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Discounting for Climate Change

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  • Anthoff, David

    (ESRI)

  • Tol, Richard S. J.

    (ESRI)

  • Yohe, Gary W.

    (Wesleyan University, CT, USA)

Abstract

It is well-known that the discount rate is crucially important for estimating the social cost of carbon, a standard indicator for the seriousness of climate change and desirable level of climate policy. The Ramsey equation for the discount rate has three components: the pure rate of time preference, a measure of relative risk aversion, and the rate of growth of per capita consumption. Much of the attention on the appropriate discount rate for long-term environmental problems has focussed on the role played by the pure rate of time preference in this formulation. We show that the other two elements are numerically just as important in considerations of anthropogenic climate change. The elasticity of the marginal utility with respect to consumption is particularly important because it assumes three roles: consumption smoothing over time, risk aversion, and inequity aversion. Given the large uncertainties about climate change and widely asymmetric impacts, the assumed rates of risk and inequity aversion can be expected to play significant roles. The consumption growth rate plays four roles. It is one of the determinants of the discount rate, and one of the drivers of emissions and hence climate change. We find that the impacts of climate change grow slower than income, so that the effective discount rate is higher than the real discount rate. The differential growth rate between rich and poor countries determines the time evolution of the size of the equity weights. As there are a number of crucial but uncertain parameters, it is no surprise that one can obtain almost any estimate of the social cost of carbon. We even show that, for a low pure rate of time preference, the estimate of the social cost of carbon is indeed arbitrary ? as one can exclude neither large positive nor large negative impacts in the very long run. However, if we probabilistically constrain the parameters to values that are implied by observed behaviour, we find that the social cost of carbon, corrected for uncertainty and inequity, is 61 US dollar per metric tonne of carbon.

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Bibliographic Info

Paper provided by Economic and Social Research Institute (ESRI) in its series Papers with number WP276.

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Length: 35 pages
Date of creation: Jan 2009
Date of revision:
Handle: RePEc:esr:wpaper:wp276

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Keywords: Climate change/income elasticity/inequity aversion/pure time preference/risk aversion/Social cost of carbon/time horizon/uncertainty/policy/growth;

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References

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  1. Tol, Richard S. J., 2002. "Welfare specifications and optimal control of climate change: an application of fund," Energy Economics, Elsevier, vol. 24(4), pages 367-376, July.
  2. William D. Nordhaus, 2006. "The "Stern Review" on the Economics of Climate Change," NBER Working Papers 12741, National Bureau of Economic Research, Inc.
  3. Winkler, Ralph, 2009. "Now or Never: Environmental Protection under Hyperbolic Discounting," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy, vol. 3(12), pages 1-22.
  4. Tol, Richard S. J. & Narita, Daiju & Anthoff, David, 2008. "Damage Costs of Climate Change through Intensification of Tropical Cyclone Activities: An Application of FUND," Papers WP259, Economic and Social Research Institute (ESRI).
  5. Helgeson, Jennifer & Dietz, Simon & Atkinson, Giles D. & Hepburn, Cameron & Sælen, Håkon, 2009. "Siblings, not triplets: social preferences for risk, inequality and time in discounting climate change," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy, vol. 3(26), pages 1-28.
  6. Tol, Richard S.J., 2005. "Emission abatement versus development as strategies to reduce vulnerability to climate change: an application of FUND," Environment and Development Economics, Cambridge University Press, vol. 10(05), pages 615-629, October.
  7. Narita, Daiju & Tol, Richard S. J. & Anthoff, David, 2009. "Economic Costs of Extratropical Storms Under Climate Change: An Application of FUND," Papers WP274, Economic and Social Research Institute (ESRI).
  8. J.K. Horowitz, 2002. "Preferences in the Future," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 21(3), pages 241-258, March.
  9. Azar, Christian & Sterner, Thomas, 1996. "Discounting and distributional considerations in the context of global warming," Ecological Economics, Elsevier, vol. 19(2), pages 169-184, November.
  10. P. Michael Link & Richard S.J. Tol, 2004. "Possible Economic Impacts of a Shutdown of the Thermohaline Circulation: an Application of FUND," Working Papers FNU-42, Research unit Sustainability and Global Change, Hamburg University, revised Apr 2004.
  11. Sterner, Thomas & Persson, U. Martin, 2007. "An Even Sterner Review: Introducing Relative Prices into the Discounting Debate," Discussion Papers dp-07-37, Resources For the Future.
  12. Tol, Richard S. J., 2001. "Equitable cost-benefit analysis of climate change policies," Ecological Economics, Elsevier, vol. 36(1), pages 71-85, January.
  13. David Anthoff & Cameron Hepburn & Richard S.J. Tol, 2007. "Equity Weighting and the Marginal Damage Costs of Climate Change," Working Papers 2007.43, Fondazione Eni Enrico Mattei.
  14. Reed, William J., 1984. "The effects of the risk of fire on the optimal rotation of a forest," Journal of Environmental Economics and Management, Elsevier, vol. 11(2), pages 180-190, June.
  15. Tol, Richard S.J. & Ebi, Kristie L. & Yohe, Gary W., 2007. "Infectious disease, development, and climate change: a scenario analysis," Environment and Development Economics, Cambridge University Press, vol. 12(05), pages 687-706, October.
  16. Richard S.J. Tol, 2004. "Multi-Gas Emission Reduction For Climate Change Policy: An Application Of Fund," Working Papers FNU-46, Research unit Sustainability and Global Change, Hamburg University, revised Jun 2004.
  17. John Creedy & Ross Guest, 2008. "Discounting and the Time Preference Rate," The Economic Record, The Economic Society of Australia, vol. 84(264), pages 109-127, 03.
  18. Samuel Fankhauser & Richard Tol & DAVID Pearce, 1997. "The Aggregation of Climate Change Damages: a Welfare Theoretic Approach," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 10(3), pages 249-266, October.
  19. William D. Nordhaus, 2007. "A Review of the Stern Review on the Economics of Climate Change," Journal of Economic Literature, American Economic Association, vol. 45(3), pages 686-702, September.
  20. Martin L. Weitzman, 2007. "A Review of the Stern Review on the Economics of Climate Change," Journal of Economic Literature, American Economic Association, vol. 45(3), pages 703-724, September.
  21. Tol, Richard S. J., 2005. "The marginal damage costs of carbon dioxide emissions: an assessment of the uncertainties," Energy Policy, Elsevier, vol. 33(16), pages 2064-2074, November.
  22. Frances Ruane & Xiaoheng Zhang, 2007. "Location Choices of the Pharmaceutical Industry in Europe after 1992," The Institute for International Integration Studies Discussion Paper Series iiisdp220, IIIS.
  23. Seán Lyons & Karen Mayor & Richard S.J. Tol, 2008. "Environmental Accounts for the Republic of Ireland: 1990-2005," Papers WP223, Economic and Social Research Institute (ESRI).
  24. Hope, Chris, 2008. "Discount rates, equity weights and the social cost of carbon," Energy Economics, Elsevier, vol. 30(3), pages 1011-1019, May.
  25. Robert Mendelsohn, 2008. "Is the Stern Review an Economic Analysis?," Review of Environmental Economics and Policy, Association of Environmental and Resource Economists, vol. 2(1), pages 45-60, Winter.
  26. Nicholas Stern, 2008. "The Economics of Climate Change," American Economic Review, American Economic Association, vol. 98(2), pages 1-37, May.
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Citations

Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. How to discount time for climate change policies
    by Economic Logician in Economic Logic on 2009-07-30 14:55:00
Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
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Cited by:
  1. Steve Newbold & Charles Griffiths & Christopher C. Moore & Ann Wolverton & Elizabeth Kopits, 2010. "The "Social Cost of Carbon" Made Simple," NCEE Working Paper Series 201007, National Center for Environmental Economics, U.S. Environmental Protection Agency, revised Aug 2010.
  2. Philippe Aghion & Antoine Dechezleprêtre & David Hemous & Ralf Martin & John Van Reenen, 2012. "Carbon Taxes, Path Dependency and Directed Technical Change: Evidence from the Auto Industry," Grantham Research Institute on Climate Change and the Environment Working Papers 102, Grantham Research Institute on Climate Change and the Environment.
  3. Tol, Richard S. J., 2008. "The Economic Impact of Climate Change," Papers WP255, Economic and Social Research Institute (ESRI).
  4. John Whitehead & Ben Poulter & Christopher Dumas & Okmyung Bin, 2009. "Measuring the economic effects of sea level rise on shore fishing," Mitigation and Adaptation Strategies for Global Change, Springer, vol. 14(8), pages 777-792, December.
  5. Richard S. J. Tol, 2010. "International Inequity Aversion And The Social Cost Of Carbon," Climate Change Economics (CCE), World Scientific Publishing Co. Pte. Ltd., vol. 1(01), pages 21-32.
  6. Simon Dietz & David Maddison, 2009. "New Frontiers in the Economics of Climate Change," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 43(3), pages 295-306, July.
  7. Narita, Daiju & Tol, Richard S. J. & Anthoff, David, 2009. "International Climate Policy and Regional Welfare Weights," Papers WP332, Economic and Social Research Institute (ESRI).
  8. Fabio Sferra & Massimo Tavoni, 2013. "Endogenous Participation in a Partial Climate Agreement with Open Entry: A Numerical Assessment," Working Papers 2013.60, Fondazione Eni Enrico Mattei.
  9. Tol, Richard S.J., 2013. "Targets for global climate policy: An overview," Journal of Economic Dynamics and Control, Elsevier, vol. 37(5), pages 911-928.
  10. Andy Reisinger, 2011. "Interdisciplinarity: are we there yet?," Climatic Change, Springer, vol. 108(1), pages 23-30, September.

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  1. Economic Logic blog

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