Comments on: Discounting the future, yet again

By: John Quiggin

John Quiggin — Tue, 27 Feb 2007 02:47:31 +0000

Radek, the distinction between individual and social mortality is obviously relevant over the (finite) period from now until 2100 central to the current debate. Virtually everyone in a position to make savings decisions today will be dead in 2100, but we can reasonably hope that society will still be around. Feel free to share my writeup with your students.

Kevin, this distinction is indeed the crucial one.

By: pinus

pinus — Tue, 27 Feb 2007 02:38:30 +0000

I agree with kevin. We have income growth and technological progress. The real return on capital is about 2-3% in the long run. This is what we should use as the discount rate.

Having said this, I have to add that there is still space for environmental protection even at this discount rate. We should just beware of self-punishing actions which could be consequences of public hype rather than sober reasoning.

By: Kevin

Kevin — Mon, 26 Feb 2007 21:07:01 +0000

There’s a more important misunderstanding being made in these comments: a SW function discounts utility, not dollars. Assume $1m real dollars of damage will occur in year 2107, with 2% annual real per capita growth. The discount rate incorporates 1) pure time preference, with which 0 (or .01 to account for the possibility of an extinction-level event) AND 2) differentials in marginal utility. We can agree (for a variety of reasons) with a 0 rate of social time preference, while still discounting the future at, say, p=.02. In this case, we’re only willing to pay 138000 real dollars to alleviate that future damage.

(This example makes some assumptions about the link between income growth and the utility curve, but the point is evident no matter how you slice it. As for Diamond, in this case we only see the weight we put on future problems go to zero because the income (and therefore marginal utility, given the “more is better” clause) goes to infinity.)

By: radek

radek — Mon, 26 Feb 2007 01:37:33 +0000

John, maybe I’m missing something but the following sounds like an infinite horizon type argument:

First, individuals are mortal whereas (except for a small probability of nuclear annihilation and similar disasters) society is not.

As far as the source, I just meant that some of this came up in the previous discussions.

Good write up, btw, mind if I share it with my students (discounting came up in class the other day and the range of opinions was WIDE)?

By: Akshay

Akshay — Sun, 25 Feb 2007 20:36:17 +0000

The Weitzman piece really is excellent! I love it when people far more intelligent then myself help me rationalize my gut feelings. A big applause for:

– showing that discount rates dominate CBA’s – acknowledging the key role of uncertainty – emphasizing that natural beauty is a source of “utility” – arguing that attitudes towards catastrophes, which might befall humanity and will befall the non-human world, will dominate the decision making – calling for more insight into the last bullet

I think this takes us pretty close to a summary of the main issues from the perspective of (generalized) (expected) utilitarianism. Of course, non-utilitarian approaches have a lot to contribute too.

By: Cranky Observer

Cranky Observer — Sun, 25 Feb 2007 19:35:01 +0000

> In a typical project evaluation, the project’s
> proponents (in the case of infrastructure, usually
> engineers) have a lot of influence over the
> projections on which cash flows are based, and
> they tend to be biased upwards (mostly by ignoring
> things that might go wrong). By contrast,
> economists usually get to choose the discount
> rate, and they almost always go for a high rate.

In my experience of large-scale cost/benefit analyses, neither engineers nor economists have much to do with being the proponents of or setting the goals for the project – that inevitably occurs in the political realm (whether corporate or electoral politics). Both economists and engineers are technicians who are called in long after those with the political power have made the decisions, and are just proxies for the final struggle between the politicians.

Cranky

By: Will

Will — Sun, 25 Feb 2007 07:06:29 +0000

I think John’s substantive point regarding time preferences is that marginal benefits are discounted over time at the individual level because individuals fear they may die before they can consume in the future, but this reasoning doesn’t follow for the everlasting society, thus society shouldn’t have time preferences.

But we should think carefully about what we mean buy ‘consume’. What is the thing that’s providing us the marginal benefits, today and tomorrow? What is the thing that we’d be giving up today in exchange for it in the future?

That I value the marginal benefit of eating today higher than my marginal benefit from eating tomorrow (i.e. I’ve discounted my marginal benefit) seems to follow from my fear of death in the next 24 hours. I might not get the chance to eat tomorrow.

That I value the marginal benefits of ‘consuming’ new knowledge today, on the other hand, doesn’t follow from my fear of death. Knowing something today means I can know more things tomorrow. I have a time preference for learning today versus tomorrow because my consumption of learning today determines my consumption of learning tomorrow.

(The assumption of time separability has precluded my example, but it shouldn’t preclude it from the discussion… We, society, do and should have time preferences independent of our individual fears of death.)

By: John Quiggin

John Quiggin — Sun, 25 Feb 2007 04:51:24 +0000

Radek, I didn’t claim the argument was new, but I haven’t seen it before. Can you point to a good source.

The Diamond impossibility theorem isn’t relevant, I think, since the argument I’m making has nothing to do with infinite time horizons. It would work fine with two periods and three generations.

By: Lord Acton

Lord Acton — Sun, 25 Feb 2007 03:08:20 +0000

Personally, even one penny spent today, to
prevent $100 of environmental damage 100 years
from now, is wasted.

And I would argue that most acturial tables
would support the statement that none of us
current posters will be around 100 years from
now, so as to even care.

However, I would be the last to oppose the
right of any of you to spend as much of your
money as you see fit to avoid ecological damage
in the future.

Since I take public transit to work, I’m already
doing MY share :-}

By: radek

radek — Sun, 25 Feb 2007 02:45:02 +0000

You can’t discriminate between generations without discriminating between people who are alive at the same time.

But the Diamond impossibility result states that you cannot not discriminate between generations. Zero time preferance still discriminates, just in a different way.

Anyway, this point has been made before.

I find the Weitzman “right for the wrong reasons” argument much more convincing, so I agree with the policy recommendations even while still frowning at the zero rate of time preferance.

By: aaron

aaron — Sun, 25 Feb 2007 01:49:30 +0000

Of course the proper thing to do is use the expected growth rate, especially considering that we are looking at highly improbable events.

By: aaron

aaron — Sun, 25 Feb 2007 01:35:34 +0000

I’ll have to dig into my notes sometime, I’m pretty sure 5% was used as a good estimate for rfr. I think there are calculations, rather than using the current bond rate.

By: John Quiggin

John Quiggin — Sun, 25 Feb 2007 00:15:07 +0000

In fact, your memory doesn’t serve, Aaron. US interest rates in 1998 were the same as they are now. .

Stern’s method gives a discount rate that is just above the projected real rate of per capita growth.

By: aaron

aaron — Sat, 24 Feb 2007 22:53:11 +0000

(granted 5% was back in 1998, things may have changed)

By: aaron

aaron — Sat, 24 Feb 2007 22:51:28 +0000

Who in their right mind would accept a 1-2% rate of return. If my memory serves, in our financial engineering classes the risk-free rate of return is generally accepted to be ~5%.

I haven’t heard an argument that would lead me to accept any discount rate lower than GDP growth. The best that I’ve heard yet is that the last couple of hundred years have been an anomaly. But if that’s the case, and we should expect growth to revert to previous low levels, then AGW should be the least of our concerns.