Intergenerational Equity, Social Discount Rates and Global Warming

Abstract

"This article is about the logic underlying social discount rates. We argue that these rates are not ethical raw material, but are derived from the more fundamental notion of justice among generations. A number of approaches to the concept of intergenerational justice are discussed, and it is argued that the most compelling formulation available to us is the one long been in use among economists, namely, the Ramsey-Koopmans theory. This theory advocates that investment projects having longrun effects should be subjected to the same conceptual treatment as those that affect only the near future. We show that social discount rates depend on the numeraire, and that methods of estimating them depend on the institutional setting within which social cost benefit analysis is assumed to be undertaken. We also show that it is incorrect to advocate project-specific discount rates as a way of conserving environmental resources. Social discount rates have universally been taken to be positive, on grounds that the rate of return on investment is positive. But if consumption and production activities give rise to environmental pollution as a by-product, the social rate of return on investment could be zero even when the private rate is positive; at the very least, the social rate would be lower than the private rate. The current practice among most global energy modellers of relying exclusively on (risk-free) market rates of return for estimating optimal carbon taxes is conceptually faulty. In the context of a formal model of environmental pollution we show how, even along an optimal programme, social rates of discount can be zero. We also demonstrate that in certain institutional settings, social discount rates can be negative."