Discounting the Future

Lumos has posted a speech by Czech President Vaclav Klaus on economists and climate. He (Klaus) manages to slip in some climate change minimization, but his real point is to discuss discounting the future.

Economists are adding other contexts - technological progress, human adaptability, increasing wealth (that moves the mankind further away from the subsistence level, allowing us to treat Nature ever more "generously"). Their main tool to acknowledge this context is to discount the future i.e. to give events the right weight that depends on the moment when they occur. A one-thousand-crown bill is "more" than what it will be in 2017 (even if it remains in the form of a banknote or a constant record in a certain bank account): this is a clear conclusion of theories in economics, any other theories about the real life, as well as common sense.

I don't think any economist would argue with his example applied to direct monetary questions. Once you start talking more generally about utility, you are talking about things that are less easy to quantify. It's probably even more important that these non monetary things are not fungible. The risks involved in a 100 or 200 year bond are different from those involved in calculating the utility of a species lost or saved. Your 100 year bond might not be cashable until 2107, but it probably will remain tradable. If you give up an island nation or two, you can't get them back.

You might notice that Klaus seems to think it might be a bigger deal if it were the Czech Republic in the drowning chair rather than Vanuatu and its ilk.

We could give a lot of examples of similar kinds. The magic of discounting, i.e. the appraisal of utility of some present acts for the future, plays a role in all of them. This principle is not an erroneous human myopia (that could be eliminated by better eyeglasses). Instead, it is an aspect of elementary human rationality that economics is based upon.

Economists thus agree - without exceptions - that the discount rate is a key parameter of any public i.e. political decision about the reaction of Man (or, hypothetically, the whole present mankind) to a potential climate change. There is not a slightest difference between them in this respect.

Gary Becker, an economics Nobel prize winner, shows that even if we used a discount rate as low as 3 percent, the consequences of global warming for the utility of mankind in 2057 would "weigh" only one quarter of the impact that the same warming would have on the present generation. For the generation in 2107, it would be one sixteenth. (An Economist Looks at Global Warming, Hoover Digest, 2007 vol. 2, page 51.) Slight changes of the discount rate in either direction are able to do total miracles with these calculations - and exactly these calculations appear in computer simulations of the current popularizers of global warming.

And finally:

What should we choose? Should we believe the market (and its ethics) or ethics of the prophets of global warming? I would prefer to believe the free market (and its interest rate) more than the elitists from the rich and developed world who want the discount rate to be zero (or almost zero).

The debate about this issue must continue. But this debate is unrelated to measurements of temperatures and it is only marginally related to the causes of these changes.

I find the last sentence incomprehensible. Surely the point is that our estimates of cost and benefits depends on all the costs - including Klaus's so-called opportunity costs, but especially upon the direct costs of major warming.

Let me make one point with respect to the question of discount "rate." The whole concept depends on replacing a function of the form 1-a(t) (the discount for a time t in the future) with a function of the form exp(- a0*t), where a0 is some constant discount rate). Any positive a0 will result in a very large discount for some time in the not too distant future. The very large net discounts assumed by Becker and Klaus are based on that, but aren't necessarily sensible.

Let's assume that an early Native American was using future discounting logic in her analysis of the marginal utility of trading with or exterminating newly arrived European settlers. She may have thought that she got a good deal in trading some turkeys and corn for some glass beads. That bet didn't work out.

The flaw, I think, is deeply embedded in economic thought. Because the history of the last three hundred years has largely been a history of exponential growth, economists have fallen prey to the fallacy of assuming that will always be the case. Biology and physics teem with example of exponential growth ending in catastrophe - but they don't have any of it continuing for a very long time. Economists who forget Darwin, Malthus, and the second law of thermodynamics are living in a bubble.

One peculiar element of the speech makes me wonder if their is some Czech national trait of equating their particular point at the momement with the proper alignment of the universe.

...this is a clear conclusion of theories in economics, any other theories about the real life, as well as common sense.

It has a quasi-theological, neo-Stalinist, or perhaps just Lumoesque cadence to it.