Climate Policies Deserve a Negative Discount Rate

By Fleurbaey, Marc; Zuber, Stéphane | Chicago Journal of International Law, Winter 2013 | Go to article overview
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Climate Policies Deserve a Negative Discount Rate

Fleurbaey, Marc, Zuber, Stéphane, Chicago Journal of International Law


Eric A. Posner and David Weisbach advocate discounting the future impacts of climate policies at the market rate of return in order to take account of opportunity costs; however, they suggest that the desirable amount of investment may have to be decided on ethical grounds. We argue that deriving the discount rate from a social welfare objective is preferable to the market rate because it both accounts for opportunity costs and suitably determines the amount of investment in climate policies that is desirable for future generations. Moreover, extending Martin Weitzman's and Christian Gollier's results on discounting under uncertainty, we show that for evaluating the long-run impacts of climate policies, a negative discount rate may be justified. This is due to the uncertainty of future growth and the fact that such policies have greater returns in bad climate scenarios. The distributive impact of such policies also justifies a low discount rate if the poorest populations are the most vulnerable to climate change. Finally, we argue in favor of going beyond classical utilitarian calculus in order to better incorporate prioritization of the worst off into the evaluation of climate policies.

(ProQuest: ... denotes formulae omitted.)

Table of Contents

I. Introduction 566

II. The Methodology of Discounting 568

III. Objections to This Methodology 571

A. Objection That Using Non-Market Rates Is Undemocratic 572

B. Objection That Non-Market Rates Neglect Opportunity Costs of Investments 574

C. Further Sources of Divergence from Posner and Weisbach 576

TV. Discounting under Risk 577

A. Considering Future Growth 578

B. Uncertainty about Returns to Investments 580

V. Prioritizing the Poor in the Long Run 582

VI. Negative Discount Rates for Climate Policies 585

VII. Beyond Utilitarianism 587

A. Inequality Aversion, Risk Aversion, and Correlated Climate Risks 587

B. The Risk of Extinction and Optimal Population Size 590

VIII. Conclusion 591

Appendix 593

I. Introduction

Climate policies are costly for the present generation, yet will benefit future generations in centuries and millennia to come. It is incredibly hard to assess whether the benefits outweigh the costs with such faraway horizons. Costbenefit analysis is generally used to assess the returns of public investments over a decade or two, a relatively short horizon over which individual time preferences and market rates provide useful guidelines. The discount rate is a convenient tool that translates future values into their equivalent present value. With a 3 percent rate, for instance, $1 million in ten years is worth about $744,000 (=1, 000,000/ 1.0310) today.

For long-term, intergenerational tradeoffs, experts are hesitant to use the same individual and market-rate time preferences because they imply discounting future consumption flows at a rate that makes dramatic changes in two generations look almost negligible in present value. Since the 2007 publication of the Stern Review? the discount rate has therefore been at the center of heated discussions about climate policies.6

In the very long run, the discount rate makes a huge difference in the costbenefit evaluation of policies. Table 1 shows the minimum return that a $1 investment for the future must have in order to be considered better than consuming $1 now, depending on the discount rate that is adopted and die horizon. The 1.4 percent discount rate is advocated by the Stern Review,1 but later Nicholas Stern suggested that 1.5 percent to 5 percent might be a better range.8 The table shows that this hesitation is not innocuous. Obviously, adopting a much higher discount rate, as recommended by Nordhaus9 - around 5.5 percent - has even more extreme consequences.10

The thesis defended in this Article is that using a negative discount rate to evaluate climate policies may be justified.

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