Academic journal article Contemporary Economic Policy

Time Preference, Abatement Costs, and International Climate Policy: An Appraisal of IPCC 1995

Academic journal article Contemporary Economic Policy

Time Preference, Abatement Costs, and International Climate Policy: An Appraisal of IPCC 1995

Article excerpt

I. INTRODUCTION

Working Group III (WG III) of the Intergovernmental Panel on Climate Change (IPCC) convened to assess the economic implications of climate change. The resulting draft report, which is a part of the Second Assessment Report of the IPCC, summarizes and examines the relevant economic literature, focusing on issues central to policymaking in this context. The IPCC intends this to be an authoritative and widely supported commentary on the economics of climate change that will be the foundation of future climate change negotiations and policies.

The draft 1995 WG III report identifies four key questions relating to climate change policies (chap. 5, p. 1): (i) By how much should greenhouse gas (GHG) emissions be reduced? (ii) When should emissions be reduced? (iii) How should emissions be reduced? (iv) Who should reduce emissions?

The first two questions are inextricably linked with the choice of discount rate, which influences policies affecting both the timing and the extent of GHG reductions. One may view the third question from a purely technocratic perspective; however, the credibility of the international mechanism chosen to bring about the requisite technology and policy changes plays an important role in their practical implementation. The fourth question is linked to the third, in that the location of emission reductions is influenced by economic wealth, technology, and equity.

This paper appraises the draft 1995 WG III report in this context, examines the four key questions within the broad setting of IPCC 1995, and highlights the more controversial aspects of the debate.

II. DISCOUNTING DISCOUNTING

Discounting brings together two aspects of modern economics that traditionally have remained separate--positive and normative microeconomics. Choosing the appropriate discount rate for global warming implies an ethical stand on how this generation values future generations, as distinct from the former's evaluation of its own future. At the same time, the choice invokes the positive concern of the degree to which current investments in GHG abatement displace current consumption and/or other investments in the economy UPCC 1995, chap. 4, pp. 3-5).

Consider a private investment in a project whose benefits accrued to the agent during her lifetime. Suppose also that this investment displaced another similar private investment. In this situation, the appropriate discount rate is the private discount rate--that is, the rate at which the individual agent values future cash flows in terms of present dollars. Typically, this is measured as the opportunity cost of capital. In the case of public policies whose impacts are spread over multiple generations, such as investing in GHG abatement, the issue of intergenerational equity becomes central to the decision making process. The appropriate discount rate then is the social rate of time preference (SRTP) that reflects the value that society places on future levels of consumption (Feldstein, 1964, p. 364).

The basic idea here is that individuals make two different types of decisions--"private" decisions reflecting personal interests and "public" decisions that account for social responsibilities to other individuals both in the present and future generations. Market or private discount rates reflect the former context, whereas the social discount rate (SRTP) reflects the latter (Markandaya and Pearce, 1988, p. 48). This distinction is important because the SRTP need not have any systematic relationship with the private discount rate. Noris there any inconsistency in people's exhibiting different preferences in the private and public domain since they make fundamentally different ecOnomic choices in the two situations (Lied, 1982b, p. 57).

Burton (1993) carefully demonstrates and analyzes the distinction between the private rate of time of preference and its social counterpart within the setting of an overlapping generations (OLG) framework. …

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