March 20, 2012
“Your Grandchildren Have No Value”
In his February letter, Grantham reiterated and expanded on warnings that he has enunciated before – in particular that corporations have too high a discount rate, which causes them to engage in short-term thinking and ascribe negligible value to the welfare of future generations. This discounting of our children and grandchildren troubles Grantham, who asked his readers, “Shouldn’t the value, and hence cost, of a child’s life in 50 years be identical to the value and cost today?”
Perhaps, in the abstract; but let’s try to apply the principle. You are confronted with a child today – perhaps even your own child – who has suffered a dreadful accident, and it will cost $100,000 to repair the damage. On the other hand, if you used that $100,000 to purchase carbon offsets, you might save the lives of five hypothetical children who might otherwise perish 50 years from now because of flooding or drought caused by human-driven climate change.
Which would you choose? Which would anyone? Is the life-saving surgery an irrational, indulgent, or short-sighted purchase? Of course not. There’s far too much uncertainty when we project the effects of our actions 50 years (or even 7 years) into the future; for all you know, the supposed children your offsets would save might be the progeny of today’s child, whose life you are sacrificing. The short term, in other words, might be the progenitor of the long term after all.
This idea is not limited to children. It can be true of technologies too. Any technology developed now – in response to investors’ and entrepreneurs’ search for the highest return on investment – might plant the seed for further innovation that is as yet unforeseeable, which in turn may solve the supposedly unsolvable problems we envision better than any solution we can currently fathom.
The discount rate
In the last few years a vigorous debate has been raging among economists about the discount rate. This debate arose in the wake of the Stern Review, a study commissioned by the British Chancellor of the Exchequer and led by Nicholas Stern, a former chief economist of the World Bank. The Review’s purpose was to examine the evidence on the economic impacts of climate change and explore the economics of stabilizing the level of climate-forcing greenhouse gases in the atmosphere.
The Stern Review’s conclusion was firm and unambiguous: “The benefits of strong, early action on climate change outweigh the costs.” Other economists, however, such as Yale’s William D. Nordhaus, have challenged this conclusion. Nordhaus says that standard economic models conclude that an optimal policy would be a tax of $30 per ton of carbon rising to $85 by the mid-21st century, while the Stern Review’s conclusions imply a tax of $300 per ton today.
Virtually the entire difference between the Stern Review’s results and Nordhaus’s arises from the difference in their assumed real discount rates. Stern used a low discount rate of 1.4%, while Nordhaus prefers one in line with the much higher competitive long-term returns on capital available in today’s marketplace.
Unfortunately, Nordhaus – like most economists – argues for the higher discount rate in terms that are mostly understandable only to other economists. The Stern Review’s arguments, on the other hand, are based on intergenerational equity considerations that anyone can comprehend. The Nordhaus argument, essentially, is that for each unit of climate change reduction we purchase, we will have to give up a unit of something else that will improve life – including, for example, some investments in technologies that might, in the future, wind up doing a better job of mitigating climate change.
Would you like to send this article to a friend?Remember, if you have a question or comment, send it to .