Environmental unsustainability: how much should we discount

the future? Donald Hay

Jesus College and Department of Economics, Oxford

25 June 2008

Environmental unsustainability

Two key processes:

• Biological resources – fish, forests, animals – over time harvested to destruction/ extinction

• External effects in production – pollution, CO2 emissions – over time generate cumulative costs to others, even globally.

Discounting the future: what does it mean?

• Investing £100 at 5% gives £105 in a years time

• A receipt [or cost] of £100 in a year’s time is worth £95.25 now, if the interest rate is 5%. Present values.

• Over many years, the discounting is compounded.

Discounting: interest rates and present values of £1

Interest rate

25 years hence

50 years hence

100 years hence

0.0 1.00 1.00 1.00

0.5 0.88 0.78 0.61

1.0 0.78 0.61 0.37

3.0 0.48 0.23 0.05

6.0 0.23 0.05 0.003

Implications of discounting • Consumers’ attitudes to future consumption:

firms’ attitudes to investment. Myopic behaviour? • Biological resources: if regeneration is less than

the discount rate, then no point in conserving stock to next period.

• Climate change: identified cost of £1million in 50 years time: present value at 0.5% is £780k, but only £230k at 3.0%: so investment of £250k to prevent cost only worth it if interest rate is a bit less than 3.0%

• Cost of carbon: build up of greenhouse gases over the long term: current cost much higher if discount rate is low, so carbon tax should be higher.

What value for the discount rate?

• Economists disagree – what’s new about that!

• Stern Review: 2.2% for the current century, and 1.4% long term

• Nordhaus: 6% is more appropriate

• Why the disagreement?

How much should we discount the future?

• The role of savings and investment in making provision for future generations

• The ‘pure rate of time discount’: (a) ‘impatience’; (b) non zero risk of destruction of the earth [hazard rate]

• Future generations getting wealthier – so discount rate depends on: (a) growth in incomes; and (b) the weight to be given to higher incomes accruing to our descendants

Why not use market rates?

• Reflects the actual preferences of current consumers. But future generations lack a voice in current capital markets, and their interests need to be protected

• Avoids crowding out investment in projects other than climate change.

• What is the ‘market rate’?

Alternative approaches

• Insuring the future: investment to avoid extreme outcomes.

• Choosing what not to discount: commodities OK, but not the environment

• Preserving human rights in the future including rights not to suffer dangerous climate change. Is the appropriate discount rate for rights zero?

The contribution of Christian moral reasoning

• Theocentric versus anthropocentric approaches to environmental issues

• Taking the side of Stern against Nordhaus: reasons for supporting low discount rates

• Collective insurance is compatible with ‘stewardship’ role for humanity

• Caring about the rights of future generations• Fallen human nature and the need for policy

interventions