Ethical dilemma profoundly sways climate economics

When a decision's benefits and costs span generations, economists have trouble divvying up responsibilities. Some say that dilemma is the dominant factor in calculating the economic impact of climate change. Photo of grandfather and granddaughter courtesy Bill & Vicki Tracey/flickr

January 28, 2011

Do we worry now about the consequences of our carbon-intensive lifestyle, or do we let our children cope? The answer has a considerable impact when assessing the economic costs of a warmer planet.

By Nicole Heller and Douglas Fischer

Climate Central and Daily Climate

Of the many moral conundrums presented by climate change, the issue's intergenerational nature is perhaps trickiest to sort out.

It boils down to this: We benefit mightily from burning cheap coal and will shoulder most of the expense associated with switching the global economy to low-carbon fuel sources.

But our grandchildren and great-grandchildren will pay the price for our profligate energy ways and will reap the majority of the benefit of our shift to cleaner-burning fuels.

So do we pay now, or let our kids deal?

Not surprisingly, the answer profoundly influences any analysis of the economic impact of global-warming emissions.

Last year a panel of experts from 12 federal agencies announced their best guess for the price greenhouse gas emissions place on society and the environment: $21 per ton of carbon dioxide. [pdf]

The federal economists used one of the same models as Sir Nicholas Stern and his economics team tapped five years ago trying to answer the same question for Her Majesty's Treasury in the United Kingdom.

Except the Stern Review pegged the cost of carbon at $85 per ton.

For an economy like the United States, that's a $374 billion difference annually. And it hinges almost entirely on how the two teams treated future costs.

The discount rate

Economists have a standard tool for dealing with big expenses over time, and it works just the same as your kid's bank savings account except backwards.

It's called the discount rate, and it starts with the assumption that $1 in your pocket today is worth more than $1 in the pocket of future generations.

The thinking is fairly straightforward: You can put the dollar to work, invest it, leverage it, and pass on $10 or $20 or $200 to your child at some future point. Or you can take that dollar out of your investment portfolio and slip it in an envelope to hand down through the generations.

The latter option has a clear cost - you don't get to earn the interest, so there is an opportunity lost. Economists assume money has tremendous earning potential over long time periods. Because of that, they figure that $1 worth of harm in the future is worth no more than a few cents worth of worry today. 

Of course, this assumption hinges on a number of things: That growth rates continue, for example, or that earnings can purchase or compensate for lost environmental or cultural assets (See Sunny, sweltering ... Scandinavia?). 

In short, the higher the discount rate, the less expensive future problems seem today; a high discount rate reflects an assumption that we prefer to pocket more money now and send a higher bill to the next generation.

Chief difference

William Nordhaus, an influential Yale University economics professor, suggests this is the chief difference in the climate-impacts debate.

"The major difference in estimates reflects different assumptions about discounting," he said in an email. 

Very low discount rates value the economic impact of climate change in the range of $50 to $100 per ton of carbon dioxide emitted, he noted, while market discount rates - 3 percent to 6 percent - peg the damage between $10 and $20 per ton.

The difference between U.S. and U.K. studies illustrates this.

For their best-guess estimate, the federal economists used a conventional discount rate of 3 percent, corresponding to the general rate of return in the 10-year Treasury bond market. 

Stern argued it was unethical to apply such a high discount rate over long time periods. Today's carbon emissions, after all, will still be trapping the sun's heat in the atmosphere 300 years from now. 

He used a discount rate of 1.4 percent, far below that of most cost-benefit analyses.

Critics lambasted Stern for using such a low rate, saying he improperly inserted his morals into the economics.

Long-lasting impacts

But many economists argue that the risks associated with climate are so severe and long-lasting that lower rates should be considered: The United Kingdom, for instance, recommends a declining discount rate that drops to 1 percent for impacts lasting 300 or more years. Harvard University economist Martin Weitzman suggests zero percent for such time-frames. 

The U.S. Office of Management and Budget generally requires discount rates of 3 percent and 7 percent but encourages analysis at lower rates for issues with "important intergenerational benefits and costs." The federal Interagency Working Group considered a range from 2.5 percent to 5 percent. 

Laurie Johnson, chief climate economist for the Natural Resources Defense Council questions the ethics of using higher rates for climate change. "What we're saying is, 'Well, you're born later. Sorry. This is about me. I want that money now.'"

Future generations

Johnson re-ran the federal numbers, varying only the discount rate. At a 1.5 percent discount rate, the cost leapt to $122 per ton. At 1 percent, the number skyrockets to $266 per ton. At 5 percent, the value of carbon emissions is $5.

Which is right? 

It all comes down to ethics. 

If you assume that high economic growth rates will continue into the future and that people prefer to have more money now, the discount rate climbs and the damage estimates for climate change shrink. It reflects an belief that future generations will be wealthier than today's and can better afford to cope with any damages.

If you're more uncertain about the future and fear that damages may be severe rather than mild - or that growth may not be so robust - the discount rate shrinks and damage costs estimates grow.

"You're talking about what's our compact with our great-great-great-grandchildren," said Frank Ackerman, an economist at the Stockholm Environmental Institute. 

"What do we owe to future generations?"

Nicole Heller is a research scientist at ClimateCentral.org, a nonprofit, nonpartisan media organization comprising earth scientists and science journalists. 

Douglas Fischer is editor of DailyClimate.org, a nonprofit news service covering climate change. 

Smoke plume from power plant in Helsinki, Finland, courtesy Pollo/Wikimedia Commons. Graphic by Nicole Heller/ClimateCentral.org

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