The particularly controversial part, from an economic point of view, of the Stern Review into climate change was the use of a very low (near zero) discount rate. The discount rate you use of course being vitally important as you try to translate possible future damages into current numbers so that you can compare them with hte current costs of trying to avoid those damages.
The argument was and is that we know that humans are subject to hyperbolic discounting. Given our lifespans we tend not to think about the far future as much as we perhaps should. Thus market interest rates are fine as a guide to events in coming decades but not to things in centuries.
There’s now been a very clever piece of new research which measures how we do actually discount for events in that far future. English property law allows for both freehold land and leasehold: and those leases can be from a century to near a millennium long. Looking at the price difference between the two it is possible to work out that discount rate that we actually do apply:
We use these estimated price discounts to back out the implied discount rate that households use to value cash flows to housing that arise more than 100 years from now. We find the discount rate for very long-run housing cash flows to be about 2.6% per year. Interestingly, we find similar implied discount rates in both the UK and in Singapore – two countries with very different institutional settings.
This discount rate is rather higher than the one Stern used in his report. And the implication of that is that if we use this new and improved discount rate then our proposed carbon tax should be lower, we should be expending less effort in attempting to avert future climate change.
We could, of course, stamp our pretty little feet and insist that humans should not value the future in this manner. That all of us should value things as Stern says we should. But the fact is that we do not: and it’s rather better to try to run the world taking account of the way we all are rather than as certain dreamers would have us be. And the simple truth seems to be that we value damages to people in a century or two rather less than the costs of averting them. So, we should do less to avert them.