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EVER since climate change became a subject for public discourse, economists have been making life difficult for environmentalists. Their problem is that mitigating climate change will require sizeable investments. When making investments, governments and companies normally look at rates of return. If an investment looks likely to deliver a decent return, it is worth making. If it doesn't, it isn't.

The trouble with mitigating climate change is that the benefits are uncertain and distant. Compared with investments that deliver clear benefits in the near future—such as education in developing countries, for instance, which commonly produces returns of around 10% a year—they do not look worthwhile. Conventional analysis would therefore suggest that those who want to make the planet a better place should invest in schools in Malawi rather than in clean energy.

Lord Stern, asked by Tony Blair, then Britain's prime minister, to look into the economics of climate change, devoted his report published in 2006 to the question of whether mitigation was worthwhile (or, according to some critics, to justifying a political decision that had already been made). He came out in favour.
The Stern review has since been used as an intellectual prop by greenish politicians everywhere. Economists have been more critical, on two grounds. The first concerns the discount rate—the annual rate at which future costs and benefits are discounted. Lord Stern uses a rate close to zero. A higher rate, often the cost of borrowing money, is more common. The higher the rate, the lower the value of future benefits or costs; and vice versa. Lord Stern agrees with Frank Ramsey, an economist who wrote 80 years ago that discounting "later enjoyments in comparison with earlier ones…is ethically indefensible and arises merely from the weakness of the imagination".

Other economists feel there is nothing wrong with their imaginations but plenty wrong with Lord Stern's near-zero rate. They think he should have used what William Nordhaus, an economics professor at Yale University, calls "assumptions that are consistent with today's marketplace real interest rates and savings rates". In a world of limited resources, they point out, it is not obvious that spending them on future generations rather than on the current one is morally right. After all, since future generations will probably be much richer than we are, it makes no more sense for us to sacrifice our well-being for them than it would to expect 18th-century peasants to go without gruel so we can buy more computers.

Mr Nordhaus argues for a 3% discount rate, which implies that benefits accrued in 25 years' time are worth about half their current value. He would prefer to spend less money now, and live with more warming, than Lord Stern would.
But others argue against using short-term rates in the long term. Paul Klemperer, an economics professor at Oxford University, points out that very long-term securities carry very low interest rates. When the British government recently issued 40-year index-linked bonds, for instance, it did so at a 0.5% real rate. And over the very long term standard discount rates lead to strange conclusions. At a modest 2% rate, for instance, a single cent rendered unto Caesar in Jesus's time is the equivalent of about $1.5 quadrillion (or 30 times the value of the entire world economy) today.

Martin Weitzman, an economics professor at Harvard University, is less critical of Lord Stern than Mr Nordhaus is: he thinks the review is "right for the wrong reasons". Its Leitmotiv, he maintains, is "the immorality of relegating future generations to live under the shadow" of serious climate change "when for a mere annuity cost of a per cent or two (or at most three) of GDP each year we might have purchased an insurance policy on their behalf". But, he says, such guilt feelings are likely to lead to the choice of a discount rate that is hard to justify intellectually. "I think that rather than trying to go through the back door with [an] unreasonably low [discount rate]…it is much better to go directly through the front door with the legitimate concern that there is a chance, whose subjective probability is small but diffuse, that global warming may eventually cause disastrous temperatures and environmental catastrophes."


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