The Stern Swindle
By Arnold Kling
Concerning the discount rate assumptions used in the Stern climate review, Partha Dasgupta writes,
suppose, following the Review, we set delta [the rate of subjective time preference] equal to 0.1% per year and eta [the elasticity of marginal utility with respect to consumption] equal to 1 [so utility is logarithmic] in a deterministic economy where the social rate of return on investment is, say, 4% a year. It is an easy calculation to show that the current generation in that model economy ought to save a full 97.5% of its GDP for the future!
Thanks to Greg Mankiw for the pointer. What Dasgupta is saying is that the approach Stern uses to evaluate intertemporal trade-offs would, if applied generally, suggest that our consumption should drop from over 80 percent of GDP to 2.5 percent, in order to leave the target legacy to our children.
What Dasgupta’s comment does is crystallize for me the magnitude of the intellectual swindle that Stern is attempting to pull off. Any time you assign a far-from-plausible interest rate to a long-term intertemporal problem, you get distorted results.
In the Social Security privatization debate, pro-privatization fanatics like Peter Ferrara were using far-from-market interest rates to make privatization sound like a free lunch.
Or consider the swindle of biweekly mortgages, which promise to save you “thousands of dollars of interest.” In fact, those savings assumed a zero interest rate. Once you discount at the mortgage rate (or even at a lower short-term rate), and take into account the fees charged by those offering to do biweekly mortgage conversion, you actually come out behind Ed Lathrop’s article concludes, “So you think my calling biweekly mortgage plans, “a scam”, is being a little harsh? I don’t think so, in fact, I think they are out and out robbery!.” I used to have an even more biting article about the biweekly mortgage on homefair.com, but it’s no longer available. The closest thing I can find is a Google cache of a highly sanitized version that I was forced to put up when we got some threatening correspondence from one of the biweekly-conversion scam artists.
The Stern Review is arguably the policy equivalent of biweekly mortgage conversion. I hope that is not true for the anti-global-warming crusade as a whole.