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Implications of a zero discount rate
From the comments, Jane Galt asks:
...doesn't a zero discount rate imply that even something that imposes trivial costs on each future generation should be avoided at catastrophic cost to us?
I would pose the question more broadly. If a policy imposes a great cost on one person, but involves many small benefits for others, should we always evaluate that policy by summing the respective costs and benefits and finding the net value?
The same question can be posed in both intertemporal and atemporal contexts. Philosopher Alastair Norcross made his name by considering Parfit-like conundrums. Let one person die a terrible and tortured death, but alleviate the headaches of billions of others by one second. (No, by its construction, this is not an exercise in risk reduction or Rawlsian reasoning. It is just a brute comparison of certain costs and benefits.) If the billions are large enough in number, is this worth it? Or does the suffering of the lone individual hold special status?
If we are willing to swallow this trade-off, we can accept it in the intergenerational comparison as well. I would myself balk at the notion, citing a mushy mish-mash of philosophic pluralism, quasi-lexical values, and the conceit of my moral intuitions. My conclusion is that we should modify cost-benefit analysis for (among other things) distributional concerns, but that the cost-benefit analysis should itself be done straight up. In any case, a non-zero discount rate, applied to consumption streams, would not do justice to the relevant moral intuitions about distribution. We might wish to count the wealthy for less, but not everyone in the future will be so wealthy, especially when China, India, and Bangladesh matter for the issue at hand.
Addendum: Here is commentary from Jonathan Adler.
Posted by Tyler Cowen on November 25, 2006 at 08:01 AM in Philosophy | Permalink
Comments
Adler takes a narrow view of history. Future generations have often been
poorer, more brutish and shorter in span. GDP is proportional to available
energy. Ten times the current available energy is hardly certain. If you
have grandchildren,even metaphorically consider the investment, if not
party on.
Posted by: bogwood at Nov 25, 2006 8:52:09 AM
There is no correct answer to that one.
Posted by: josh at Nov 25, 2006 9:10:44 AM
Adler has to make up his mind what scenario he is discussing because he is confusing two very different possibilities.
He corectly says if you start with current gdp of $44,403 and allow it to grow by 2% a year for 100 years you will get $321,684.
But next he makes two scenarios. One if gdp in year 100 is 10% less then it would have been it would be $289,515.
But his second scenario is:If global warming cuts GDP by 10% a year beginning about 50 years from now, then GDP per capita will be $289,515 in 2106 rather than $321,684.
this is incorrect. In this case gdp in year 100 would be $616--
derived from growing gdp of $44,403 at 2% for 50 years to get $119,507 in year 50 and second having it falling at a 10 rate for the second 50 years.
I doubt he is aware that he is talking about two very different things.
I have not read the original report so I do not know which scenario is correct, but Adler is guilty of very sloppy thinking
Posted by: spencer at Nov 25, 2006 10:20:53 AM
Well, I am going to be boring. The green golden
rule argument is driven by an ethical argument.
The current generation should not shaft the future
generations, implied by using too high a discount
rate, but the future generations should not shaft
the current one, which is an outcome of using a
zero discount rate. So, use one that declines from
roughly market rates to not too far above zero as
one moves to examining longer time horizons, thus
achieving some kind of a moral intergenerational
balance.
Posted by: Barkley Rosser at Nov 25, 2006 4:58:17 PM
You don't need a zero discount rate, you just need a discount rate lower than the population growth rate to get a quickly divergent infinite sum.
Posted by: Darren at Nov 25, 2006 8:35:55 PM
Barkley, I think that's what Koopmans said.
Posted by: radek at Nov 25, 2006 8:55:18 PM
Radek,
Where and when?
Of course Robert Strotz is credited with having proposed
hyperbolic discounting in 1956, now de rigueur among
behavioralists. But that is more a matter of what people
do internally, and involves very high short term rates
that then decline to something more like market rates.
This is something different.
Of course it was Frank Ramsey who first clearly proposed
a zero discount rate on ethical grounds. Said anything
more involved a "myopic telescopic facility." Just what
you would expect from somebody who died at 28.
Posted by: Barkley Rosser at Nov 25, 2006 10:34:48 PM
Doesn't anyone think that uncertainties about the future justify a non-zero discount rate, and not myopically or imorally so?
-dk
Posted by: Dick King at Nov 25, 2006 11:44:46 PM
Considering future generations, shouldn't you also take into consideration that there are different streams of future generations, even different streams of species, depending on present policies? You seem to take just one stream for granted.
Posted by: Art at Nov 26, 2006 6:35:39 AM
To answer Megan:
Why in the world would a zero discount rate imply that tradeoff? It would just mean that we would be better to accept $X worth of damage now, rather than put $X worth to be paid off by future generations. A zero discount rate implies that if the future cost will be less than the current cost, we should let our children pay it, not us. It does not mean that we would accept an infinite cost.
I'll have more to say on the problem of cost-benefit analysis involving lives in the other thread.
Posted by: Michael sullivan at Nov 26, 2006 5:40:26 PM
In Stern’s calculation, two factors (arguably three) contribute to the level of the discount rate: a) the adjusted rate of consumption growth, and b) the pure discount rate for consumption in an individual’s utility function. Unless the growth rate of consumption is negative, the discount rate will not hit zero according to Stern’s calculation. He argues the pure discount rate in an individual’s utility function should be very low. He uses 0.1% for his calculation because, even at that low level, he suggests, there is a nearly 10% chance of human race extinction by the end of the century. I challenge his argument. 0.1% discount rate in the utility function really means, ceteris paribus, I would withhold my $100 consumption today if my offspring 100 years later to spend $110. Who is that offspring of mine 100 years from today? My offspring 3-to-4 generations later will only have 6-10% of my genes. If I only care about my own genes, the discount rate I use in my utility function should be between 2-3%, ln(1/6-10%), instead of 0.1% assumed by Stern. Adding the adjusted rate of consumption growth, we will then have the discount rate rating around 5-6% in the initial years trailing down to 4-5% in later years.
Posted by: Yan Li at Nov 27, 2006 1:54:27 AM
At any point in history has a people improved their ancestors standard of living by intentionally cutting growth?
Posted by: Matt at Nov 27, 2006 3:17:22 PM
There is no reason to include the utility of people who haven't been born in current policy analysis. That would lead to the conclusion that we should all reduce consumption and use our resources for capital accumulation and research to make future generations richer. And so should our children. And their children. Obviously no government (or serious economist) thinks like this.
People do not enter this world with some sort of God-given right to have their utility handed to them on a platter.
Of course, we care about future generations. But that simply means that the utility of future generations is already included in our utility functions. Even parents who love their children have a rational time preference of money.
If you could have $100 now or your great-grandchild could have $100 in 100 years, do you really think that is a close choice? Take the money now. Even if you don't want a cent, invest it and give it to little johnny in 100 years.
The discount rate should be 5-15% like most other sensible public policy analysis.
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