Thursday, June 5, 2008

Is Discounting Fair to Future Generations?

Would you rather have $100 dollars now or in a year from now? Most people would choose to have $100 dollars now because, why wait, right? It is also rational to want the $100 dollars now because there is a lot you could do with that money in a year. You could spend it, invest in a new business, or put it in an interest-yielding bank account. So $100 dollars is literally more valuable to us now than it is in the future, especially in an environment in which there is positive inflation. In economics, this understanding of the time value of money is calculated by "discounting" the future value of money. But is this practice fair to future generations?

In the climate change context, there is disagreement on the trade off of money generated now and burdens to future generations. This tension comes up in the recent New York Review of Books article on the economist William Nordaus's new book A Question of Balance and Ernest Zedillo's book Global Warming. Nordaus starts with the conventional assumptions on the time value of money, while the British Government-supported Stern report disagrees. From the New York Review of Books:

There is a fundamental difference of philosophy between Nordhaus and Sir Nicholas Stern. Chapter 9 of Nordhaus's book explains the difference, and explains why Stern advocates a policy that Nordhaus considers disastrous. Stern rejects the idea of discounting future costs and benefits when they are compared with present costs and benefits. Nordhaus, following the normal practice of economists and business executives, considers discounting to be necessary for reaching any reasonable balance between present and future. In Stern's view, discounting is unethical because it discriminates between present and future generations. That is, Stern believes that discounting imposes excessive burdens on future generations. In Nordhaus's view, discounting is fair because a dollar saved by the present generation becomes fifty-four dollars to be spent by our descendants a hundred years later.

This has very real implications:

The practical consequence of the Stern policy would be to slow down the economic growth of China now in order to reduce damage from climate change a hundred years later. Several generations of Chinese citizens would be impoverished to make their descendants only slightly richer. According to Nordhaus, the slowing-down of growth would in the end be far more costly to China than the climatic damage. About the much-discussed possibility of catastrophic effects before the end of the century from rising sea levels, he says only that "climate change is unlikely to be catastrophic in the near term, but it has the potential for serious damages in the long run." The Chinese government firmly rejects the Stern philosophy, while the British government enthusiastically embraces it. The Stern Review, according to Nordhaus, "takes the lofty vantage point of the world social planner, perhaps stoking the dying embers of the British Empire."

Is the Stern report advancing a new way to think about the rights of future generations or is it British imperialism in disguise? And what about political risk? If Chinese Communist Party opted for green policies over growth, theoretically, would it fulfill its obligations to its people?

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