December 14, 2006
On October 30 Sir Nicholas Stern (who happened to be one of my tutors at Oxford many years ago and is a marvelously accomplished economist and a great guy) published, at the behest of the British Government, the Stern Review on the Economics of Climate Change. (That report is available at the HM Treasury site here. There is an Executive Summary available at that site. The full report is over 700 pages long.) Let me begin my brief summary of the Review by confessing that I believe that global warming is an extremely serious problem, that it presents significant -- possibly insurmountable -- collective action problems, and that because of those problems, it strikes me as highly unlikely that anything will be done about the issue until there is a palpable crisis (rather than mere warnings in academic work, however well done).
The Stern Review finds that global temperatures are, for identifiable reasons, rising relatively rapidly, and that if left unchecked, those rising temperatures could cause very large economic damages in the future. The Review estimates that the damages could amount to future reductions of 20 percent of global production. Dealing with global warming later will have far higher costs that dealing with it soon. Sir Nicholas recommends setting aside 1 percent of global output beginning today to avoid the larger later costs.
The Economist magazine criticized some of the Stern Review but also found much of it to be helpful. See their coverage here, here, and here.
Professor Hal Varian's "Economic Scene" column today in The New York Times Business section is a brief but trenchant critique of the Stern Review. He mentions a critique by Professor Sir Partha Dasgupta of the University of Cambridge (available here and only nine pages) but focuses on the critique by Professor William Nordhaus of Yale (available here and only 21 pages). Both critiques make the same general point -- namely, that Sir Nicholas has found such large damages from global warming by using an inappropriate social rate of discount. The "social discount rate" is the rate of interest at which to discount (or divide) future social values so as to convert them into current social values, presumably in dollars or some other currency. In our personal lives we should (or do, there's some controversy about this) discount future values into present values so as to make rational and reasonable decisions about the allocation of time and effort as between the present and the future. For example, if the current annual rate of interest is 5 percent, then $100 loaned to someone for a year will result in the lender's receiving $105 one year later. So, in a sense $100 today is worth $105 one year from today (when the rate of interest is 5 percent). Just as we discount future personal values, one suspects that we ought to discount future social values. But at what discount rate?
Here's where the problem arises. There is a serious argument to be made that the social discount rate is zero. That argument takes its force from the contention that one should not give future generations less moral weight or significance than the current generation (as would seem to be implied by a positive social discount rate). The Stern Review comes close to adopting that position by assuming that the appropriate social discount rate is 0.1 percent per year (set equal to the Committee's estimate of the probability of the extinction of the human race through some exogenous event, such as an asteroid collision). But there is also serious commentary in favor of a positive social discount rate, generally following the analogy to individual decisionmaking over time, in that where there is a choice to be made between action today and action tomorrow, rational and reasonable comparison and decisionmaking requires converting future values into present values. Professors Nordhaus and Dasgupta adopt this alternative view of the appropriate social discount rate.
Both Professor Nordhaus and Professor Dasgupta use a social rate of discount equal to 3 percent per year (declining, in Professor Nordhaus' calculations, to 1 percent per year over the next 300 years). This positive rate implies giving the costs of global warming to future generations less weight than those same costs would inflict on the current generation. So, when those future costs are discounted to present values, the result is a lower current estimate of the costs of global warming than results from using Sir Nicholas' 0.1 percent per year discount rate. And those resulting lower current costs of global warming result in lower current policy correctives (such as a carbon emissions tax) than the Stern Review recommends.
Note that the debate is not about whether to take global warming seriously or whether to take corrective action today. All three -- Sir Nicholas Stern, Professor Nordhaus, and Professor Dasgupta -- argue in favor of immediate correctives to lower the social costs of global warming. Rather, the debate regards only the extent of the correctives.
December 14, 2006 | Permalink
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