Discount rates and greenhouse gas emissions
A big part of this question concerns the discount rate: the rate used to balance future expected benefits against today's costs of reducing emissions. Common thinking among some economists is that since you can put money in the stock market and expect a decent return over the long run, benefits in the distant future should be worth a lot less in today's dollars. This thinking suggests we shouldn't spend much on reducing greenhouse gases emissions.
That first-cut thinking by economists gets the economics wrong.
Consider that we might also think of current emission reductions as insurance. We buy insurance all the time and insurance premiums typically have negative expected returns. We're willing to accept that negative expected return because insurance pays big indemnities in unusually bad circumstances when we really need the money.
Curbing greenhouse gas emissions seems a lot more like buying insurance than investing in stocks, and this pushes the discount rate down a lot.
Let's step back and spell out all the pieces.
There are three essential considerations in choosing the discount rate: (1) the benefits will accrue many years in the future; (2) the benefits, like climate change itself, are highly uncertain; (3) the discount rate itself is uncertain.
(1) means small differences in the discount rate have a huge effect on the bottom line because the discount rate interacts with time exponentially; (2) matters because risk premiums appear to be really high; (3) matters for the same reason (1) matters, as I'll explain below.
Standard theory says the discount rate (d) is the sum up of three parts:
d = eta + g + r
eta is the value of consuming something today verses consuming it tomorrow, holding all else the same. Stern set this parameter to 1% and some felt that number was too low, probably because they misinterpreted this number as the discount rate itself. I think 1% is reasonable. Those hugely worried about intergenerational equality might set eta equal to zero. In any case, its probably smallest and least important part of d.
g is economic growth, adjusted by the inverse elasticity of intertemporal substitution, if not 1 (log utility). Greater growth means lower marginal utility in the future and a higher discount rate. Given historical growth rates, log utility would put this number around 3%, higher if the elasticity of intertemporal substitution is low.
r is the risk premium. Because investments in reduced GHG emissions will pay off most in bad times, if climate change turns out to be a very bad thing rather than a mild or even beneficial thing, the risk premium is negative. This gets at the insurance/stock-market dichotomy above. Investments in assets like stocks, which pay off most in good times, have a positive risk premium. Given historical estimates of risk premiums, this could be a big negative number.
A reasonable person can probably justify anything in the range of -3 to + 5% for the sum of thee three numbers. That's a big range. And yes, it could be a negative number. How could it be negative? It's that negative risk premium, which could be huge. Subtract a big risk premium from a typical real bond rate and you're in negative territory.
Okay, now (3), what's the implication of the discount rate itself being uncertain?
Weitzman showed that this pushes the effective rate down. This follows from the simple fact that the present value of future benefits decline at a decreasing rate with the discount rate. In other words, the value function is convex. If it turns out that the discount rate is low or negative, expected returns are absolutely huge. So, we should err on the downside when we choose a
In sum, I have no idea how much we should spend reducing GHG emissions because I have no idea how costly reductions would be, the costs should warming occur, or how GHG affects all the possibilities. But I think a low discount rate, in the ballpark of zero, should be used when weighing current expenditures to future expected benefits. Moreover, I don't think a zero discount rate should be controversial among serious economists.
Nick Stern used low number but not as low as zero, and he got a lot of grief for it. I don't think grief was justified, except maybe he could have done a better job explaining why the number should be so low.
For more on this, read Martin Weitzman. John Quiggen has a nice writup on this too. I think I've summarized the essence of their arguments here.