Sunday, April 12, 2009

Discounting dilemma for enviros - Reilly and Stern can't both be right (I think)

Climate Progress quotes the Republican congressional claims that cap-and-trade legislation will cost $3100 per household in increased energy costs. They came up with this figure by taking MIT Professor John Reilly's estimate of total costs of the legislation up to 2050 and then dividing the figure by total households. Reilly has issued a letter protesting how completely wrong this is and a misrepresentation of the study. Among several mistakes, the Republicans used a 0% discount rate, saying we have no preference between incurring a cost now and incurring the same cost in 40 years. Reilly, by contrast, uses a 4% discount rate typical for the value that the stock market exceeds inflation.

The Stern Review famously concluded that costs from unchecked climate change between now and 2100 will be very large. Part of the reason is that Stern assumes a low discount rate, about that of government bonds (which I believe is around 1%). To confuse matters, or maybe just confusing me, Stern assumes a near-zero "social discount rate" which I think is different from the monetary discount rate, but regardless, Stern uses rates of 1% or less.

The dilemma for those of us supporting action on climate change is that Reilly and Stern can't both be right. It might not be a problem for Republican leaders to talk out of both sides of their mouths, but the reality-based community can't accept one set of discount rate assumptions for assessing costs of climate change and another for assessing costs of actions to address change.

So it's fine for Climate Progress to quote without dissent Reilly's estimate of cap-and-trade costs of $340 per household, but it's contradictory to also say Stern's discount rate wasn't flawed. I'm sure that the bloggers there just overlooked the contradiction and that many other enviros made similar mistakes. It's also possible for both Reilly and Stern to be right on their overall conclusions, based on many factors beyond discounting. But Reilly and Stern can't both be right on their cost figures and discounting assumptions.

FWIW, which isn't much, I'm leaning towards Stern on discount rates for John Quiggin's general reasons. I also suspect the assumptions on the historical rate of return for stocks will have to be reduced after recent years, even long after this recession fades from memory.

So yes, climate change is going to be very bad. I also suspect doing something about it won't be cheap. Better then to get started soon on a big and expensive project.

UPDATE: Just noticed the first Climate Progress post is a guest post and not by Joe Romm, so I've changed the wording throughout. Joe and his guest blogger are contradicting each other.

No comments:

Post a Comment

Note: Only a member of this blog may post a comment.