A belated rejoinder

A few weeks back, Sam Roggeveen of the Lowy Institute came across this post offering an intuitive response to a Cato Institute article on the uneconomical nature of climate change mitigation.

Roggeveen made two criticisms of the post. Firstly, it did not offer grounds for preferring one discount rate over another, so it's not clear why the 'do very little' school is wrong. Secondly, it suggested the post implied all attempts to analyse climate change in these terms are bogus without offering an alternative.

Why the 'do very little school' is wrong - preferring discount rates

The reason why Stern's discount rate is to be preferred over Norhaus is that the discount rate represents not merely the future trend of economic growth (itself a considerable presumption in the face of major climate change impacts), but two ethical decisions.

The first ethical decision is the value that a given generation places on a particular good. This theory is called prioritism. Prioritism in this context means that future generations can make a lower claim on goods.

The second ethical decision is the choice to disregard events in the future simply because they are so far in the future that it really does not matter. This is called temporal impartiality. Economists have a fairly short-term view of the world which treats what happens in 2050 as almost negligble importance. Treating the future welfare as of little importance leads to a rapid rate of discounting for future costs. Norhaus ultimately ends up with the conventional discount rate of 6% per annum which applied to the finance market from 1900-2000.

Temporal impartiality and prioritism are thus interrelated ethical judgments rather than mere economic factors which go to the value one places on the position of future generations. The usual underlying assumption is that future generations are going to be richer and able to look after themselves so we in the present do not need to worry about their fate. The problem arises when one considers that future generations may not have the same easy access or unconstrained ability to deal with resources that we currently do, not to mention being further hampered by climatic conditions.

Stern's reduced discount rate means that the welfare of future generations is valued far more highly than conventional financial models and thus takes into account the principle of intergenerational equity which usually plays a very limited role in financial decision-making. It is to be preferred to Norhaus as it encompasses both the economic and moral implications of climate change.

Are all economic models wrong - the alternative?

Remarks made in my post regarding problems with economic modelling related to the assumptions included in them by 'do very little'-favouring economists. The rule to remember with all modelling is that models are the children of their creators. The outcome of a given model depends entirely on the assumptions used in its design. If one believes for instance, that climate change is really not likely to be a problem, humans have little agency to affect climate and/or that any constraint on progress is a bad outcome, it is very easy to take the best case scenario of the IPCC Report, apply a high discount rate and conclude that climate damage costs do not justify reforming the entire economic structure. Underestimating the potential real cost of climate change on this basis constitutes a statistical lie.

In dealing with economic costs from climate change, we are dealing with two levels of modelling, economic modelling and climate effect modelling. The magnitude of risk from climate change comes from the likely outcome of differing concentrations of carbon emissions in the atmosphere. Host of variables such as sea level rise, feedback mechanisms such as increased sunlight absorption, decreased carbon sink capability of vegetation, release of permafrost, ocean current variations can affect the ultimate outcome.

So the best approach to economic modelling on climate change would adopt a low discount rate and a medium to high range assessment of climate impacts. This would ensure that there was enough fat in calculations to take into account feedback mechanisms and policy could be developed on a prudent basis rather than the 'wishing and hoping' exercise that doing very little would entail.

It is patently obvious that we need to develop technology that involves less reliance on finite resources and more reliance on renewable energy. It is surprising that economists who believe in growth without end have not pushed this argument further and instead lead us down the path of using a finite supply of resources from an increasing number of inefficient sources such as shale oil and tar sands.