Now that Congress is moving toward legislation on global warming, the comparison of specific policies' economic benefits and costs will play an important part in the debates. But the danger arises that a highly technical controversy over this comparison will aggravate the uncertainty over climate policy and encourage politicians to delay decisions.
Benefit-cost analysis is a valuable tool, but its application to climate legislation is especially complex because of the time factor. The costs of stabilizing the climate would begin immediately, while the benefits - in the form of catastrophes avoided - might lie many years and even centuries in the future.
This complexity is illustrated by the sharp controversy that has erupted over the Stern Review: The Economics of Climate Change, published in October by the British government. A massive survey of the field, it was designed to move world opinion in support of the British call for immediate and vigorous action. Its principal author, Sir Nicholas Stern,clearly intended the review to be the authoritative text in the debate.
Instead, it has opened a furious discussion among economists over the proper way to compare present costs and future benefits. This debate elevates a highly technical question that, with all its algebra, is incomprehensible to most laymen.
Laymen, including Congressmen, need to understand that, as economists have shown, the mathematics of very long-range comparisons of benefit and cost requires ethical judgments. Some of the numbers represent philosophical values, not economic data in the common meaning of the term.
The important point here is that it is not necessary to resolve this issue - the discounting of costs and benefits over time - to make decisions on climate legislation. These calculations are helpful to economists, who have been trained to think numerically as they sharpen their ideas. In legislative deliberations, however, the full range of considerations is much wider. And in the end, only public consensus, not economics or mathematics, can legitimately support the profound ethical and practical decisions on which a climate policy is built.
The concept of a discount rate comes from standard financial analysis as taught in business schools and embodies the common-sense notion that a dollar today is worth more than a dollar tomorrow. The discount rate here is derived from actual market rates. It is a tool to compare the cost of a capital investment - a power plant, say, or a dam - with the benefits it will produce over the coming decades and, in the case of climate change, the cost of doing something today compared with the costs avoided in the future.
The social discount rate used in the Stern analysis is something else entirely - a value judgment, rather than a number derived from actual market rates, about how we should compare the costs to ourselves with the benefit to future generations. In fact, the various models contain assumptions about valuing costs and benefits which are beyond our current capacity, and hence the results carry a misplaced concreteness.
A low discount rate, like the one that Stern uses, represents a judgment not to defer these decisions and their related costs to future generations, despite the general assumption that a dollar is worth more today than a dollar tomorrow. A high discount rate, conversely, shifts more of the burden to future generations, supported by the belief that real rates of return indicate that the world will be richer in the future than it is today and better able to make climate investments. An underlying assumption is a continually growing economy that makes future generations better off than the current one.
But the twists and turns of climate change and its highly unpredictable nature - of necessity not easily captured in economic models because the basic science is not well understood - make the whole exercise highly speculative. At best it can be indicative of policy trade-offs.
Unlike financing power plants, climate decisions have uncertain consequences and costs. In the extreme case, climate change could affect growth. For another thing, scientists warn of a long lag between the emission of greenhouse gases and their full effect on the climate; choices delayed today may not be available in future decades. Policy to reduce emissions is properly seen as investment in keeping open the options that rapid warming might otherwise foreclose.
A growing body of scientific research suggests with some urgency that warming, already under way, will produce irreversible results.
Regardless of how rich future generations may be, it's hard to believe they could reverse the consequences of the melting of the Greenland ice sheet, suck out of the ocean the melted ice as it raises sea levels, or undo changes in precipitation patterns. Possibly our descendants could pay for higher and higher levees to protect the coastal areas of the United States, or sophisticated CO2 catchers to remove carbon from the troposphere, but that is a huge bet to make. Even technology optimists would have to swallow hard.
"I take the problem of discounting for projects with payoffs in the far future (climate change, nuclear waste disposal) to be largely ethical," the economist and Nobel laureate Kenneth J. Arrow wrote. It was the opening line in a chapter that he contributed to the 1999 RFF book, Discounting and Intergenerational Equity, edited by Paul R. Portney, then president of Resources for the Future, and John P. Weyant. The book reflected the thinking of some of the best minds in contemporary economics, but they came to no consensus on the central issue of the discount rate. The reason is that it is not derived from mathematics or the market, but from highly subjective moral judgments regarding the present generation's responsibility to its great-grandchildren and beyond.
So how to resolve the question of how much to invest now in emissions control to prevent future unknown and unpredictable disasters? Two RFF economists, Raymond J. Kopp and Portney, wrote in the same book that since it is an ethical rather than technical issue, perhaps it should be treated as such. They proposed what they called "mock referenda" in which the choices would be left to statistically representative groups of people.
A lot has happened in the eight years since the book came out, and one important development is the enormous rise in the prominence in American politics of the threat of warming. In 1999, it was possible to say that public awareness of the warming issue was so low that a mock referendum would produce more valid results than the normal political process. That is clearly no longer true. The American public is at least as well informed on warming as it is on Social Security financing, foreign aid, or many other prominent controversies that have economic implications but are fundamentally ethical in nature.
Polling data analyzed by Anthony Leiserowitz and others indicate that "since 2000, numerous public opinion polls demonstrate that large majorities of Americans are aware of global warming (92%), believe that global warming is real and already underway (74%), believe that there is a scientific consensus on the reality of climate change (61%) and already view climate change as a somewhat to very serious problem (76%)." "[O]f the 92% of Americans who have heard of global warming," they add, "large majorities" across the political spectrum "support a variety of national and international policies to mitigate climate change, including regulation of carbon dioxide as a pollutant (77%), improving auto fuel efficiency (79%)," and other measures.
The difficulty, as Leiserowitz points out, is that Americans "continue to regard both the environment and climate change as relatively low national priorities." He explains these results in this way: "Americans think the impacts will mostly affect people and places that are geographically distant" and lack "vivid, concrete, and personally-relevant affective images of climate change."
These issues are now before Congress as it takes up greenhouse emissions legislation that, for the first time, appears to have a real chance of passage.
Climate change policy, like a great many other current political issues, is one to which economists are making important contributions. But in the end, the balance between present cost and future benefit is best left not to an algebraic formula, but to the voters, to legislative debate, and to the normal process by which democratic societies resolve questions of basic values.
