Discounting Greenhouse Gas Effects in the Distant Future

Under present scientific calculations, environmental damage from global warming at current rates of CO2 emissions will be large, especially during the latter half of this century and throughout the next few centuries. With such long delayed effects, uncertainty about magnitudes of the damages is enormous. And it is obvious that the size of the rate at which future effects are discounted, if they are discounted at all, will make an enormous difference to estimates of the total value of the damages.

The main concern expressed about discounting of future utilities in evaluating public policies is that it would give the welfare of future generations much less weight than the welfare of present generations. Even with the "small" discount rate typically used in policy analysis of 3 percent, the effects of global warming on the utility of generations fifty years from now will be weighted only a bit more than ¼ as much as the effects on the utility of the present generation. Generations 100 years in the future would be weighted a mere 1/16th as much as the present generation. With a 3 percent rate, the weights are cut in half every 24 years, or approximately every generation.

Is this fair to future generations? The well-publicized Stern Review on the Economics of Climate Change for the British government thinks not, which is why the calculations in the Report generally use a social discount rate close to zero. William Nordhaus of Yale University who has done substantial research on evaluating the costs of greenhouse warming uses about a 3 percent social discount rate. He shows that one should use a significant discount rate to match the discount rate to evidence on the long-term return on capital, the growth of consumption, and savings rates.

Suppose the utility damages from global warming to generations 50 years from now are equivalent to about $2 trillion of their welfare. At a 3 percent discount rate, this major damage would be valued today at about $500 billion, while any spending today that reduces the harm to future generations would be valued dollar for dollar. Then with a 3 percent discount rate it would not pay to eliminate these very harmful effects on future generations if the cost were $800 billion (or more generally at least $500 billion) to largely eliminate the future harm from greenhouse gas emissions through steep taxes on emission, carbon sequestration, and other methods. To be sure, benefits would exceed the present value of costs of greenhouse warming if damages were discounted only at 0 percent, 1 percent, or as high as almost 2 percent discount rate. When analyzing effects much further into the future, such as 150 years into the future, the discount rate used is even more crucial. The overwhelming reason why the Stern Review gets so much larger estimates of damages than work by Nordhaus and other is the use of a negligible discount rate in the Review.

To illustrate the advantage of using a discount rate that reflects the return on capital, assume that the long-term return on investments in physical capital is 3 percent. If instead of spending $800 billion on eliminating greenhouse gases, suppose it were invested by the present generation in physical capital, and that all the income yielded by the investment were also invested with a 3 percent return. Then the value of this amount saved to generations 50 years from now would be $800 billion (1.03)50, or more than $3 trillion. Hence future generations would be better off if instead of the present generation investing the $800 billion in greenhouse gas-reducing technologies, they invested the same amount in capital that would be available to future generations.

One criticism of this argument is that if the resources were not invested in greenhouse gases, they would not be invested in other capital that would accrue to future generations. Perhaps not, but during the past 150 years, later generations in the United States and other developed and developing nations have been much better off than earlier generations when measured by income, health, education, and virtually all other important criteria. This rising standard of living across generations has been achieved mainly through advances in technology and generous savings and investments for children and grandchildren by parents and their elected representatives. Why should this fundamental aspect of family and public behavior be changed as a result of the accumulation of very harmful greenhouse gases in the atmosphere?

Put differently, later generations have benefited from large and continuing advances in technologies of all kinds during the past 150 years, including those related to the environment. The rate of technological advance has not slowed down, and may even have speeded up, during the past 20 years. Parents and governments have chosen not to offset the benefits to later generations of advances in technology by leaving descendants less education or capital than they have. Of course, just the opposite has occurred.

Parental behavior toward their children and grandchildren illustrates the importance of discounting future benefits and costs. Many parents like their children at least as much as they like themselves, and would be devastated if any serious harm came to their descendants. Yet in evaluating how much they want to give to their children in the form of education, bequests, or education, they recognize that savings and education have positive rates of return. If they invest say $40,000 in their children's education, the benefits to children would be much greater because of the high return on education-say it would be $80,000. By recognizing this, however, parents are in effect discounting the benefits they provide children since they would be costing the $80,000 benefit to children at $40,000.

Using a social discount rate of say 3 percent does not sweep away the greenhouse gas problem. The latest climate report cited by Posner strongly suggests that the problem is quite serious, perhaps even starting 50 or fewer years from now. However, it does imply that low weight be given to effects on the utility of generations 150 years from now, and even more so 400 years from now. Common sense also dictates that one recognizes that technologies will be much improved in the future, including technologies related to improving health, income, and the environment. A positive and non-negligible discount rate is the formal way to recognize the importance of these and related considerations.