Understanding the economics of climate change mitigation

Climate Change Economics is an excellent, thoroughgoing look at the economics of climate change mitigation. Aimed at legislators and people interested in policy implications of climate change, CCE offers a series of well-organized directories of white papers and technical information from a variety of sources for people trying to understand why it makes good economic sense to take immediate, drastic measures to curb emissions and mitigate the effects of anthropogenic climate change.
In practice, economists' analyses of the effects of climate change and the positive and negative returns to mitigation efforts have generally come to agree that a constant discount rate is not appropriate, and that the rate must generally decline over time. They do NOT agree on a rate at which to start the calculations, nor on the way in which the rate should be reduced over time.

Looking back at the table, it is obvious that the rate that applies at first - and how long it applies - will play a major role in the prevent value derived. Using a 5% rate for the first decade, for example, would leave under 62% of the FV in the PV, even if the discount rate used for the rest of time was zero. That is why many analysts claim that the discount rate for possibly catastrophic outcomes (possible but not known) should be negative relative to the known investment results, which would push calculations of PVs toward using the 0.6% rate rather than in the direction of the 7% rate.

This argument is not based on risk alone, which is what is used in investment analysis, but on the combination of risk and uncertainty, factors that combine to shape all forecasts, but especially those of processes and events about which we know relatively little, such as the processes of global climate change and species survival and extinction.

So the question of the initial discount rate used, and why it is used, is central to any analysis of the economics of climate change and alternative policies intended to slow the growth of greenhouse gasses.



  1. Cory, thanks for these posts.  I was irritated by Charles Platt’s posts prior to yours, and it’s good to be reminded that Boing Boing is not one single viewpoint or voice.

  2. This is a useful website. If you want a broader understanding of the economics of environmental issues from economists whose research supports a progressive environmental agenda, check out Economics for Equity and the Environment Network (www.e3network.org). Their climate taskforce includes some of the most innovative researchers in the climate arena.

  3. @NJP: Do you have that in a file somewhere, for easy cut n’ pasting to any remotely related comment thread?

  4. The discount rate isn’t the only important variable: the eta coefficient also matters a lot. Delta (discount rate) tells you how much society values money tomorrow in terms of money today; Eta tells you how much society values a poor person having a dollar as compared to a rich person.

    So, first think about what your social preferences are over those two variables. How much weight should we be putting on the present as compared to the future. Suppose that we have two possible states of the world, A and B. In A, folks today have $100 and will have $110 in a century. In B, folks today have $101 and folks in a century have $105. Which is better? That tells you something about your preferred delta. If you pick A, you have a relatively low delta; if B, high delta. Ok. Eta. Suppose that we have two possible states of the world, A and B. In A, one group of people earn $20 and the other earn $100. In B, one group of people earn $30 and the other group earn $70. Which do you prefer?

    The Stern report takes a near-zero discount rate and an eta value of 1. In other words, Stern says that a dollar a century from now is worth the same as a dollar today, and that a dollar is worth as much to a poor person in Bangladesh as it is worth to Bill Gates. I’m not going to argue with those parameter choices, but I will point out that those choices are consistent with a lot of policies that most folks who like the Stern report would deem horrible. In short, if those parameters are true, then we should immediately abandon any economic redistribution programme currently in place that hurts economic growth. If taking a dollar from Bill Gates to give to a homeless person (via taxation and welfare) means that economic growth slows by even the slightest amount, we have to oppose that policy IF we accept Stern’s parameter choices.

    All I’m asking for is some consistency.

    It is awfully fun to watch. The right wingers who’ll typically argue against redistribution on the grounds that it hurts economic growth are basically on Stern’s side when it comes to the parameter choices, but they oppose Stern’s conclusions. The lefties who’ll typically argue that we should expropriate the rich and give everything to some homeless guy because economic growth is evil anyways support Stern’s conclusions, despite his parameters being opposite to theirs.

    Me? I think a delta of zero and an eta of one are both ridiculous.

  5. I stumbled on this earlier this week. Seems relevant to the discussion.

    “What is the economist’s bottom on global warming? The fundamental problem is the climate-change externality – a “global public good.” Economic participants (millions of firms, billions of people, trillions of decisions) need to face realistic carbon prices if their decisions about consumption, investment, and innovation are to be correct. To be effective, we need a market price of carbon emissions that reflects the social costs. Moreover, to be efficient, the price must be universal and harmonized in every sector and country. But a major economic question remains: what is the appropriate price of carbon?”
    Nordhaus. W. 2008. The Challenge of Global Warming for the Global Economy. World Bank slide presentation, 9-11-08. http://nordhaus.econ.yale.edu/WorldBank_091108_post.ppt

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