DeLong, Dasgupta, and Stern
On the question of choosing a discount rate to determine the cost of global warming, Brad DeLong chimes in.
A consumption-to-output ratio of 77.5% is far from absurd, and so Dasgupta’s critique of Stern fails. His mistake is in failing to remember that in his model Haig-Simons output is very, very different indeed from standard reported GDP.
That being said, I agree with most of Dasgupta’s major point: the action here is in the choice of the parameter η. I think it’s appropriate to consider different ηs in the range from 1 to 5, and think the Stern Review should have done so.
Let me see if I can explain the economics to people who find Greek letters intimidating.Suppose that Robyn Crusoe lives on a large island with a small fruit forest. If Robyn eats all the fruit very year, she can have 1000 pieces of fruit per year. However, if she foregoes eating some fruit and plants it instead, she will have more fruit in the future. Fruit planting is subject to diminishing returns.
(Diminishing returns might mean, for example, that if she plants 1 unit of fruit, she will get an additional 5 units of fruit per year forever starting 15 years from now. But if she plants 10 units of fruit, she will only have an additional 20 units of fruit starting 15 years from now.)
If Robyn follows an equal-fruit strategy, she will not plant any fruit, and she will eat the same amount every year. At the other extreme, if she follows a total-fruit strategy, she will plant all of her fruit, and eat nothing this year. The first extreme corresponds to a social discount rate of infinity, and the second extreme corresponds to a social discount rate of zero. Most likely, her discount rate will be somewhere in between those extremes, and she will plant some fruit as well as eat some fruit.
Dasgupta argued that the Stern report was based on a discount rate that was much too close to zero. It looks like it is telling Robyn to eat only 25 units of fruit and to plant the other 975. This seems like an absurdly high weight on the total-fruit strategy and a correspondingly low weight on the equal-fruit strategy.
DeLong is saying: but what if there is spontaneous growth of fruit trees, such that they yield 3 percent more each year without Robyn planting any new trees? In that case, even if Robyn leans toward a total-fruit strategy as Stern assumes, there will be so much more fruit in the future that the small weight she gives to equal-fruit will be sufficient to get her to save only 22 percent of her fruit and to eat 78 percent of her fruit. (As an aside, I do not think it would be easy for DeLong to defend an assumption of pure technical progress as high as 3 percent per year. And I suspect that with that much technical progress we could enjoy lots of GDP with relatively low carbon emissions…but no matter)
My concern is with Stern, Dasgupta, or DeLong playing social engineer and picking a social discount rate that deviates from market interest rates. I think you get unreliable conclusions any time you do that.
If as a social engineer you think that real interest rates of 2 to 4 percent are too high, then this is a huge issue, with or without global warming. You are saying that we need to lean toward a total-fruit strategy regardless, and save a lot more for the future. The form of that saving does not matter–it could consist of reduced carbon emissions (as an investment in the environment), but it equally well could consist of investments in human and physical capital.
Even if the Stern report had nothing to do with global warming, its assumption for the social discount rate has radical policy implications. Implicitly, it argues for an all-out effort to reduce private-sector and public-sector consumption and to increase investment instead.
It seems to me that the idea of engaging in social engineering to address global warming is plenty ambitious. To add to it an even more significant effort of social engineering in order to get people to defer a much larger share of consumption than they would otherwise is very brave.