How Much is the Future Worth?

By Timothy Damon ’12

The economics behind policies to address climate change can be highly confusing, especially with different economists reaching very different conclusions. One example of such disagreement is seen between the work of The Stern Review and the review of the Review made by Nordhaus. Their point of contention centers upon the implementation of an economic principle known as “discounting”.

Discounting - It's all about time. And the clock is ticking...

But what is discounting? Simply put, discounting is a means of comparing the relative values of present and future costs or benefits. The idea is that $100 dollars would benefit you more today than it would a year from now. This is due to the fact that time itself has a value; money now can be invested to generate more over time. Thus, your $100 dollars today could, just by setting it in the bank, give you $101 dollars after a year – one dollar more than you would have if you were given the same $100 dollars after waiting the one year. Obviously there are ways to make even greater returns, causing people to value the present more than the future.

But how does this relate to climate policy? Discounting provides a way to compare the costs of taking actions to prevent climate change now against actions in the future, as well as immediate losses from climate change with future ones. Such calculations can give an indication of how rapidly it makes economic sense to act. A low discount rate would place a high weight on the future, while a higher rate places more weight on the present.

And the appropriate discount rate is precisely where The Stern Review and Nordhaus take different views. The former takes a very low discount rate to emphasize the need to “avoid the worst impacts of climate change”, arguing that “delay would be costly and dangerous” (Stern 27). Drastic action right now is justified, it asserts, because the future costs are weighted nearly as strongly as they would be if they were to occur tomorrow.

Nordhaus criticizes this representation of future costs in nearly present terms, what he calls a “radical revision of the economics of climate change” (Nordhaus 686). This assumption, he claims, does not represent the reality of markets and human behavior – people do, in fact, value the present more than the distant, uncertain future, and so good economic modeling would not deviate from this method. Thus, climate policies should take a more gradual approach that increases over time.

So what does all this mean? It reveals that the “right” pace of action on climate change largely depends upon how one chooses to discount – how much weight one places on the future compared to the present. In my own view, climate change is a kind of challenge very different from those economics typically addresses, and the notion of “discounting” may therefore need to be modified. The costs and benefits in this case extend well beyond the lifespan of a single human decision-maker.

I know you haven't landed yet, little fella, but which sounds better to you: 450 or 950 ppm atmospheric CO2?

Thus, I think it would be wise for us today to take the perspective of not merely ourselves, but of humanity as a whole. Should we hold off on taking immediate action for as long as possible to reduce the harms from climate change because we value our own present, or should we also consider that what is for us the distant future will eventually be the present our children and grandchildren will value equally highly? The answer is not for me to say alone, but it is one that we must all find together – and the sooner the better.

Works Cited:

Stern, N. 2007. Executive Summary. In: The Stern Review of the Economics of Climate Change. HM Treasury, London, UK.

Nordhaus, W., 2007. “A review of the Stern Review on the Economics of Climate Change,” Journal of Economic Literature XLV, pp. 686-702.