Intergenerational Equity, Social Discount Rates and Global Warming

Abstract This article is about the logic underlying social discount rates. We argue thatthese rates are not ethical raw material, but are derived from the more fundamentalnotion of justice among generations. A number of approaches to the concept ofintergenerational justice are discussed, and it is argued that the most compellingformulation available to us is the one long been in use among economists, namely, theRamsey-Koopmans theory. This theory advocates that investment projects having long-run effects should be subjected to the same conceptual treatment as those that affectonly the near future. We show that social discount rates depend on the numeraire, andthat methods of estimating them depend on the institutional setting within which socialcost benefit analysis is assumed to be undertaken. We also show that it is incorrect toadvocate project-specific discount rates as a way of conserving environmentalresources.Social discount rates have universally been taken to be positive, on grounds thatthe rate of return on investment is positive. But if consumption and productionactivities give rise to environmental pollution as a by-product, the social rate of returnon investment could be zero even when the private rate is positive; at the very least, thesocial rate would be lower than the private rate. The current practice among most globalenergy modellers of relying exclusively on (risk-free) market rates of return forestimating optimal carbon taxes is conceptually faulty. In the context of a formal modelof environmental pollution we show how, even along an optimal programme, socialrates of discount can be zero. We also demonstrate that in certain institutional settings,social discount rates can be negative.