IN Earth in the Balance, Al Gore warns that we are approaching “ecological catastrophe.” In a report issued in June, the Clinton administration tells us what it will look like. Blistering heat. Rising seas. Endless rains. Drought. This catalog of horrors, outlined in a report called “Climate Change Impacts on the United States,” is intended to stir the American public to dramatic action.
But is dramatic action a good idea? Even if the worst-case scenarios of the Clinton administration are on target, standard economic reasoning says we should do little for now. The reason is the practice known as “discounting,” which helps us know how much it’s worth paying today to avoid some harm in the future.
Discounting is one of those concepts like write-offs that many people have heard of yet don’t fully understand. But it’s not that hard to grasp; it’s just compound interest in reverse. Say a rich uncle announces he’s going to give you $ 1 million. Great news! But then your uncle mentions he won’t be giving you the money for 50 years. Not so great. $ 1 million in 2050 isn’t worth nearly as much as $ 1 million today. In fact, with an interest rate of 10 percent, it’s worth just $ 8,519. Why so little? Because money received in 2050 can’t be invested for the next 50 years, while money received today can. So you must “discount” the money received in 2050 to know what it’s worth today.
What’s this have to do with global warming? Say the costs of global warming, as in the above example, were going to be $ 1 million 50 years from now. It would only make sense to pay $ 8,519 today (at 10 percent interest) to avoid them. Many environmental activists, though, want to spend huge sums today to slow the pace of global warming. But any real benefits from that spending, experts agree, won’t show up for decades or even centuries to come. And using any reasonable discount rate, those benefits aren’t worth much today.
If we use, say, the White House Office of Management and Budget’s standard discount rate of 7 percent, we should spend just $ 1,152 today to avoid $ 1 million of damages 100 years from now. If the damages won’t occur for 200 years — a plausible timeframe for the most serious global warming horror stories — we should spend just $ 1.33 now.
That’s unacceptable to the critics of discounting, who fall into two groups. One is made up of environmental activists, who are inclined to reject any weighing of costs and benefits and often don’t really understand what discounting is. To many environmentalists, Al Gore included, discounting is a sham. “The accepted formulas of conventional economic analysis contain short-sighted and arguably illogical assumptions about what is valuable in the future as opposed to the present,” Gore writes in Earth in the Balance.
We need “a new global economics,” he declares. “We must also change our current use of discount rates, the device by which we systematically undervalue the future consequences of our decisions.” For guidance, Gore observes, “we have much to learn from the Iroquois nation,” whose tribal leaders look seven generations into the future. Indeed, Gore believes that by discounting we “discriminate against future generations.”
This is silly. Consider a middle class family who want to send their daughter to Harvard. Should they sell their house the day she’s born and put $ 200,000 into a lock-box marked, say, “Karenna’s Tuition”? Of course not. If they’re prudent, they will start saving a little bit each year, after checking interest rates and figuring out how much their savings will compound over 18 years.
The other group that’s critical of discounting consists of certain economists who are unhappy with the policy answers (don’t spend much on far-off-in-the-future environmental problems) that discounting provides. In The Economics of Global Warming, for example, William Cline opens his discussion of discounting with this “logical syllogism”:
* Very-long-term environmental effects are important.
* With discount rates in the range of 5 percent to 10 percent, often used in public investment project analysis, very-long-term effects are not important.
* Therefore, discount rates in the range of 5 percent to 10 percent are inappropriate for analysis of very-long-term environmental effects, despite their frequent use in other public policy contexts.
With that established, Cline sets about to find an alternative. He concludes that conventional discount rates are much too high, and that we ought to be using a rate of about 2 percent. Slashing the discount rate in this way makes a huge difference, as Cline is well aware. “At 10 percent, the present discounted value of one dollar 200 years in the future is one-half of one millionth of one cent,” he writes. “In contrast, discounting at 1 percent, a dollar to be received 200 years in the future is worth 14 cents today.” Suddenly, investing in global warming projects makes sense.
Another, unusually creative effort to avoid the logic of discounting has been devised by economists Raymond Kopp and Paul Portney of Resources for the Future, a Washington, D.C. think tank. They propose to ignore the uncongenial results of standard discounting and instead hold a “mock referendum.” This, they say, is “consistent with political decisions that must be made if climate mitigation (or other long-term environmental protection) measures are to be taken.”
Kopp and Portney argue that a problem like global warming “may tax traditional [cost-benefit analysis] beyond its limits. It requires us to make estimates of changes in physical effects (such as lives saved, ecosystems preserved, miles of shoreline protected) so far away in time as to be essentially meaningless.” This is just another way of saying that it’s hard to plan for the distant future. But of course, the people who vote in a mock referendum would have to do just that. The hope, apparently, is that they could be persuaded to come up with alarmist conclusions.
In the end, the best approach to global warming is the simplest: standard cost-benefit analysis using standard discount rates. While this won’t support the kind of dramatic action that environmental activists would like, it will lead to smarter policy. And as the scientific evidence continues to mount, the smartest policy looks to be less and less dramatic. Over the past five years, scientists’ models of what global warming will bring have grown much more encouraging. Rises in temperatures are likely to be much smaller than originally thought. And the temperature rises we do see are now expected to be a mixed blessing — bringing some losses, but also some gains. “It is now only a possibility — and not even a likely one — that warming will cause significant net damage in the coming century,” writes Robert Mendelsohn, a professor at Yale University’s School of Forestry and Environmental Studies. “Global warming may, in fact, turn out to be a lot like Y2K. We were very anxious before it happened. However, with a reasonable amount of planning and action, everything turned out all right in the end.”
We should, in short, listen to what the discount rates tell us. Future generations will be able to deal with their environmental problems as we deal with ours. And they will thank us for not squandering their prosperity.
Ira Carnahan is a freelance writer in Washington, D.C.
