I am unashamedly quoting from the comments made by Nicholas (Lord) Stern noted in the Guardian this morning. As they record:
Many economic assessments of the climate crisis “grossly undervalue the lives of young people and future generations”, Prof Nicholas Stern warned on Tuesday, before the Cop26 climate summit in Glasgow.
Vitally, what he then notes is that:
Economists have failed to take account of the “immense risks and potential loss of life” that could occur as a result of the climate crisis, he said, as well as badly underestimating the speed at which the costs of clean technologies, such as solar and wind energy, have fallen.
This, though, is the key comment that I want to draw attention to:
Stern said the economics profession had also misunderstood the basics of “discounting”, the way in which economic models value future assets and lives compared with their value today. “It means economists have grossly undervalued the lives of young people and future generations who are most at threat from the devastating impacts of climate change,” he said. “Discounting has been applied in such a way that it is effectively discrimination by date of birth.”
I am delighted to see Lord Stern say this. As I argued in February this year:
There is an obvious relationship between past experience, which inevitably taints us, whether for good or not If the recent past is what determines much of our trajectory, at least as far as thinking goes, then the future does not seem very inviting right now. The prospect of a world more extreme, intolerant, and even uninhabitable, is not one that people want to embrace. It is all too easy to recoil from it. But that only plays into the hands of the extremist who wants to occupy the space we might want to vacate.
There are other reasons why we do not consider the future. For example, for the last few decades economists have pretended it does not exist. They use a method called discounting to evaluate all future consequences of current behaviour with aim of ascribing to that future a value in the present. They do this by literally ‘discounting' the financial consequences of those decisions to the present using a risk weighted interest rate. It is claimed that this produces objective current decision making. Supposedly rational organisations use this approach, accepting its implicit assumptions.
One of those is that we can actually predict what is going to happen. That's just wrong, of course. But that has never stopped an economist making an assumption.
The other is that we are actually indifferent as to when things might happen. This is much more troubling. What the theory of discounting implies is that I am indifferent between a relatively modestly good thing happening in a year's time compared to a monumental event in ten or more years time, presuming the assumed discount rate can literally equate the two to a similar value now. And that is just not true either.
As a matter of fact there are good things that I definitely want to happen in the future that are decidedly time critical, for my family for example. And some of them I would definitely not wish for now.
The indifference within discounting is wrong for these reasons. But what I said next was, I think more important:
But there are also events that I know that are not possible now that might be in the future and which I know I wish to be achieved by certain points in time. Take carbon neutrality, for example. I know it is not possible now. I put enormous stores on the fact that it may be possible in the future. I am not going to take comfort now from some mathematical model that tells me that I can be happy at this moment that carbon neutrality might be possible in the future, and may increase my wellbeing if it is. I want to know that there is a concrete plan of action to achieve that goal, and the two are not the same thing, at all.
It's worse than that, in fact. The mathematical model can provide a perverse incentive to delay, by diminishing future cost and so enhancing current supposed well-being by simply pushing back the time when a required action takes place, when in practice we know that taking action now really is a matter of the highest priority if the goal is to be achieved.
The Covid crisis has demonstrated the negative consequences of deferring action in the moment. Our government has been a master of doing so.
And this is also true of climate change. There discounting cannot work. It encourages deferred action when what is required is current activity if this crisis is to be beaten.
This thinking is informing my work:
The means to address this false logic of discounted decision making are the focus within the Time Mirror academic project, funded by the Danish government, in which I am taking part over the next four years. Explicitly exploring the idea of sustainable cost accounting, which I have created, as a means for addressing this issue the project will look at why discounting would hinder effective accounting decision making on climate change, not least within the private sector economy where a massive behavioural transformation is very clearly required.
It also influences my work on accounting:
Sustainable cost accounting demands that companies put the costs of achieving net carbon zero on their balance sheets upfront. It challenges the logic of not disclosing the potential costs upfront and in full, and accounting for them on a deferred, drip feed, basis instead. It says that in this case the future must be addressed now by provisioning on company balance sheets the full expense thought likely to be incurred and that the plan for action must be explicit in the present, even if it can only occur in the future, at which point outcomes against stated expectations must be compared and consequences be accounted for.
This is radical accounting. I am pleased that the opportunity to explore it in more depth is being provided. But the lesson is not just for accounting, or climate change. The logic says that you cannot discount the future in the present. It says instead that we must embrace the future, and the actions that we might wish for as activities that are as relevant to the moment as they might be at the time that they occur.
My conclusion was:
Embracing the future has massive current consequences. It is what we need to do, but we are so poor at thinking about the future as a result of the training in indifference that we have been given that we, and most especially our politicians, rarely take into account foreseeable events that might happen in only a few months time, and literally discount them instead. And that is both shocking, and as we now know, deeply costly.
