October 30, 2006
Stern Report: Chapter 2
Standard treatments of discounting are valuable for analysing marginal projects but are inappropriate for non-marginal comparisons of paths; the approach to discounting must meet the challenge of assessing and comparing paths that have very different trajectories and involve very long-term and large inter-generational impacts. We must go back to the first principles from which the standard marginal results are derived.
You can do all sorts of lovely things by playing with discount rates. Use 10% and it's difficult to see that any expenditure now is worth solving a problem even 50 years away. Use a zero one and all expenditure now can just about be justified to solve a problem 500 years away. Use declining ones as time spans lengthen (as the Treasury itself suggests) and you might get closer to something useful: wonder what rates will be suggested?
In common with many other environmental problems, human-induced climate change is at its most basic level 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 directly, neither via markets nor in other ways, the full consequences of the costs of their actions.
Absolutely true, it is indeed the heart of the economic side of the problem.
The basic theory of externalities and public goods is the starting point for most economic analyses of climate change and this Review is no exception. The starting point embodies the basic insights of Pigou, Meade, Samuelson and Coase (see Part IV).
Yup, they're the people to start with.
Page 26 and following need to be read closely. Very interesting point made, that the optimal level of abatement depends upon predictions both of future emissions and of future abatement costs. Almost back to the scenarios of the SRES: what we do will at least in part be determined by which scenario we think we'll be following.
Yet assessing impacts over a very long time period emphasises the problem that future generations are not fully represented in current discussion. Thus we have to ask how they should be represented in the views and decisions of current generations. This throws the second rationale for ‘discounting’ future consumption mentioned above – pure time preference – into question. We take a simple approach in this Review: if a future generation will be present, we suppose that it has the same claim on our ethical attention as the current one.
Are they going to use a zero discount rate? Off to the technical annex to the chapter I guess. Hhm. They seem to be using something close to The Treasury model suggested: discount rates start at about 3%, and fall, given longer time periods, to as low as 2% or so for periods of a centuryish.
That is obviously going to make the costs of mitigation now when set against future benefits seem lower. The reject the idea of using market discount rates to measure such values: they may even be right in stating that doing so would be unethical because it does not take account of inter-generational transfers.
I'll admit to that making me a little queasy: very easy for someone to state that the values of this or that are what I say they are rather than what the 6 billion people partaking in the market say they are.
Chapter 3 here.
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You are missing the point. The analysis will not be sensitive to discount rates because the costs & benefits are expressed as a percentage of GDP.
Tim adds: Then why do they spend 30 pages discussing discount rates?
Posted by: james C | Oct 30, 2006 3:18:03 PM
Because to make comparisons between GDP now and in the future you need to decide what a unit of GDP 20 years hence is worth today, i.e. you need to discount!
Posted by: mike phelps | Nov 1, 2006 9:38:17 AM