15 Aug 2009

Why Discounting Matters in the Climate Change Policy Debate

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Someone who is working on these matters emailed me in regard to this article. Here is a self-explanatory portion of my response. I’m trying to show the problems of “treating our grandchildren as just as entitled to happiness as we are.” In other words, I’m trying to show why you need to use market interest rates when comparing present costs of emission cutbacks, with future benefits of averted climate damage. (You might want to do a rights-based approach, not a cost/benefit. That’s fine, but if you are going to do a cost/benefit, then you need to use a discount rate, arguably the market’s.)

OK so let’s say that we have decided we’re going to limit GHG
emissions today and this will cause our (conventional) GDP to drop by
$1 billion. Someone says, “Wow, that’s a lot of money. Is the program
worth the high cost?”

The proponent says, “Yeah, it sure is! Our scientists tell us that our
policy will spare our grandchildren climate change, and our economists
tell us that the damage we are thereby averting would be priced at $3
billion at the time it occurs. So we’re spending $1 billion today to
spare our kids $3 billion in damages, as they would have appraised

Then the critic says, “Are you nuts? Instead of cutting back our
output, let’s go ahead and produce that $1 billion in extra GDP, but
then we’ll put $200 million of it into a safe investment earning 3
percent (after inflation) per year. One hundred years from now, that
will be worth $3.7 billion, which we’ll bequeath to our grandkids. So
everyone is better off! We only lose $200 million this year, instead
of the $1 billion you suggested. And our grandkids are happier too.
Sure, they’ve got $3 billion in climate damages to deal with, but
they’ve got an extra $3.7 billion in wealth to deal with it.”

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