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No wonder we have problems with social mobility and progressive policy when you have a world view skewed to things essentially staying as they are!
As you say – it plays straight in to the hands of vested interests whose only idea is the grab that future now.
What was it that Orwell says in 1984:
“Those who control the present, control the past and those who control the past control the future”.
Our orthodox economist friends really know how to mess things up don’t they?
Yes, in a word
I think this paragraph says all we need to know about your (lack of) understanding and knowledge of discounting:
“There are other reasons why we do not consider the future. For example, for the last few decades economists have pretended it does not exist. They use a method called discounting to evaluate all future consequences of current behaviour with aim of ascribing to that future a value in the present. They do this by literally ‘discounting’ the financial consequences of those decisions to the present using a risk weighted interest rate. It is claimed that this produces objective current decision making. Supposedly rational organisations use this approach, accepting its implicit assumptions.”
Economists don’t pretend the future doesn’t exist. What they do understand is you can’t accurately predict it.
Discounting has nothing to do with behaviour or future consequences. It is simply a purely mathematical way of comparing future prices with prices today, using current interest rates.
So the decisions you talk about are completely separate to discounting. I also don’t know where this risk weighted business comes from – that isn’t even a real thing so I am guessing you have made it up to try and sound clever.
There are literally zero assumptions made when you discount. You take a future cash flow, use current market interest rates and that discounts back to what that cash flows equivalent is in today’s money. That is all.
It does not mean that the value of that future cash flow cannot change but that is nothing to do with discounting, and it does not mean interest rates cannot change.
It would really help your case if you knew what basic concepts in economics and finance were before you start pontificating about how they are wrong. It just make you look like an idiot.
It takes some extraordinary stupidity (I use the word fairly) to say this:
“There are literally zero assumptions made when you discount. You take a future cash flow, use current market interest rates and that discounts back to what that cash flows equivalent is in today’s money. That is all.”
What you are saying is that there are certain future cash flows when. it comes to climate change and the costs and benefits that we will encounter. Very obviously that is not true. We do not know what those cash flows will be. We guess them. So all discounting is completely subjective. But, by pretending we can compare spending over time as of there is an indifference between the two it creates a wholly false danger that the two might be substitutes when they are not.
There are two idiots here. You, and the teachers who taught you the drivel that you are spouting. Don’t call again.
Sorry but you are once again quite wrong here, because you are mixing up two completely separate things.
“We do not know what those cash flows will be. We guess them. So all discounting is completely subjective.”
The future cash flows are calculated by some means other than discounting. They may or may not be subject to assumptions and subjectivity.
Once you have those cash flows though, discounting them requires no assumptions at all. It only requires an interest rate curve – which is known from market prices.
So your statement above is false. Which points to the fact you don’t understand discounting.
So you can complain that the cash flows are going to be not fully known, but you cannot complain that discounting is the cause of this.
I might also add, that your SCA suffers from exactly the same problem. You have no idea what the cost of making a company net zero is, so are going to make assumptions. Not to mention those costs would have to be discounted on the balance sheet under GAAP or IFRS. At which point SCA is rendered pointless – not that it seems anyone has taken this idea up anyway.
“There are two idiots here. You, and the teachers who taught you the drivel that you are spouting.”
As opposed to the idiot who doesn’t understand what discounting is. I guess this is why you are not taken seriously.
Only an idiot would think you can separate the discounting from the assumed cash flows
Sorry – but I told you that you’re stupid and you really are
Thankfully I had the insight to see through the crap you have absorbed and now vomit here
For decades if not centuries environmental factors have been regarded as “externalities” and don’t affect the working of the supply and demand curves and the marginal utilities and all the other nonsense that they have been obsessed with mainstream economics. Now climate change is upon us this traditional thinking leaves them clueless about how to think ahead to deal with the catastrophe that awaits us unless drastic changes are taken now. Lord Stern is to be congratulated for bringing some sense to this and hopefully, now David Attenborough says that unless proper climate action as a result of COP26 then we are doomed unless world leaders will put in place the drastic policies needed and not heed the expense as any future expense will either be so huge as to be impossible or we will be all dead before our time. Young people know this and will rise up we hope to insist that action is taken now.
It seems to me that if I am asking you for business advice, discounting is a perfectly sensible way of looking at the future.
If however you are looking at the future of the planet it isn’t.
Everyone in business knows that discounting is the way to provide any answer the questioner wants….
Hi Richard
These links have some interesting/sobering observations on the energy costs of fossil fuel extraction.
Well worth a read.
https://dothemath.ucsd.edu/2011/10/the-energy-trap/
https://surplusenergyeconomics.wordpress.com/