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Discounting for Climate Change

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

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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  1. Hope, Chris, 2008. "Discount rates, equity weights and the social cost of carbon," Energy Economics, Elsevier, vol. 30(3), pages 1011-1019, May.
  2. 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).
  3. 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.
  4. 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.
  5. 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).
  6. 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, vol. 0(Special I), pages 235-250.
  7. 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.
  8. Tol, Richard S. J., 2001. "Equitable cost-benefit analysis of climate change policies," Ecological Economics, Elsevier, vol. 36(1), pages 71-85, January.
  9. Richard S.J. Tol, 2002. "Emission Abatement Versus Development As Strategies To Reduce Vulnerability To Climate Change: An Application Of Fund," Working Papers FNU-12, Research unit Sustainability and Global Change, Hamburg University, revised Apr 2002.
  10. Ralph Winkler, 2006. "Now or Never: Environmental Protection under Hyperbolic Discounting," CER-ETH Economics working paper series 06/60, CER-ETH - Center of Economic Research (CER-ETH) at ETH Zurich.
  11. Atkinson, Giles D. & Dietz, Simon & Helgeson, Jennifer & Hepburn, Cameron & Sælen, Håkon, 2009. "Siblings, not triplets: social preferences for risk, inequality and time in discounting climate change," Economics Discussion Papers 2009-14, Kiel Institute for the World Economy.
  12. 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.
  13. 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.
  14. 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.
  15. 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.
  16. Richard S.J. Tol & Kristie L. Ebi & Gary W. Yohe, 2006. "Infectious Disease, Development, And Climate Change: A Scenario Analysis," Working Papers FNU-109, Research unit Sustainability and Global Change, Hamburg University, revised Jun 2006.
  17. William D. Nordhaus, 2006. "The "Stern Review" on the Economics of Climate Change," NBER Working Papers 12741, National Bureau of Economic Research, Inc.
  18. 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.
  19. 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.
  20. 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, vol. 53(3), pages 371-384.
  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. 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.
  23. 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.
  24. 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.
  25. Nicholas Stern, 2008. "The Economics of Climate Change," American Economic Review, American Economic Association, vol. 98(2), pages 1-37, May.
  26. 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.
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