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Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 1993
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Global warming: a comment

In the debate “Discounting Our Descendants?” (Finance & Development, March 1993), Nancy Birdsall and Andrew Steer are right to argue against low discount rates, for all the reasons they give. May I make two additional points? One is that we do not need low discount rates to arrive at good policies; quite the opposite.

The other is that environmental policymaking requires the use of direct instruments, and in the case of the problem in hand, this changes the way we need to calculate the present worth of costs. The discount rate would be a blunt (and probably a counterproductive) instrument of policy.

The implication of William Cline’s analysis, that high discount rates imply inaction, is false; it makes unduly pessimistic assumptions about the scope for technical progress and substitution. Several policies can confidently be recommended at present discount rates, in addition to those associated with the “easy” option of energy efficiency. High discount rates will help better choices to be made in carbon dioxide abatement policies because they more likely favor investments with good economic—not to say commercial— promise, and they also favor the more efficient production and use of energy (which is a capital intensive sector).

Despite all the uncertainties about the greenhouse effect, the one thing we do know is that it is a stock and not a flow problem. We do not yet know what a safe limit on the stocks of carbon in the atmosphere might be, but once it is reached, we will have no alternative than to turn to the backstop, or non-net carbon-emitting technologies to meet our energy needs. The costs of complying with an agreed limit will therefore be determined by the difference between the marginal costs of using these technologies and those of using fossil fuels.

The difference in costs may well be smaller than is implied in Cline’s curves. For forty years, the main backstop technology that policymakers have supported has been nuclear power: fission for current generations and fusion for the future. But the 1970s and 1980s saw completely unpredicted reductions in the costs of renewable energy. A convincing case can be made that renewable energy sources will soon become competitive with nuclear power and possibly with fossil fuels; indeed, they are competitive already for small-scale applications. An exception may be in the liquid fuel markets, where it is hard to find low-cost alternatives to gasoline and diesel fuels—though even here the fuel cell may offer surprises. Even if this interpretation is optimistic, we know for certain that functional backstop technologies are emerging at costs not far removed from those of fossil and nuclear fuels. Yet, the recurrent subsidies and tax write-offs for the latter in the United States alone amount to more than a century’s worth of research and development in renewables at present rates, and worldwide to a thousand years’ worth. It would be a waste if disputes over the discount rate were to detract attention from the far more important problem of eliminating such gross distortions in public policies.

That having been said, global warming shares one feature in common with other resource depletion problems, which is as follows. As we approach the permissible limit on carbon accumulations, whatever it is, the present value of the difference in marginal costs between fossil fuels and the backstop technologies rises at a rate equal to the discount rate. This means that, while we divide the future cost differences by the discount factor [(1+r)**t, where r = the discount rate], we should in theory multiply the imputed costs of complying with the limit or constraint by the same factor. The discounted term thus cancels out in this component of the cost calculations.

Of course, it could be argued that we cannot determine the optimum safe limits on carbon dioxide and other greenhouse gas accumulations without deciding on “r.” But it is a brave economist who will stick his or her neck out on this one: climatolo-gists have said that it will be one to two decades before we have a reasonable understanding of the physical consequences of global warming. Moreover, even when the phenomenon is better understood, others will have their say in policy, besides economists, much as they rightly do in other aspects of human welfare, such as health and safety, or the proper treatment and disposal of hazardous wastes. Economists need not be discouraged; cost-benefit analysis cannot answer every question to mankind’s satisfaction, and many of us suspect this will be the case for dealing with global warming (should the need arise). They should instead take their cue from engineers and recall their time-honored interests in innovation and substitution.

Dennis Anderson Energy and Industry Department The World Bank

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