Discounting and Intergenerational Equity

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This post is from Dennis Meadows, "a professor of Systems Management and director of the Institute for Policy and Social Science Research at the University of New Hampshire. He lives in Durham, New Hampshire" (From Chelsea Green Publishing). He also is the author of Limits to Growth: The 30 Year Update. Find more about him at Wikipedia.

Discounting and Intergenerational Equity

Young people should be aware of the importance of discounting of costs and benefits in all matters relating to intergenerational considerations.

Discounting is used in many studies of costs and benefits of proposed actions and policies. It is essentially a way of taking into account that money is more useful now than in the future because it can be put on deposit and interest collected. The higher the discount rate, the more severely future costs and benefits are "disregarded".

Sir Nicholas Stern, a senior economic advisor the UK Government, recently completed his report on the economic implications of climate change. It was submitted to the Prime Minister and the Chancellor of the Exchequer. He used discounting to compare costs of taking action now with the value of reduced damage from climate change in the future. His report stimulated much discussion of discounting. Economists' criticisms of the Stern report are almost totally focused on his use of the discount rate. He uses a low one, and they think it should be higher. I will not get into that issue, because I believe the concept of a discount rate (high or low - it makes no difference) is completely invalid in this case.

The idea that future costs and benefits should be discounted from their present values is based absolutely on one implicit assumption that the economists never mention. Probably they are even mainly unaware of it. Discounting only makes sense if you can buy back in the future whatever benefits you forego now. Or putting it in another way, it only makes sense if the costs of correcting current actions do not become infinite in the future.

A related assumption is that all the costs and benefits of an action can and will be expressed in financial terms. Economists are content to do a discounted cost analysis of species extinction, for example. I think that is total lunacy and arrogance. What qualifies a couple of economists living today to judge if losing a species forever will only impose on us the costs and benefits that we can foresee accurately now? And how could we imagine that future generations -- who will be deprived forever of the species -- will evaluate the costs and the benefits exactly as we do?

With climate change we are facing a social problem where delay now will give us a future that cannot be reversed, no matter how much money we spend. If we permit the climate to change, there will simply be no way we can buy back the situation we have now (to which we have adapted technically, politically, and economically over the past several centuries.) So there is no discount rate that can legitimately be used to decide whether it is "optimal" to act now or later.

I would caution all young people that if they get into the argument about the appropriate discount rate to use in developing climate policy, they have already lost the argument.

For decisions related to global climate change, modern economists' theory of discount rates is simply irrelevant.

-Dennis L. Meadows