Discount rates, again

Arnold Kling discusses Dasgupta, Stern, and de Long.  Here is his bottom line:

My concern is with Stern, Dasgupta, or DeLong playing social engineer and picking a social discount rate that deviates from market interest rates.  I think you get unreliable conclusions any time you do that.

I’ll recap my views as follows:

1. For resources which will be reinvested, use the rate of return on capital, adjusting for taxes, risk, and the like.

2. For resources which will otherwise be consumed within the current generation, use the market rate of interest, again with adjustments.  That rate reflects time preference within a life.

3. If we are comparing different consumption units across the generations, there is no time preference in the economically meaningful sense.  (Prior to 1962, I was not impatiently waiting to have been born.)  Use zero, noting this is an ethical rather than economic choice.

Depending on the configuration of the variables, the correct "net" discount rate usually will be above zero but below the current market rate.

Note that the future consumption/investment ratio is not a current fact about the world, but rather a matter of choice.  That means the correct discount rate is also not a "current fact about the world," but rather will depend on other choices we make.  This is a common confusion.

Arnold also writes:

Even if the Stern report had nothing to do with global warming, its assumption for the social discount rate has radical policy implications. Implicitly, it argues for an all-out effort to reduce private-sector and public-sector consumption and to increase investment instead.

I am less worried.  Not all or even most current consumption reductions will much benefit the next generation.  (Does anyone know what percentage of a marginal increment of savings ends up in bequests?)  The prospect of current consumption is also a (the?) driving force behind innovation and technological improvement, which most definitely  benefits future generations.  We should invest more in the future, but the intergenerational zero rate view, correctly interpreted, does not require that we should limit consumption as much as possible.

Addendum: Here is commentary from The Economist.


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