Problem of Discounting the Future in Accounting

From P2P Foundation
Jump to: navigation, search


Contextual Citation

by Brett Clark, John Bellamy Foster and Richard York:

"The atmospheric carbon target (in the Stern review) is determined not according to what is necessary to sustain the global environment, protect species, and ensure the sustainability of human civilization, but by what is required to keep the capitalist economy itself alive." (https://monthlyreview.org/2009/05/01/capitalism-in-wonderland/)

Discussion

By John Bellamy Foster et al.:

"The issue of discounting may seem esoteric to most people, but not to economists, and deserves some examination. Discounting is fundamentally about how we value the future relative to the present—insofar as it makes any sense at all to attach numbers to such valuations. The “discount rate” can be thought of as operating in inverse relation to compound interest. While “compounding measures how much present-day investments will be worth in the future, discounting measures how much future benefits are worth today.”13 Estimation of the discount rate is based on two moral issues. First, there is the issue of how we value the welfare of future generations relative to present ones (the time discount rate). As Nordhaus states, “A zero discount rate means that all generations into the indefinite future are treated the same; a positive discount rate means that the welfare of future generations is reduced or ‘discounted’ compared with nearer generations.” A catastrophe affecting humanity fifty years from now, given a discount rate of 10 percent, would have a “present value” less than 1 percent of its future cost. Second, there is the issue of how wealthy future generations will be relative to present ones and whether it is appropriate to shift costs from the present to the future. If we assume a high rate of economic growth into the indefinite future, we are more likely to avoid investing in addressing problems now, because we assume that future generations will be wealthier than we are and can better afford to address these problems, even if the problems become substantially worse.

The difficulty of the discount rate, as environmental economist Frank Ackerman has written, is that, “it is indeed a choice; the appropriate discount rate for public policy decisions spanning many generations cannot be deduced from private market decisions today, or from economic theory. A lower discount rate places a greater importance on future lives and conditions of life. To many, it seems ethically necessary to have a discount rate at or close to zero, in order to respect our descendants and create a sustainable future.” Indeed, the very notion of sustainability is about maintaining the environment for future generations.

Economic growth theorist Roy Harrod argued in the 1940s that discounting the future based on a “pure time preference” (the myopic preference for consumption today apart from all other considerations) was a “polite expression for rapacity.” A high discount rate tends to encourage spending on policies/projects with short-term benefits and long-term costs as opposed to ones with high up-front costs and long paybacks. It therefore encourages “wait-and-see” and “go-it-slow” approaches to impending catastrophes, such as climate change, rather than engaging in strong preventive action.

Nordhaus, like most mainstream economists, through his support of a high discount rate, places a low value on the welfare of future generations relative to present ones, and assumes, despite considerable uncertainty in this regard, that future generations will be much wealthier than present ones. This leads him to argue against large immediate investments in curtailing climate change. He advocates putting a tax on carbon of $30 to $50 per ton and increasing this to about $85 by mid-century. Taxing carbon at $30 a ton would increase the price of gasoline by a mere seven cents a gallon, which gives one a sense of the low level of importance Nordhaus places on curtailing climate change as well as the future of humanity and the environment. Nordhaus has tripled his estimate of the loss to global economic output due to climate change in 2100, moving from his earlier estimate of almost 1 percent to nearly 3 percent in his latest study. Still, such losses are deemed insignificant, given a high discount rate, in comparison to the costs that would be incurred in any attempt to curtail drastically climate change today, leading Nordhaus to advocate a weak-kneed response.

Nordhaus is particularly interested in countering the arguments presented in The Economics of Climate Change (commonly known as The Stern Review), the report written by Nicholas Stern (former chief economist of the World Bank) for the British government, which advocates immediate and substantial investments aimed at reducing carbon emissions. Stern, deviating from the practice of most orthodox economists, uses a low discount rate, arguing that it is morally inexcusable to place low value on the welfare of future generations and to impose the costs of the problems we generate on our descendants. Nordhaus discounts the future at roughly 6 percent a year; Stern by 1.4 percent. This means that for Stern having a trillion dollars a century from now is worth $247 billion today, while for Nordhaus it is only worth $2.5 billion.18 Due to this, Stern advocates imposing a tax on carbon of greater than $300 per ton and increasing it to nearly $1,000 before the end of the century.19 Lomborg in the Wall Street Journal characterized the Stern Review as “fear-mongering,” and referred to it in Cool It! as a “radical report,” comparing it unfavorably to Nordhaus’s work.

It is important to recognize that the difference displayed here between Nordhaus and Stern is fundamentally a moral, not a technical, one. Where they primarily differ is not on their views of the science behind climate change but on their value assumptions about the propriety of shifting burdens to future generations. This lays bare the ideology embedded in orthodox neoclassical economics, a field which regularly presents itself as using objective, even naturalistic, methods for modeling the economy. However, past all of the equations and technical jargon, the dominant economic paradigm is built on a value system that prizes capital accumulation in the short-term, while de-valuing everything else in the present and everything altogether in the future.

