Stern Report Triggers Debate on How to Value Grandchildren

The Stern Report -- a report by Sir Nicholas Stern, head of Britain's economic advisory panel -- that came out last month urged action on climate change in terms of future economic loss. I reported on people like Richard Tol who took issue with Stern's numbers in terms of the costs and benefits of climate change abatement.

The Economist has a summary of Stern's critics culminating in the issue of how to value grandchildren. The issue has to do with how you discount money that you would recieve in the future. Money now is worth more than money in the future because you can do something with money now -- like invest it. So we discount money that we will recieve later by a certain rate depending on the reasonable expectation of what we could earn during that time. (The economists are going to have to tell me if I got that explanation right. This is yet another example of why this blog needs an economist.)

It turns out that in Stern's report he was using a discount rate of 0.1% because he argues that the benefits of climate change abatement would vanish to zero using higher rates -- and the higher rates do not reflect benefits that are delayed well into the future.

A third line of criticism, made by William Nordhaus, a father of climate-change economics, has emerged as the most forceful. It turns on fairness, and how we place a value today on benefits in the future.

When economists do a cost-benefit analysis, they try to place a present-day value on benefits assumed to be enjoyed in the future. To do this they discount the future value by an annual percentage rate, a discount rate, which is typically set at around 3-5%.

But such calculations are typically done for benefits expected to come in 20, 30 or, at most, 50 years' time. Climate-change economics requires a time horizon of centuries. A typical discount rate would assign almost no current value to benefits accruing in, say, the 23rd century. So why spend money today on something with no apparent value today?

Sir Nicholas argues that, in this case, we are wrong to use a typical discount rate. How can we say that our great-great-great-grandchildren are worth less than we are worth ourselves? He argues for a discount rate of 0.1%. That places a much higher present-day value on benefits accruing centuries into the future, and thus makes a stronger case for spending money now.

Mr Nordhaus retorts that there are other ways to look at the ethics of inter-generational investment. One option would be to take into account the expected wealth of future generations. Global per capita consumption is increasing by 1.3% a year in real terms. At that rate today's average income per head, of $7,600, would rise to $94,000 by 2200. If climate change were to reduce global income by 13.8% over the same period (a figure derived from Stern), the average income per head would rise to $81,000 rather than $94,000. On that basis, says Mr Nordhaus, it would be fairer to constrain the income of future and richer generations, than to impose additional costs on a poorer generation today.

Mr Nordhaus does not contend that the world should do nothing about greenhouse-gas emissions. But he questions the confidence with which the Stern report concludes that lots of things should be done, and fast. The "central questions" about any policy response to global warming, says Mr Nordhaus, "how much, how fast, and how costlyâremain open". As far as he and like-minded critics are concerned, the Stern report has informed the debate about climate change, but has not come anywhere near resolving it.

It is an interesting part of the debate that I hadn't really thought about. How can we appropriately price something that is going to pay off decades after we are all dead?

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