Comments on Chris Robinson's "Discounting Grandchildren and Spotted Owls"
Sherman Hanna, Professor, The Ohio State University

Robinson summarizes discounting as a positive and normative process, quickly dispensing with discounting for inflation, he focuses on discounting for time preference and risk. He provides an example of discounting of a future disaster that might take place 200 years in the future. The disaster would, if it occurred, cause damages equal to one trillion Canadian dollars. I will interpret this as U.S. dollars, since in the future a Canadian dollar might go the way of the ruble. First of all, with a 5% discount rate, the present value would be very low, and by the standard method, we would not invest more today than the expected present value of the costs. If we were not certain that the event would take place, the expected present value would be even lower, thus limiting the amount we would be willing to spend to prevent the possible disaster.

I agree that political structures around the world are not set up to deal with uncertain distant disasters - for instance, if a large asteroid hit the earth in 100 years, the results might be even more catastrophic. What's worse, it could happen next year. How much should we be willing to spend on a Star Wars program to save the earth?

 

The Expected Utility Approach
There is a method in economics for accounting for such possibilities, assuming that we give future generations some weight - expected utility models. Let us consider a two period model. Should I be willing to make a sacrifice today to protect against a small risk of a big loss? If I am risk neutral, the answer would be NO unless the expected value of the loss were smaller than the sacrifice today. However, if the risk included the possibility of zero or very low consumption in the second period, the answer could be YES, if my utility function were at least as risk averse as the natural log utility function. Consider the following example:

Assume that income in period 1 = Y and income in period 2 will either = 3*Y or zero.

Should you save any money out of your period 1 income if you face an interest rate=0?

For instance, assume that your income in period 1 is $10,000, and that there is a 99% chance that in period 2 your income will be $30,000, and a 1% chance that you would have an income of zero. If your lifetime utility = U(C1) + EU(C2) and U=Ln(C), then you should save $146 out of year 1 income, so that your consumption in period 2 would either equal $30,146 or $146. If, however, you had a relative risk aversion level of 6 and a constant relative risk aversion utility function, then you would save $3,170 out of your period 1 income, and your period 2 consumption would either equal $33,170 or $3,170. If you have extremely high risk aversion, you might save over 40% of your period 1 income to protect against the 1% chance that your period 2 income will equal zero.

Therefore, a standard economic approach is available to analyze the type of problem Robinson discusses. Of course, there is the question of whether we will value future generations. If we do, however, the expected utility approach can provide reasonable answers, if we frame the question appropriately, just as a normative life cycle model can help us consider how much to save for an uncertain old age. However, we should consider several variations on Robinson's examples:

a. Actions we should take to prevent truly irreversible changes that may lead to disaster.

b. Actions we might take to prevent possible disasters, but for which delay is possible, although possibly expensive.

I believe that Robinson poses the environmental issue in a way similar to Pascal's wager in Pensées

"If God does not exist, one will lose nothing by believing in him, while if he does exist, one will lose everything by not believing."

Just as Pascal’s argument is not a compelling argument for believing in God, I do not think that posing an extreme scenario provides a compelling argument for not discounting the future.  I did provide a simple example of providing for the future even with no discounting.  But consider an extension of my example.  A 25 year old is considering whether or not to start saving for retirement.  Discounting the future may be appropriate, to allow for the possibility that she may not be alive at age 90, etc.  The real rate of return on investments is important, as it will affect the optimal amount of savings at each age.  However, delay in starting to save is not fatal, and may even be rational, if she is confident that real earnings will increase.  For some environmental issues, we face a similar concept.  We will be richer in the future – I am confident of that, just as I am confident of the fact that humans are better off today on the average than they were 100 years ago and 200 years ago.

Who should make the sacrifice today to make people have a better environment 100 years from now – Us?   Our children?  Our grandchildren?  Our great-grandchildren?  This is a question that economics can help provide an answer for, as it depends on projections of real per capita growth, and technological progress.  If our children will be richer than we are, then their sacrifice will be relatively less than our sacrifice for a given investment.  If you asked whether the people of South Korea should have made a particular sacrifice in 1960 or 1970 or 1995, surely it is relevant that real per capita income increased almost tenfold between 1960 and 1995.

