the work of the likes of Nordhaus and Stern. The blockage is politics.

#climatechange #NicholasStern #TheresaMay #WilliamNordhaus

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