Environmental unsustainability: how much should we discount the future?

1. Environmental unsustainability: how much should we discount the future? Donald Hay Jesus College and Department of Economics, Oxford 25 June 2008

2. 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.

3. 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.

4. Discounting: interest rates and present values of £1

5. 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.

6. 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?

7. 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

8. 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’?

9. 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?

10. 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