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.