Climate Policies Deserve a Negative Discount Rate

Chicago Journal of International Law Volume 13 Number 2 Article 14 1-1-2013 Climate Policies Deserve a Negative Discount Rate Marc Fleurbaey Stephane Zuber Follow this and additional works at: https://chicagounbound.uchicago.edu/cjil Part of the Law Commons Recommended Citation Fleurbaey, Marc and Zuber, Stephane (2013) "Climate Policies Deserve a Negative Discount Rate," Chicago Journal of International Law: Vol. 13: No. 2, Article 14. Available at: https://chicagounbound.uchicago.edu/cjil/vol13/iss2/14 This Article is brought to you for free and open access by Chicago Unbound. It has been accepted for inclusion in Chicago Journal of International Law by an authorized editor of Chicago Unbound. For more information, please contact . Climate Policies Deserve a Negative Discount Rate Marc Fleurbaey* and Stephane Zuber t Abstract EricA. Posnerand David Weisbach' advocate discounting thefuture impacts of climate policies at the market rate of return in order to take account of opportunity costs; however, ihey suggest that the desirable amount of investment may have to be decided on ethicalgrounds.2 We argue that deriving the discount ratefrom a social welfare objective is preferable to the market rate because it both accounts for opportunity costs and suitaby determines the amount of investment in climate policies that is desirable for future generations. Moreover, extending Martin WeitZman'? and Christian Gollier' results on discounting under uncertainty, we show thatfor evaluating the long-run impacts of climate poliies, a negative discount rate may bejustfied. This is due to the uncertainty offuture growth and the fact that suchpolicies have greaterreturns in bad climate scenarios. The distributive impact of such policies alsojustifies a low discount rate if the poorestpopulations are the most vulnerable to climate change. Finally, we argue in favor of going beyond classical utilitarian calculus in order to better incorporate prioritiZationof the worst off into the evaluation of climatepolicies. t Robert E. Kuenne Professor of Economics and Humanistic Studies at Princeton University. Research Associate at Centre de Recherche Sens, Ethique, Societ6 (CERSES)-Universite Paris I Descartes and Centre National de la Recherche Scientifique (CNRS). We have benefited from comments by Geir B. Asheim, David Weisbach (who in particular encouraged us to examine risky returns to investment), the participants at the Conference on Climate Change Justice, and the editors of this journal. Eric A. Posner and David Weisbach, Climate Change Justice (Princeton 2010). 2 Id at 161-62 and 167-68. 3 Martin L. Weitzman, Why the Far-DistantFuture Should Be Discounted at Its Lowest Possible Rate, 36 J Envir Econ & Mgmt 201, 201-02 (1998). 4 Christian Gollier, Discounting an Uncertain Future,85 J Pub Econ 149 (2002). 565 ChicagoJournalofInternaionalLaw Table of Contents 566 I. Introduction ..................... 568 ........................................ II. The Methodology of Discounting 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 IV. Discounting under Risk ................................ ..... 577 .......... 578 A. Considering Future Growth...................... B. Uncertainty about Returns to Investments ................. ..... 580 ................... 582 V. Prioritizing the Poor in the Long Run ............. 585 VI. Negative Discount Rates for Climate Policies ...................... VII. Beyond Utilitarianism ...................................... 587 Risks..........587 A. Inequality Aversion, Risk Aversion, and Correlated Climate ........ 590 B. The Risk of Extinction and Optimal Population Size....... ............... 591 VIII. Conclusion.............................. 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 (=1,000,000/1.03') 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 566 VoL 13 No. 2 Climate PoliciesDeserve a Negative DiscountRate Feurbaey and Zuber publication of the Stern Review,s the discount rate has therefore been at the center of heated discussions about climate policies.' 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 the horizon. The 1.4 percent discount rate is advocated by the Stern Review,7 but later Nicholas Stern suggested that 1.5 percent to 5 percent might be a better range.' The table shows that this hesitation is not innocuous. Obviously, adopting a much higher discount rate, as recommended by Nordhaus 9 -around 5.5 percent-has even more extreme consequences.o TABLE Time horizon (years) 1. THE IMPLICATIONS OF DIFFERENT DISCOUNT RATES Required return on $1 investment, by discount rate ($) Ratio 2.7% 1.4% 50 $2.00 $3.79 1.89 100 $4.02 $14.36 3.57 200 $16.13 $206.11 12.78 500 $1,044 $609,848 584 1000 $1,091,327 $371,914,916,666 340,791 Legend: With a 1.4 percent discount rate, a $1 investment today must yield at least $4.02 in one hundredyears; nith a 2.7 percent discount rate, the numberjumps to $14.36, which is 3.57 times greater. 5 Nicholas Stern, The Economics of Ckmate Change: The Stern Review (Cambridge 2007). 6 See, for example, Richard Zeckhauser and W. Kip Viscusi, eds, Special Issue on Discounting Dilemmas, 7 37 J Risk & Uncertainty 95 (2008) (including contributions by economists Partha Dasgupta, Christian Gollier, Paul A. Samuelson, and Lawrence Summers, among others). Stem, The Stem Review at 184 (cited in note 5); see William D. Nordhaus, A Review of the Stem 8 Review on the Economics of Cimate Change, 45 J Econ Lit 686, 694 (2007 (...truncated)