Friday, 24 May 2013

Climate change and discounting the future

Last week in class we studied discount rates.  Here is Martin Weitzman on climate change and discount rates


Discounting the Costs of Climate Change in the Future
To add to the complexities and uncertainties, there is the fact that long periods of time are involved. The really high temperatures would likely materialize, if at all, only in the course of centuries. The worse the magnitude of the climate disaster, the more likely is it to occur at a further-off future time.
One premise of modern economics is that we humans discount the future. This simply means that we value something that happens in the here-and-now -- the present -- more than we value it, right now, if we will only get it in the future. A dollar today is worth more than a dollar a year from now, for example. And that means that a dollar a year from now is worth less, in today's money, than the dollar today.
We use a discount rate to compare the two -- which is, in the case of money an interest rate. So if the discount or interest rate were 3 percent a year, a dollar a year from now would be worth 3 percent less -- only 97 cents -- than a dollar today. At a 3 percent discount rate, that is the so-called "present value" of a dollar you wait a year to get and spend. And indeed, 3 percent a year is a commonly used discount rate for rewards in the future compared to rewards today.
It's important to notice that if an ordinary interest rate like 3 percent were used to discount the distant future, the power of compound interest is such that the present value of even very large damages could be made to appear small. A dollar today is worth 3 percent less than a dollar a year from now: 97 cents. Discount that 97 cents by another 3 percent to wait yet another year, and so on, and by the time you repeat the process for about 24 years, a dollar is worth just half what it is today. Wait 50 years and it's worth 22 cents. Wait a hundred years and a 2113 dollar would be worth barely 3 cents to someone living in the present.
There is a vigorous debate among economists about what interest rates should be used to discount the inter-generational damages from climate change. If we value highly the climate-associated welfare of future generations then we should be using low discount rates -- say 1 percent or less -- which would register the present value of their catastrophic damages as if it were equivalent to a very high level of present damages -- something that must be avoided by action now. If we used market interest rates, which are usually much higher, it could still be the case that catastrophic damages should be avoided by action now if the magnitude of the future catastrophic damages were high enough. So time and discounting introduce new wrinkles, but it could still be the case that what is most worrisome about climate damages is not their average or expected or most-likely mid-range value, but the extreme upper-end values associated with various sorts of catastrophe.
Once it is in the atmosphere, CO2 remains there for a very long time. Even if CO2 emissions were cut to zero at some point in the future (a very drastic assumption), about 70 percent of CO2 concentrations over the pre-industrial level of 280 ppm would remain in the atmosphere for the following one hundred years, while about 40 percent would remain in the atmosphere for the following one thousand years. This, along with the possibility of bad outcomes, is the argument for keeping CO2 concentrations from reaching very high levels.

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