We Should Discount the Costs of Climate Change, But Maybe Not That Much

by Patrick Brennan

The overwhelming scientific evidence suggests that increasing carbon dioxide emissions are going to raise world temperatures in the coming decades. There’s a chance that doesn’t happen, but even if we’re 100 percent sure, and believe that will substantially disrupt existing economic and living arrangements so much that the benefits of warming are easily negated, it’s still not clear how much we should do about it today.

Why? Because in economics, and human psychology, costs incurred in the future aren’t nearly as important as costs incurred now. The degree to which we calculate how much this is the case is the “discount rate” — a concept that gets quite complicated but basically implies that people care about something further and further into the future less and less — a dollar today is worth more than a dollar tomorrow. (This should be basically intuitive, though sometimes it isn’t.) As long as this rate isn’t really low, at some point in the future, the discount rate puts the positive or negative value of something at zero, meaning people don’t really care about it at all.

While this is universally accepted (and used to greatly irresponsible effect by government budgeters), when it comes to climate change, it’s a tough question, because we’re dealing with extremely long time frames — certain catastrophic effects, such as the collapse of the west Antarctic ice shelf that a recent scientific paper predicted could raise sea levels by 10 or 15 feet, won’t happen for a century or more. There’s no reason to apply such long time frames to a corporation’s or an individual’s finances, so it’s hard to decide how big of a discount rate is appropriate. If there isn’t a discount rate at all, or if it’s very low, it may be worth undertaking some interventions now that will be relatively costly in order to avoid costly events in the future; if the discount rate is something like what individuals, governments, and corporations use for their longest-term calculations (30 years or so, 4 to 6 percent), there’s a lot less we should do because things in the future just don’t matter very much.

But they might be a lot lower, meaning that events quite far into the past matter to use now. The Economist’s Ryan Avent highlights a recent NBER paper that attempts to answer this question, of how much people generally value things really far into the future. The authors find out that the discount rate people apply over the very long term is pretty low — meaning that people, when their money is on the line, do seem to care about what it’s doing in 100 or 150 years.

How do they figure this out? Quite cleverly. In one of British real-estate law’s many delightful oddities, people buying a house can apparently choose to buy the land on which it sits outright, or they can agree to a leasehold, which can be of extremely long duration — 99 to 999 years. By looking at how much value people place on, say, a 200-year lease versus a 100-year one, the economists can try to estimate how much people care about having something for their progeny in 100 or 200 years. The discount rate they find is 2.6 percent for 100-year contracts — which means we need to discount the future costs of climate change, but not a huge amount. People in general don’t want to ignore what the world will look like in 100 years, even when it costs them.

If they’re willing to pay noticeably more to own the land underneath their house in 2114, in other words, people also care whether or not the house is going to be floating. The question then of how to deal with climate change is extremely difficult one (what is the right way to prepare for slowly but steadily rising sea levels, for instance?), but economics seems to have proved something of intuitive sense here: We care about how people are doing well beyond our lifetimes.