Climate change, uncertainty and discounting the future

Economics cannot solve the problem of climate change. But it can explain why electorates are so reluctant to do anything about it.

The devastating storms in America have kept the issue of climate change firmly in the public mind. 

But so far, it has proved very difficult for politicians to persuade electorates to change consumption patterns in ways which many scientists would like to see.  More expensive air travel, steeper energy bills, these are not very popular.

People are being asked to accept lower increases, or even reductions, in their living standards now, in exchange for escaping potentially large costs in the future. 

The problem is easy to state.  But it raises some difficult issues in economic theory.

An obvious one is how to analyse uncertainty.    Suppose, for example, you are offered odds of four to one on a horse in a particular race.  You can then judge whether you think the true probability of it winning is more or less than the odds suggest.

But the uncertainty around the whole climate change issue is much trickier to deal with.  It is as if you are offered these odds on a horse, but you do not know which other horses it will be running against.

A simple illustration is given by Geoff Heal of Columbia University in a paper in the latest Journal of Economic Literature. We face both scientific and socioeconomic uncertainty. Uncertainty about the underlying science of climate change and uncertainty about the economic and social impacts of an altered climate.

Heal points out that scientists working on climate change take it almost for granted that a rise in global temperature of 2 to 3 degrees would inflict massive costs on our societies.  However, he goes on to say that “nothing in the emerging econometric studies of the impact of climate on economic activity confirms these dramatic concerns”.  So even the different groups of experts disagree.

A second challenge is that people value benefits received and costs incurred in the present and the immediate future, more than they do the same amounts in the more distant future.

The Bank of England is rock solid and has never defaulted.  So when it issues debt, you can be as certain as possible that you will get your money back.  But the Bank still has to offer you interest, more money in the future, to persuade you to buy it now. 

A key question is then: how do people discount the future?  What rate of interest do they use when they think about it?

Behavioural economics has provided a large amount of evidence on this question.  It is not at all good news for climate change activists.  In the jargon, people often use “hyperbolic discounting”.  Translated, this simply means they place far more weight on small rewards or costs which occur now than on much larger ones in the more distant future. 

A non-obvious implication of this is that they make choices today that their future self would prefer not to have made, despite knowing the same information.

Economics cannot solve the problem of climate change.  But it can explain why electorates are so reluctant to do anything about it.