Discounting the Future

'Discounting’ is a clever wheeze that conventional economics uses to balance utility (its measure of what we want to gain through our economic activity) achieved in different time periods, based on the assumption that we would always rather have a bird in the hand than in the bush. This is in itself questionable, of course, but conventional economics is unable to take account of delayed gratification, not to mention concern for our fellow species.

The consequences of many environmental losses and impacts are likely to be felt many years into the future. In the case of climate change we may be talking about 2050 to 2100; in the case of nuclear pollution we are talking about hundreds of thousands of years. Discounting is the method economists use to compare these impacts as though they were all happening in the now.

When working out the costs and benefits of any economic policy or production process over time the outcome depends entirely on the discount rate that is applied. The higher the discount rate, the lower the future costs of current actions. The discounting formula has the effect of diminishing the impact of environmental destruction caused in this present time-period and making our current actions appear less costly to future generations.

The discount rate is made up of pure time preference and wealth components. The ‘pure time preference’ component is a source of much debate since logically it should be zero, jam today and jam tomorrow having equivalent utility value, in the economic jargon. However, experiments and everyday experience suggest that in reality people are impatient and prefer to have things now rather than later, suggesting that they have a positive time preference. Somewhat ironically, the suggestion that we ourselves are undermining the possibility of future life for human on earth may actually greater increase our time preference for present consumption.

The wealth component is based on the assumption that incomes will rise, so that future generations will be richer than the present one. So if we are concerned with equity we do less to protect future generations who we assume will be richer than we are. Again, there is an obvious problem with this line of reasoning, since the idea of ever-increasing consumption is itself based on the economic growth that may be destroying the potential for future generations to enjoy their comfortable lives. In this sense we might reasonable suggest a negative wealth component to the discount rate.

Estimates from the World Bank for discount rates for different countries indicate that for poorer countries the discount rates are negative, meaning that future consumption there should be valued more than present consumption and these countries should have very protective attitudes towards the environment. This is not found in reality – just another proof of the flawed thinking that underlies the concept of a discount rate. The rates for developed countries are high, which, if they were applied to environmental problems, would mean that we would make little effort to protect the environment since the discount rate would suggest that, not so far into the future, the impact of our present behaviour would have been greatly diminished.

While this may seem an arcane and technical discussion, it is one which has an enormous impact on our chances of protecting our environment, which is why I have weighed down my blog with it this unseasonably chilly morning. These discounts rates are applied when future impacts of current policies are calculated, and if the equations are in error then we risk huge future damage to our environment. This is why, following the publication of the Stern Review of the Economics of Climate Change, orthodox economists engaged in their usual trick of missing the wood for trees and focused their discussion almost entirely on the discount rate Stern had chosen.

Stern’s conclusion that we need to act rapidly to tackle climate change resulted from his setting what was, for orthodox economics, a very low discount rate. Conventional economists were shocked by the consequences for the economy and challenged this on the basis that it had exaggerated the effects of climate change in the distant future. Stern was basing all his conclusions on statistical models about the probability of events occurring. The possibility that the planet might cease to exist would clearly have a major impact on people’s ‘time preference’, i.e. their preference for consuming now rather than in a (possibly non-existent) tomorrow. Even an economist can grasp that.

As green economists we would argue that the only legitimate discount rate is zero, since all generations’ preferences should be treated equally and the time at which somebody lives should not affect their right to be part of our beautiful and unspoiled planet. Tweet

Go Forth and Quantify!

Having worked at a modern, 'metropolitan' university for six years I have finally started teaching economics. The resistance was more my choice than theirs, since I felt reluctant to teach the holy writ I didn't believe in. This term I'm sharing the applied economics course with a true believer. He does the graphs; I do the real-world horror stories.

My content has focused on climate change, food security, localisation and trade. Yesterday, perhaps to convince them that I really am an economist, I drew one of the classic economics graphs myself for the first time in years. It was the usual two lines, one sloping up, the other sloping down. Something magical and meaningful and mysterious was supposed to happen at the point where the two lines cross: equilibrium.

Of course the flaw with this method of representing the world in a system of initially straight and then, in the more advanced courses, curved lines, is that there are no numbers! Axes are labelled capital P and Q while points on the axes are labelled with lower-case ps and qs. The point of equilibrium is represented by p and q with an asterisk.

On one level I can see the funny side of this. In a rather dry and Puritanical sense, the signs and symbols of economics speak to the ritualistic side of proponents of the most positivistic of the social sciences. When I write of 'holy writ' it is only partly a joke. The jargon of economospeak carries power just as the words of the Nicene creed do. We shall not resist the command to compete, to achieve economies of scale, to avoid moral hazard. The true economist is convinced that s/he has some sense of order and some grasp of meaning in the world of uncertainty and unpredictability. What else is a religion for?

But beyond the humour something very serious is going on. The lines I was drawing were taken from the Stern Review and represented the costs and benefits of taking action to tackle climate change. They were literally matters of life and death. In this case numbers did emerge; numbers which gave justification to the continuation of the economic system that is eliminating our species and harming our planet. My question is whether something of such depth and importance should be left in the hands of economists.

*Thanks to Rupert Read for the title for this post. Tweet

Learning a stern lesson

As part of the Green Party’s submission to the Stern Review I wrote that ‘the globalised capitalist economy is inherently unsustainable because it is based on turning energy into money without regard for ecology. Climate change is just the first and most urgent piece of evidence that this is the case.’ OK, this is rather trite and simplistic, and says nothing of the vast proportion of capitalism (around 97%) that generates profits by speculating on the future values of currencies or commodities, but as a slogan it has much to recommend it.
In the sustainable economy energy will the important measure rather than money. In fact these two can be joined through the creation of a currency backed by carbon, as first suggested by Richard Douthwaite. Scarcity is one of the key requirements of a successful form of money (hence the use of gold or cows in other societies at other times) and now our most valuable scarce resource is the global atmosphere.
The poverty of the South can be explained in terms of their inadequate consumption of the global economy’s energy; the over-consumption of the rich, developed countries can be explained in the same way. The shares of carbon dioxide of poor countries do not match their shares of world population. The comparison of India and the USA is the most striking: a direct swap of carbon dioxide would resolve around a fifth of the inequality at a stroke. India is responsible for 5% of the global output of CO2 but has nearly 20% of the world’s population; the USA, by contrast, is responsible for 25% of emissions but with only 5% of world population.
The IPCC (Intergovernmental Panel on Climate Change is a UN panel of experts who have exhaustively analysed available data about the consequences of carbon dioxide emissions to estimate the ‘carrying capacity’ of the planet, that is how much CO2 it is reasonably safe for us to emit. The Global Commons Institute (GCI) in London has developed a model for sharing this total amount fairly between the world’s people on a per capita basis, and then for reducing this amount rapidly over time, called Contraction and Convergence (C&C). If we work with the year 2000 the sums work out rather neatly, since the model suggests around 6 billion tonnes of carbon can be produced, and the planet had around 6 billion people, which allows us 1 tonne each. At present in the UK we produce around 2.5 tonnes, which gives a clear idea of the size of cuts required just to reach fair shares today, even before the cuts that are necessary.
A comparison of CO2 emissions by country shows how the poorer the country is the less of its share of carbon dioxide it is producing and the more it needs an input of energy from the richer nations. At present we measure economic energy in terms of money, usually dollars. In an economy that respected planetary limits we would measure activity in terms of energy, since this is the scarcest planetary resource. As green economists we need to move towards an economy which uses energy as both a way of measuring the economy and, ultimately, the basis for its means of exchange or money. Tweet