Intergenerational discount rates

I’ve been idly wondering about how philanthropic behavior and the saving patterns of parents should influence our understanding of intergenerational discount rates. It seems that when people do selfless things for their progeny, or simply for posterity, they are exhibiting very low to zero intergenerational discount rates; at the very least it seems to complicate the transition between investment preferences within an agent’s life and those across human generations.

Why have I been thinking this?

These days I’m working on a project that’s being billed internally as a follow up to the highly influential Stern Report, which was commissioned by the UK government and published in 2006. In a nutshell, the Stern Report attempted to understand the scale of climate change as a market failure.

Although our understanding of the science is always evolving, climate change is often understood as a problem that has causes today, and effects later on. There is thus the immediate challenge of comparing temporal apples and oranges – how do you compare the benefits of the causes with the damages of the effects if they don’t happen at the same time?

For economists and most social scientists, the answer is discount rates. Conceptually, discount rates “discount” the future – i.e., between $1 today and $1 in a year, we’ll value the $1 today higher than the $1 in the future – for a variety of reasons: the future is uncertain, for example, we may never get that $1; there are productive investments available – if you give me a $1 today there is a good chance I can turn that into more than a dollar by investing it; and other reasons as well.

The question – the $1,000,000 question – is what the discount rate should be. A very low discount rate values the future almost as highly as the present. A high discount rate amplifies the present significantly – future payoffs or costs will barely register.

The application to an economic understanding of climate change should be immediately obvious. If the causes (the production of goods and services – good things) are today, and the effects (destructive weather and climatic effects – bad things) are tomorrow, the choice of a discount rate will completely determine whether or not we should adjust our path.

The biggest critiques of Stern Report were that they chose a very low discount rate. They had good reasons, but many economists essentially pointed out that they were begging the question. Yes – with a low discount rate, Climate Change is Bad. Their contribution was essentially to estimate the scale of the market failure at their very low discount rate.

At the same time, my own thoughts have been changing rapidly. I used to be on the carbon price everywhere train – but it appears that this is not politically feasible. Carbon prices may be possible – i.e. through things like gas taxes or permitting fees that effectively collapse to an economy-wide price on carbon. But personally, I’m now turning towards technological progress as the only feasible source of solutions to GHG emissions. That has different policy implications that I’m only beginning to grasp beyond “let’s spend a lot of money figuring it out”.