As someone who tries to keep up with stories related to energy and climate change, I know how hard it is to keep your finger on the pulse. I used to do a weekly review here at TLW and it was actually very close to work (shudder).
Judith Curry at Climate Etc. has done a remarkable job following the various segments relevant to the climate debate. This week’s post on energy and policy is no exception. I want to explore one of the stories she linked to in a little more depth.
If you think that the climate change debate is all about temperatures and models, her link to a discussion of the social cost of carbon should wake you up to the fact that it’s all about the money. And I’m not talking about contributions from the Koch brothers or subsidizing solar power.
When companies pollute the water or air and they don’t have to pay for the damages that pollution causes, it’s called a negative externality. Now that CO2 is classed in the U.S. (wrongly, IMO) as a pollutant, there are efforts to quantify the damages and to create a metric known as the Social Cost of Carbon (SCC).
This is done by estimating the price in today’s dollars to repair the damage a unit of CO2 (or equivalent) will cause in the future.
I think it’s a legitimate exercise in theory, but I don’t place much stock in early efforts. One of the reasons why it’s difficult is that people on different sides of the climate debate cannot agree on what is called the ‘discount rate’.
One of the stories Judith Curry linked to shows just how contentious this can be. It has a point of view–heck, it’s titled ‘OMB Whitewash on the Social Cost of Carbon‘–but whatever your stance on the impacts of climate change, there is good information here.
That includes a good plain-language explanation of discounting:
“Present dollars are more important than future dollars. If you have to suffer damage worth (say) $10,000, you will be relieved to learn that it will hit you in 20 years, rather than tomorrow. This preference isn’t simply a psychological one of wanting to defer pain. No: Because market interest rates are positive, it is cheaperfor you to deal with a $10,000 damage that won’t hit for 20 years. That’s because you can set aside a smaller sum today and invest it (perhaps in safe bonds), so that the value of your side fund will grow to $10,000 in 20 years’ time.
In this framework, it is easy to see how crucial the interest rate is, on those safe bonds. If your side fund grows at 7% per year, then you need to set aside about $2,584 today in order to have $10,000 in 20 years. But if the interest rate is only 3%, then you need to put aside $5,537 today in order to have $10,000 to pay for the damage in 20 years.
An equivalent way of stating these facts is to say that the present-discounted value of the looming $10,000 in damages (which won’t hit for 20 years) is $2,584 using a 7% discount rate, but $5,537 using a 3% discount rate. The underlying assumption about the size and timing of the damage is the same—the only thing we changed is the discount rate used in our assessment of it.”
Faithful readers of this space will know that much of the criticism of Nicholas Stern’s massive report on the costs of climate change and efforts to combat it were centered on his choice of a very low discount rate, which greatly colored his conclusions.
It’s an important issue. CAGW alarmists and Konsensus Kooks prattle on about the end of the world, saying we are heading for an environment that looks like a Mad Max movie or worse. However, in actual fact even Stern only predicts economic losses of between 1% and 5% of global GDP as a result of climate change. (And to arrive at that figure he not only used a low discount rate, but also over-estimated population rise and the rise in CO2 concentrations.)
But it’s a confusing issue as well. Those who most want action on climate change are also the ones urging a small discount rate, which pushes up the cost of fighting climate change, often to the point where the struggle seems impossible. I imagine they feel that if the cost is too low nobody will take it seriously. And just perhaps they hope that the fight against climate change will get more funding if the cost is higher.
My point is that most of the time we are focused on small ball. Temperature adjustments, solar variation, foolish pronouncements by people who would be better off keeping silent–all of that can be reduced to trivia by a simple accountant’s decision.
More importantly, a lot of these decisions are being made now–and made perhaps in too much haste. We may indeed be headed for a long term future of low interest rates that justify the EPA’s choice of a low discount rate. We’ve already had a long period of almost zero interest rates and Japan’s example shows that such periods can last longer than anyone expects.
However, at some point inflation will return and interest rates will rise. This can confound estimates of the Social Cost of Carbon.