 

Is Growth an Illusion?
Robinson implies that real growth is an illusion and that sustainable growth is not possible. However, citing as evidence of this proposition a book by the Erlichs is not very convincing to me, partly because of Paul Erlich's well publicized loss to the late Julian Simon about the price of raw materials:

In 1980, the year after the tenth Earth Day, Ehrlich and two associates wagered with me about future prices of raw materials. We would assess the trend in $1000 worth of copper, chrome, nickel, tin, and tungsten for ten years. I would win if resources grew more abundant, and they would win if resources became scarcer. At settling time in 1990, the year after the twentieth Earth Week, they sent me a check for $576.07.

Simon also noted that:
In 1970 Paul Ehrlich wrote, "If I were a gambler, I would take even money that England will not exist in the year 2000."

In dismissing Ehrlich as a source, I do not mean to imply that we should not worry about future environmental problems. However, if you want to convince others, you should not only quote friendly sources, but quote opposing sources and deal directly with the opposing arguments. The writings of Julian Simon on the environment provide a good starting point. (See the links at the bottom of this paper.)

More documentation is needed for the assertion that real growth is an illusion. To convince me of that assertion, first you would have to convince me not only that official statistics on national income and other social indicators are flawed, but that some alternative system of accounting for human welfare is more reliable. I have not seen anything that would convince me that an alternative system is both valid and reliable. Therefore, I am left with the belief that in the past 200 years there has been a general trend toward improvements in the human condition, not only in terms of real per capita income, but in terms of human health, life expectancy, education, water quality, and air quality. The fact that gasoline is as cheap as it has ever been does not help the cause of pessimism.

Conclusions
Therefore, what is left to be done in improving discounting to help the environment? The answer is not to have a zero discount rate, but I agree that a low social discount rate is appropriate. Defining appropriate social utility functions would help deal with the problem of uncertainty and distant costs. I think that part of the issue of counting the "votes" of future generations is already underway. In the United States and I assume many other countries, the children of finance professors are being indoctrinated in the religion of the environment. Most people accept the concept of recycling, even if they may need selfish incentives to get them to take action. However, activists must go beyond "preaching to the choir" if they want to change the method of analyses of future risks - they must directly analyze the counter-arguments.
Appendix I: Do Only Capitalists Over-Discount the Environment?
Consider what was written 150 years ago:
The bourgeoisie, during its rule of scarce one hundred years, has created more massive and more colossal productive forces than have all preceding generations together. Subjection of nature's forces to man, machinery, application of chemistry to industry and agriculture, steam navigation, railways, electric telegraphs, clearing of whole continents for cultivation, canalization of rivers, whole populations conjured out of the ground -- what earlier century had even a presentiment that such productive forces slumbered in the lap of social labor?
Karl Marx and Frederick Engels, Manifesto of the Communist Party, 1848

It is not only capitalistic economists and finance professors who might not value nature highly enough -- obviously most who have followed Marxist thought in the past 150 years believed that capitalism was capable of tremendous economic growth, and just as obviously, some communist countries went further than free enterprise countries in degrading the environment.  Therefore, I would suggest that the villain is not necessarily the discounting method used in finance.

 

Appendix II: Related links

Sierra Club
http://www.sierraclub.org/global-warming/factsheets/basfact.html
 

Resources for the Future
http://www.rff.org/
 

Cato Institute
http://www.cato.org/pubs/regulation/reg15n2g.html

Brief overview by Julian Simon
http://www.intellectualcapital.com/issues/98/0212/icbusiness.asp

Simon's views on Human Progress
http://www.intellectualcapital.com/issues/97/1002/icbusiness.asp
 

Simon's views on conservation and inducing guilt about 'waste'
http://www.inform.umd.edu/EdRes/Colleges/BMGT/.Faculty/JSimon/Articles/EXTROPYA.txt

Simon: The amazing theory of raw-material scarcity:
http://www.inform.umd.edu/EdRes/Colleges/BMGT/.Faculty/JSimon/Ultimate_Resource/TCHAQ01A.txt
 

Simon's views on why resource forecasts are so often wrong:
http://www.inform.umd.edu/EdRes/Colleges/BMGT/.Faculty/JSimon/Ultimate_Resource/TCHAQ02A.txt
 

Simon's proposals on analyzing altruism, binding commitments, etc.
http://www.inform.umd.edu/EdRes/Colleges/BMGT/.Faculty/JSimon/Articles/INTERPER.txt
 

Simon's views on Earth Day after 20 years:
http://www.inform.umd.edu/EdRes/Colleges/BMGT/.Faculty/JSimon/Articles/EARTHDA5.txt
 

Manifesto of the Communist Party, 1848
http://www.anu.edu.au/polsci/marx/classics/manifesto.html