Intertemporal equity, discounting, and economic efficiency

Abstract

The selection of a discount rate is the primary determinant in evaluating the net present value of climate change mitigation policies, given the significant temporal lag between initial costs and future benefits. Two distinct methodologies guide this determination: the prescriptive and descriptive approaches. The prescriptive approach is rooted in normative ethics and intergenerational equity, often assuming a low or zero rate of pure time preference. This perspective typically results in relatively low discount rates, emphasizing a moral obligation to protect future generations and favoring immediate investment in greenhouse gas abatement. In contrast, the descriptive approach relies on the observed opportunity cost of capital and market interest rates, reflecting actual societal trade-offs and investment returns. This positive perspective generally yields higher discount rates, suggesting that mitigation is only efficient if its returns exceed those of alternative investments in physical or human capital. While the mathematical framework for discounting—incorporating time preference, consumption growth, and the elasticity of marginal utility—is widely accepted, the choice between ethical prescriptions and market-based descriptions fundamentally alters policy recommendations. Reconciling these approaches involves addressing market distortions, the feasibility of intergenerational transfers, and the long-term valuation of environmental goods. – AI-generated abstract.