Discounting Discounting

Lots of energy is consumed in the nerdier end of the global warming debate arguing about discount rates. I think this is mostly a waste of time.

Now, comparing current vs. projected costs and benefits is critical, but the effort put into defining discounting functions by academic economists strikes me as formalism run amok, whether it is about discount rates (a la Stern) or, in a more sophisticated fashion, functional forms (a la Weitzman).

Human intuition is very poor at considering either rates or functional forms in the abstract, especially for decisions with effects that play out over centuries. If you ask me whether a given discount rate or functional form makes sense, I will immediately start to consider the decisions that it would imply under a wide variety of test cases. The rate or function that under a wide variety of relevant cases advocates the trade-offs between costs and benefits over time that strike me as correct (or fair or ethical or whatever) is the one I will support. The famous “wrinkle experiment” I have referenced in a prior post is a classic example of this in the case of global warming.

More to the point, when it comes time to consider whether I support a specific policy, I would want to see the data on projected costs and benefits by time period in order to come to a decision, rather than rely on the single-number estimate of net benefits created by any utility function. The primary practical use for these discounting / utility functions in global warming analysis is to have a function that allows integrated environment-economics models to search a wide space of possible policies automatically with a commonly-applied set of explicit assumptions without requiring human intervention to consider each model run. When it comes time to look at the policies that the model says are best, I would always want to see the actual data by time period for a variety of “good” scenarios to determine what policy I think makes sense.

Think of these models as being like a Google search. With infinite time and patience, I could review every document on the Web, but I have only finite time. The Google PageRank algorithm imperfectly, but usefully, narrows down the number of documents I need to review; usually, however, I don’t use the “I Feel Lucky” button, and certainly would not in a case where my life depended on it.

Why, in fact, should I believe that there is any discounting function relevant to global warming that exists in closed form? I have a set of preferences for comparing current to future scenarios of projected costs vs. benefits. Much of the knowledge that informs this set of preferences is tacit and/or contingent on elements of the scenarios that I didn’t list comprehensively in advance, but react to as I am presented with specific scenarios. This is of particular practical importance in a case like global warming which operates across a scope – centuries of time across the globe – in which many of the embedded assumptions that I use when making discounting assumptions in day-to-day life will likely be violated. If an economist can’t find a function that encompasses these, I’m not necessarily irrational; the economist just can’t model my beliefs in a way that he finds convenient. The discounting function is merely a heuristic, not some straightjacket that I have agreed to be bound by just because I haven’t disputed its assumptions.