Almost three months after publication, The Stern Report on the costs of climate change still generates much buzz. Some of the buzz echoes methodological concerns we have aired earlier about use and abuse of cost-benefit analysis. (Or, if in a hurry: Top 10 Reasons why CBA fails ….) Here is an condensed version of Jane Galt's recent commentary:
Discount rates, again, Jane Galt, Asymmetrical Information, 01.09/2007: …[T]hough I essentially agree with the Stern Report's conclusions, I am bothered by its methods. …
It is really, really hard to price the costs of climate change. This is true for many reasons. First, some regions will benefit: Siberia and Canada will probably blossom under global warming. A true cost benefit analysis would net those benefits out, but how do you price them? How do you price losing Bangladesh? Is that a one-time loss, or should be impute to each generation a new cost for not being able to visit Bangladesh, and how do we counterbalance that against the new pleasures of visiting the Minnesota Tropical Rainforest? Should we take into account happiness research which indicates that people are roughly as happy after a big loss as they were before?
The uneven distribution of the benefits presents another pricing problem, particularly since there are wide income disparities between the affected countries. I'm not entirely clear which way this cuts, since Britain and Ireland get hosed along with Bangladesh, but it's hard to dodge the moral injustice that the United States, which produces more carbon per capita than these countries, may end up a net beneficiary of global warming.
The biggest problem is the easiest one to state: what is a cost and what is a benefit? How do you value the changes?
As I read it, Stern sort of punts when faced with these impossible calculations. Instead, it relies on status quo bias; now is good, so we should bequeath a world to our descendants that looks as much as possible like the one we live in today. Obviously, there are huge problems with status quo bias, most notably that none of us would like it at all if our ancestors had been at all successful in applying it. On the other hand, "better the devil you known than the devil you don't" is not an entirely awful heuristic. At any rate, that seems to be the underlying assumption of the report. The quickest way to produce that result financially is to set the pure rate of time preference to effectively nothing, and (says William Nordhaus) to rely on the more pessimistic forecasts.
Now, I actually find the moral intuition behind a zero rate of intergenerational time preference pretty compelling, but the practical implications are rather daunting. (A John Quiggin post responds that" Strange as it may seem to Economist writers, there are phenomena in the world that aren’t particularly illuminated by applying economic concepts. Attitudes towards abortion have nothing at all to do with discounting rates."Which doesn't strike me as illuminating, because the question at the heart of the Stern Report's choice of discount rates is no more a matter of economic concepts than abortion is. It's a moral philosophy problem: are we, or are we not, entitled to privilege our own interests over the interests of those who are not yet born, but probably will be? Otherwise, the low social discount rate is just a pseudomathematical attempt to dress up your preferences as science.)
Can one reject a compelling moral precept just because it's nearly impossible to live by? That's a question that devout Christians wrestle with every day. I am still thinking through this question. But my instinct to reject the precept simply because it would require me to overthrow half of my policy positions is not, at first glance, an admirable one.
But even if you accept a zero rate of intergenerational pure time preference, you can't just smack the pure time discount rate to zero and leave it. Discounting covers a multitude of financial sins by literally making them disappear. For example, if you have a very low rate of discounting, you run into a problem with future generations: there are too damn many of them. Because there are so many of them, even trivial income streams have extremely high net present values. … [E]ven with a low discount rate, the present value of constant income streams quickly declines to nothing. If you don't use discounting, you have to account for this in some other way, by selecting a utility threshold or something. And measuring utility is a rather tricky business.
Another problem is wealth disparities between generations. As I read it, the Stern Report basically assumes that there are low diminishing returns to income (it sets the elasticity of marginal utility of consumption, or η, to 1). It strikes me as odd to see the left half of the blogosphere supporting this proposition; I'm fairly sure that John Quiggin, who is a social democrat, thinks it is higher than that. (Or at least I hope he does). Heck, I think it is higher than that; this is why I support a progressive, indeed negative, income tax, rather than a flat tax. … Discounting takes care of this problem by getting rid of very rich future generations; having done away with it, we are now stuck with them, the lucky bastards. I don't even know how you value marginal utility of even large income streams when incomes are $6 trillion, but it has to be pretty trivial. (Or maybe that's what our ancestors thought about incomes of $30K.) Anyway, I'm unhappy with Stern's approach. I'm not sure that you can reconcile owing anything to that thousand year generation with even moderate utilitiarianism, unless you keep ratcheting up the price of Cape Cod views.
Then there's uncertainty. There's still an awful lot of it…. At the risk of sounding like a broken record, normal discounting takes care of this problem, because things become more uncertain the farther they are in the future. Discounting progressively lowers the weight placed on future income streams, until they rapidly vanish.
A fourth problem was pointed out by an economist of my acquaintance: if you do away with time preference, you can't just apply this to the environment; you have to apply it to everything. … If you deliberately apply these low discount rates selectively, that's not a serious intellectual effort; it is at best cargo cult science, at worst intellectual fraud. I, too, have a strong intuitive preference for leaving the planet to our descendants in as good as, or preferably better, condition than we found it. But I recognize that there are strong practical and moral challenges to this desire, and the costs of advancing my preferences by random application of high discount rates outweigh the benefits. Let me make it clear that I am not accusing Mr Stern or anyone else of acting in bad faith. I am just saying that I think committing to the discount rate also entails committing to its use in a range of other applications, or justifying your environmental preferences on other grounds. I presume that Mr Stern and all of his supporters are prepared to do so, or to convince me that I am wrong and that ultra low pure time discount rates are uniquely applicable to the environment.
Which of course raises the fifth, and possibly the biggest problem with Stern: who the heck knows what our descendants want? Again, discounting takes care of this problem by essentially saying, "to hell with those young whippersnappers!" But if you don't do this, you have to attempt to grapple with changing preferences, a task at which, if Fifties SF is anything to go by, you will almost certainly fail.
This is not support for the "do nothing" crowd; like Megan, I think we should do rather a lot, starting with (in America) really whopping gas and carbon taxes. I am against subsidies for alternative fuels as a policy matter; I want to use a cap-and-trade system on greenhouse emissions with declining annual quotas that includes gasoline. …But having endorsed these methods, I don't know how much we need to shoot for—and given the crudeness of the Stern Report's methodology, after reading it I still don't know.
Postscript: Given the state of the Stern Report debate, it appears that Paul Baer's predication has come too true:
Indeed, I fear that in either supporting Stern against those who support even weaker mitigation, or in arguing on economic grounds for more stringent targets, it will be too easy to be drawn into a discussion about economic technicalities like discount rates, risk aversion and contingent valuation. The crucial questions are about our ethical obligations to those distant in time and space, and about our ideas and ideals for the world we want for our descendants and for the rest of our own lives. An analysis of Stern's approach can show that its conclusions aren't compelling, but the positive case for a truly precautionary policy must stand on other grounds. Developing these arguments is truly an urgent matter.Remember, if nothing else, Baer's closing plea: We urgently neede to develop arguments for, standards for, and support for "precautionary policy." For more on that, read Baer's post from the Post Normal Times .
Paul Baer completed his PhD in the Energy and Resources Group at UC Berkeley in 2005, and is currently the Research Director for EcoEquity. (www.ecoequity.org).