Holding the Hot Potato: Why climate change is still a debate, even in academic circles

Academia agrees that human influence on the climate system has widespread impacts on human and natural systems. However, decisions are lacking on how much to do about it, if anything at all.  What's the hold-up?
 
First, the issue of bang-for-your-buck. Will mitigation or adaptation be the way forward? Many scholars advocate for curbing greenhouse gasses while others support poverty alleviation and small island-state assistance. It is still unclear if we should try to curb effects or increase resilience. But if we take a step back, it's not just about how beneficial these options are, but how many resources we should devote to the issue of climate change.
 
Numerous economic studies address climate change action. They all use similar economic principles and similar data. Yet, recommendations vary widely from no action to billion dollar investments. At the heart of the issue – discounting.
 
Cost-benefit analysis usually applies a discount to future costs or benefits. This reflects how most of us prefer money today to the same amount of money next year. Inflation and uncertainty generally make this choice rational – a bird in the hand is worth two in the bush mentality. While this works well for near term decisions, over a long time horizon a positive discount rate will eventually render any cost or benefits negligible.
 
This presents problems for environmental issues such as climate action, which have short-term costs and long-term benefits. At the commonly used 5 percent discount rate, a rational and well-meaning "social planner" would have to expect at least $100 in avoided future flood damages to invest 76 cents in a storm-wall today, an unlikely return. In a recent paper, published in Review of Environmental Economics and Policy, thirteen leading economists tackle the question "Should Governments Use a Declining Discount Rate in Project Analysis?"
 
A declining discount rate (DDR) starts at a level informed by short-term markets, and then declines over time. The argument is simple. If we expect economies to have positive but uncertain growth, then the efficient discounting method will incorporate that uncertainty through lower discount rates. Such a schedule says: the further out we look, the less certain we are about opportunities, and therefore the more we want to save resources for the future.
 
To determine the validity of this argument, the authors looked at the two declining discount rate approaches: the precautionary extension of the Ramsey formula and Weitzman's extension of Expected Net Present Value.
 
The Ramsey formula assumes that as long as an economy is growing, the social-planner will use a positive discount rate. Future generations will be wealthier and therefore will value each dollar, and what it buys, less. However, Ramsey and many of the article's authors believe that it is unethical to discount the consumption of future generations. By this logic, the discount rate should be zero, a normative claim not validated by US financial markets. Yet, these markets neglect normative aspects.
 
Therefore, the extended Ramsey formula tries to mathematically portray social values, thereby combining positive and normative aspects. A single number, ɳ, tries to capture how many birds in the bush we would be willing to trade for one bird in the hand, as well as risk and intergenerational inequality aversion. Economists estimate ɳthrough empirical data such as income-tax schedules. The extended Ramsey formula creates a declining discount rate when shocks to the economy are interdependent, as is the case in an increasingly globalized world.
 
While the Ramsey formula approach provides a theoretical basis for intergenerational discounting and supports a DDR schedule, the Expected Net Present Value approach argues that uncertainty alone justifies a DDR schedule. One of the study's authors, Martin Weitzman, created a distribution with over two thousand expert opinions on the proper discount rate for climate change projects. Weitzman used the resulting distribution to create a DDR schedule. Since this distribution had more variation than positive forecasts on the future interest rate, Weitzman argued that it reflected normative opinions on intergeneration justice rather than uncertainty. Weitzman's Gamma distribution suggests a DDR is more efficient than a constant discount rate.  Like the Ramsey formula, this approach tries to mathematically capture normative beliefs.
 
The United Kingdom and France use declining discount rate schedules. In the US, the Office of Management and Budget recommends constant exponential rates while allowing for a lower rate for long-term projects. However, these rates are often outdated and the ambiguity leaves room for uncertainty on the relative economist costs and benefits of climate action. Therefore, a DDR schedule would be an improvement over the current U.S. approach.
 
While no less subjective than a constant discount rate, DDR provides a consistent schedule for all projects, both short and long term.  Therefore, policy makers make normative decisions during the initial discussion about what the declining rate schedule should be, rather than every time a new long-term project is proposed. This paper begins a productive debate around the appropriate declining discount rate schedule, which can help the US and other countries define and formalize what our collective beliefs are. After that, it's all numbers.