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.

Various links

1.  The OECD Economic outlook is out. Pretty depressing stuff.  Here's what they say about the UK

 The government has committed to implementing a number of
reforms which, if implemented fully, will boost both short and long-term
growth. Increasing the state pension age in line with longevity will foster
long-term fiscal sustainability. Implementing the recommendations of
the Independent Commission on Banking will strengthen the financial system. The Universal Credit will reduce disincentives to work, and government training and apprenticeship programmes will contribute to a better integration of young people into the labour market and enhance the availability of skilled workers. The planning reform and further support to the housing market and infrastructure should allow construction to grow.

1.  I found this interesting. House price/rental ratios are not as low as I would have thought, note Ireland is very different.

1. 

 2. Tim Taylor has a great piece reviewing McKinsey's report on manufacturing.
He has an interesting quote:

"As economies mature, manufacturing becomes more important for other attributes, such as its ability to drive productivity growth, innovation, and trade. Manufacturing also plays a critical role in tackling societal challenges, such as reducing energy and resource consumption and limiting greenhouse gas emissions. ...Manufacturing continues to make outsize contributions to research and development, accounting for up to 90 percent of private R&D spending in major manufacturing nations. The sector contributes twice as much to productivity growth as its employment share, and it typically accounts for the largest share of an economy’s foreign trade; across major advanced and developing economies, manufacturing generates 70 percent of exports."

3. http://marginalrevolution.com/marginalrevolution/2012/12/marcia-angells-mistaken-view-of-pharmaceutical-innovation.html Pharmaceutical innovation arguments

Various links

1. Via Tyler Cowan, markets in everything: Osama Bin Laden example.

2. Who is more brilliant on the history of innovation than Joel Mokyr?  Note here the interesting non-use of patents.  The Rate and Direction of Invention in the British Industrial Revolution: Incentives and Institutions.

3. The use of discount rates to calculate pension liabilities: good example of discounting for lecture 3 on costs.

4. Tim Harford very good links on AV.  I particularly liked this one by Dennis Leech. He says

"I will be voting in the referendum for AV because, while it is flawed, it is better than First Past The Post for two good reasons. First, it rules out the possibility of an unpopular extremist being elected due to the vote being divided among the main parties. Second, it frees voters to express their true preferences without having to think about voting tactically. Voters can vote for the candidate they prefer, rather than for the candidate they think is most likely to keep out the one they least prefer, in the knowledge that second preference votes will count if his or her preferred candidate is eliminated before the last round of counting."