The Social Discount Rate and Global Warming
Tyler Cowen has a good summary of his views on the social discount rate, in a post relating to Stern’s assumption of it being zero in global warming calculations:
1. For resources which will be reinvested, use the rate of return on capital, adjusting for taxes, risk, and the like.
2. For resources which will otherwise be consumed within the current generation, use the market rate of interest, again with adjustments. That rate reflects time preference within a life.
3. If we are comparing different consumption units across the generations, there is no time preference in the economically meaningful sense. (Prior to 1962, I was not impatiently waiting to have been born.) Use zero, noting this is an ethical rather than economic choice.
Depending on the configuration of the variables, the correct “net” discount rate usually will be above zero but below the current market rate.
That sounds right to me, except for the last paragraph. If we are thinking of building a bridge that will benefit people $101 in 90 years and cost $100 now, we shouldn’t build it. If we want to help those people in 90 years, we would do better to invest the $100 in other things and give them the return of $800 or whatever it would be by then.
On the other hand, if it is a question of whether to having a war now that will kill 100 people in order to avoid a war in 90 years that will kill 101 people, it seems as if we ought to have the war now.
That might not be a good example, though. Suppose we today would prefer to pay 1 billion dollars to avoid that war, and that billion dollars could be invested to be worth 800 billion dollars in 90 years. Then we ought to have the war later, and have the present generation invest the billion dollars.
In any case, global warming policy is an investment decision, and hence should use the market rate of interest. If we have a choice to cut our consumption by $500 billion now to reduce CO2 emissions and avoid $550 billion in climate losses in 90 years, we shouldn’t do it. Instead, if we want to help the future we should cut our onsumption by $400 billion now and invest it in general capital, which would yield far more in 90 years.
PS: I see that I misunderstood Prof. Cowen. In another post he says,
4. The resources that would have gone into consumption are harder to discount, especially if we are comparing those resources across the generations, and if the change in question is “large” rather than “small.” I tend to favor a very low or zero discount rate in these settings, if only because there is no pure time preference across the generations. (Before you are born, you are not sitting around impatiently, waiting, unless of course you are a character in Maeterlinck’s The Blue Bird.) In any case this is predominantly an ethical question, and no correct answer follows directly from examining marginal analysis and market prices.
If the change is “small” for the affected people, in the precise sense of not much affecting their marginal utility of wealth, we should discount by the market rate of interest, adjusted for risk, taxes, transactions costs, etc.
It seems he is not doing the thought experiment of alternative ways to help the future. He is comparing keeping things the way they are now (with investment being assumed to help the future generation) versus the suggested policy change.