Some of the same blinders are in fact common in varying degrees to both Nordhaus and Stern. Nordhaus proposes what he calls an “optimal path” in economic terms aimed at slowing down the growth of carbon emissions. In his “climate policy ramp” emissions reductions would start slow and get bigger later, but would nonetheless lead eventually (in the next century) to an atmospheric carbon concentration of nearly 700 parts per million (ppm). This would present the possibility of global average temperature increases approaching 6°C (10.8°F) above preindustrial levels—a level that Mark Lynas in his Six Degrees compares to the sixth circle of hell in Dante’s Inferno.21

Indeed, with a level of carbon concentration much less than this, 500 ppm (associated with global warming on the order of 3.5°C or 6.3°F), the effects both on the world’s biological diversity and on human beings themselves would be disastrous. “A conservative estimate for the number of species that would be exterminated (committed to extinction)” at this level, according to James Hansen, director of NASA’s Goddard Institute for Space Studies, “is one million.” Moreover, rising sea levels, the melting of glaciers, and other effects could drastically affect hundreds of millions, conceivably even billions, of people. Hansen, the world’s most famous climatologist, argues that in order to avoid catastrophic change it is necessary to reduce atmospheric carbon to a level of 350 ppm.22

Yet, the Stern Review itself, despite being designated as a “radical” and “fear-mongering” report by Lomborg, targets an atmospheric carbon concentration stabilization level of 480 ppm (550 ppm in carbon equivalent), which—if never reaching Nordhaus’s near 700 ppm peak (over 900 ppm carbon equivalent)—is sure to be disastrous, if the analysis of Hansen and most other leading climatologists is to be believed.23 Why such a high atmospheric carbon target?

The answer is provided explicitly by the Stern Review itself, which argues that past experience shows that anything more than a 1 percent average annual cut in carbon emissions in industrial countries would have a significant negative effect on economic growth. Or as the Stern Review itself puts it, “it is difficult to secure emission cuts faster than about 1 percent a year except in instances of recession.”24 So the atmospheric carbon target is determined not according to what is necessary to sustain the global environment, protect species, and ensure the sustainability of human civilization, but by what is required to keep the capitalist economy itself alive." (https://monthlyreview.org/2009/05/01/capitalism-in-wonderland/)

The Ethics of Discounting

By Mariano Torras:

"I mentioned that any cost-benefit analysis of climate change requires projections years into the future. Consequently, another challenge involves the valuation of future costs and benefits relative to present costs and benefits. The difference is of vital interest to the capitalist investor. Investors use what is known as the “discount rate” to calculate how much future receipts of income are worth today (what economists call their present value). While anyone could tell them that $1,000 in ten years’ time is worth less than the same amount received today (because in that decade they could have invested the money at some rate of interest), the question remains of exactly how much its value would diminish. Dividing by the discount rate (compounded, in this case, over ten years) gives an estimate of this projected loss. Such information enables cost-benefit analysis of private projects, even many years into the future, because it permits the translation of all future benefits and costs into present values that are directly comparable to today’s benefits and costs.

Social cost-benefit analysis uses a similar procedure, but in the social arena, discounting is more dubious. For discounting purposes, private investors typically use an interest rate for an investment of comparable risk to their project, since it represents what economists call the “opportunity cost” of capital. But how relevant is capital opportunity cost when we are talking of intangible social benefits and costs that have real impacts on people’s lives? To say that, by dint of a compounding discount rate, benefits and costs far into the future carry far less weight in a climate change cost-benefit calculation is morally questionable. It is tantamount to saying that future people are not “worth” as much as people today.

Any thinking, feeling person will recognize the problem with any policy that forces us to choose among different people’s lives as a matter of policy. But it gets worse. Orthodox economists generally justify the discounting of future human lives on the grounds that people not yet born will, on average, be better off than their predecessors. They assume this on the basis of a historical extrapolation from the sustained growth in global income per capita over the past two centuries. Marxists, among others, would of course not concede this point, but let us do so for the sake of argument. If, then, we knew that future people would be better off, one might plausibly argue that discounting makes sense on grounds that we should not be making sacrifices today for a future population that will benefit regardless. A higher discount rate effectively means we are less concerned about future climate change damages—which, to continue this line of reasoning, is acceptable because richer, healthier, more stable future generations would be better positioned to deal with or adapt to these problems.

As ecological economist Joan Martinez-Alier has noted, such thinking is perverse, since by making us less cautious toward the fates of future people, the implied higher discount rate makes it less likely that they will be better off than us.10 The high discount rate, in other words, makes capitalist investors even more rapacious than they might be otherwise, leaving a smaller resource endowment for future generations. One of orthodox economics’ most basic analytical tools thus proves self-contradictory when applied to human lives.

More important, a positive discount rate requires that we assume that there is a zero percent chance of catastrophic climate effects in the future. If the probability of future human extinction caused by climate change were any number greater than zero—however small—we could not, by any metric, assume that future generations would be better off. In expected value terms, any positive probability multiplied by an infinite loss is still an infinite loss. Such a prospect would require us to use a large negative discount rate, with the inevitable policy recommendation that we must aggressively confront climate change at any cost. This is why it is so important, for orthodox analyses to “make sense,” to assume tacitly that the probability of catastrophe is zero.

Arbitrarily choosing some private interest rate to stand for the social discount rate would of course be absurd, but many orthodox economists, including William Nordhaus or Nicholas Stern (of the Stern Review), defend the use of discount rates in social cost-benefit analysis, even if they differ over its proper value. The Stern Review aroused much controversy in economic circles because of the relatively low discount rate (1.4 percent) it used for its calculations, compared to Nordhaus’s preferred rate (6 percent).11 Based solely on this discrepancy, there is a hundred-fold difference in the estimated benefit of aggressive climate policy today. Consequently, Stern, to the chagrin of many economists, advocates a much more active role for government in combating climate change.

While it is true that one cannot conduct social cost-benefit analysis without committing to some discount rate value, if anything this very point illustrates why the use of cost-benefit analysis should be confined to capitalists and their private investments. For ethical matters concerning society, there can be no such thing as a “correct” discount rate. Choosing a particular one merely produces an arbitrary cost-benefit conclusion. If politicians read the conclusion at face value, the chosen rate could, in theory, carry far-reaching policy implications. Yet whatever the outcome, one could never claim that it was objectively determined." (https://monthlyreview.org/2016/05/01/orthodox-economics-and-the-science-of-climate-change/)