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Discounting for Climate Change

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  • Anthoff, David
  • Tol, Richard S. J.
  • Yohe, Gary W.

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 version 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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Paper provided by Kiel Institute for the World Economy in its series Economics Discussion Papers with number 2009-15.

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Date of creation: 2009
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Handle: RePEc:zbw:ifwedp:7539

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Keywords: Social cost of carbon; climate change; pure time preference; risk aversion; inequity aversion; income elasticity; time horizon; uncertainty;

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References

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  1. Daiju Narita & Richard Tol & David Anthoff, 2010. "Economic costs of extratropical storms under climate change: an application of FUND," Journal of Environmental Planning and Management, Taylor & Francis Journals, Taylor & Francis Journals, vol. 53(3), pages 371-384.
  2. Anthoff, David & Hepburn, Cameron & Tol, Richard S.J., 2009. "Equity weighting and the marginal damage costs of climate change," Ecological Economics, Elsevier, Elsevier, vol. 68(3), pages 836-849, January.
  3. 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.
  4. Winkler, Ralph, 2009. "Now or Never: Environmental Protection under Hyperbolic Discounting," Economics Discussion Papers 2009-4, Kiel Institute for the World Economy.
  5. 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.
  6. Hope, Chris, 2008. "Discount rates, equity weights and the social cost of carbon," Energy Economics, Elsevier, Elsevier, vol. 30(3), pages 1011-1019, May.
  7. 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, Economic and Social Research Institute (ESRI) WP259, Economic and Social Research Institute (ESRI).
  8. Richard S.J. Tol, 2006. "Multi-Gas Emission Reduction for Climate Change Policy: An Application of Fund," The Energy Journal, International Association for Energy Economics, International Association for Energy Economics, vol. 0(Special I), pages 235-250.
  9. John Creedy & Ross Guest, 2008. "Discounting and the Time Preference Rate," The Economic Record, The Economic Society of Australia, The Economic Society of Australia, vol. 84(264), pages 109-127, 03.
  10. Nicholas Stern, 2008. "The Economics of Climate Change," American Economic Review, American Economic Association, American Economic Association, vol. 98(2), pages 1-37, May.
  11. Sterner, Thomas & Persson, U. Martin, 2007. "An Even Sterner Review: Introducing Relative Prices into the Discounting Debate," Discussion Papers, Resources For the Future dp-07-37, Resources For the Future.
  12. Tol, Richard S. J., 2001. "Equitable cost-benefit analysis of climate change policies," Ecological Economics, Elsevier, Elsevier, vol. 36(1), pages 71-85, January.
  13. 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.
  14. 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.
  15. Azar, Christian & Sterner, Thomas, 1996. "Discounting and distributional considerations in the context of global warming," Ecological Economics, Elsevier, Elsevier, vol. 19(2), pages 169-184, November.
  16. Frances Ruane & Xiaoheng Zhang, 2007. "Location Choices of the Pharmaceutical Industry in Europe after 1992," The Institute for International Integration Studies Discussion Paper Series, IIIS iiisdp220, IIIS.
  17. Tol, Richard S. J., 2005. "The marginal damage costs of carbon dioxide emissions: an assessment of the uncertainties," Energy Policy, Elsevier, Elsevier, vol. 33(16), pages 2064-2074, November.
  18. P. Michael Link & Richard S.J. Tol, 2004. "Possible Economic Impacts of a Shutdown of the Thermohaline Circulation: an Application of FUND," Working Papers, Research unit Sustainability and Global Change, Hamburg University FNU-42, Research unit Sustainability and Global Change, Hamburg University, revised Apr 2004.
  19. Richard S.J. Tol, 2002. "Emission Abatement Versus Development As Strategies To Reduce Vulnerability To Climate Change: An Application Of Fund," Working Papers, Research unit Sustainability and Global Change, Hamburg University FNU-12, Research unit Sustainability and Global Change, Hamburg University, revised Apr 2002.
  20. 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.
  21. Seán Lyons & Karen Mayor & Richard S.J. Tol, 2008. "Environmental Accounts for the Republic of Ireland: 1990-2005," Papers, Economic and Social Research Institute (ESRI) WP223, Economic and Social Research Institute (ESRI).
  22. Tol, Richard S. J., 2002. "Welfare specifications and optimal control of climate change: an application of fund," Energy Economics, Elsevier, Elsevier, vol. 24(4), pages 367-376, July.
  23. 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, European Association of Environmental and Resource Economists, vol. 10(3), pages 249-266, October.
  24. 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.
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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
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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, National Center for Environmental Economics, U.S. Environmental Protection Agency 201007, National Center for Environmental Economics, U.S. Environmental Protection Agency, revised Aug 2010.
  2. Simon Dietz & David Maddison, 2009. "New Frontiers in the Economics of Climate Change," Environmental & Resource Economics, European Association of Environmental and Resource Economists, European Association of Environmental and Resource Economists, vol. 43(3), pages 295-306, July.
  3. 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," CEP Discussion Papers dp1178, Centre for Economic Performance, LSE.
  4. Narita, Daiju & Tol, Richard S. J. & Anthoff, David, 2009. "International Climate Policy and Regional Welfare Weights," Papers, Economic and Social Research Institute (ESRI) WP332, Economic and Social Research Institute (ESRI).
  5. Richard S.J. Tol, 2009. "International inequity aversion and the social cost of carbon," Working Papers, Research unit Sustainability and Global Change, Hamburg University FNU-178, Research unit Sustainability and Global Change, Hamburg University, revised Nov 2009.
  6. Richard S. J. Tol, 2010. "The Economic Impact of Climate Change," Perspektiven der Wirtschaftspolitik, Verein für Socialpolitik, Verein für Socialpolitik, vol. 11(s1), pages 13-37, 05.
  7. Richard S.J. Tol, 2012. "Targets for Global Climate Policy: An Overview," Working Paper Series 3712, Department of Economics, University of Sussex.
  8. Andy Reisinger, 2011. "Interdisciplinarity: are we there yet?," Climatic Change, Springer, Springer, vol. 108(1), pages 23-30, September.
  9. Fabio Sferra & Massimo Tavoni, 2013. "Endogenous Participation in a Partial Climate Agreement with Open Entry: A Numerical Assessment," Working Papers, Fondazione Eni Enrico Mattei 2013.60, Fondazione Eni Enrico Mattei.
  10. 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, Springer, vol. 14(8), pages 777-792, December.

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