Sunday, 6 May 2012

Invertebrates and discount rates

Grandpa, when you were young, did you see the Houses of Parliament?

Of course. I walked past them all the time.

There’s a school trip there next week. We’re going to sail the boat over the top of Big Ben. That was where all the decisions were made before the Emergency Committee ran things, wasn’t it?

That’s right.

Grandpa... why didn’t people then do anything about global warming? Didn’t they realise what was going to happen? Did they get the science all wrong?

No, lots of people realised and we had a pretty good idea about the science. We knew just what we were doing. In fact, we worked it all out using advanced economics. We calculated exactly how much effort we should make to move to a low-carbon economy.

So why did London get submerged, and we have to build dykes in play hour? You must have made some big mistakes in your sums!

No, we got our sums right. You see, we used a formula where your happiness now was as valuable as half of our happiness back then. So, for example, one person getting Ebolaic Footrot then was as bad as two people getting Footrot now.*

You counted us as half as valuable as you?

That’s right. Don’t upset the worm bucket or we won’t have any dinner. It’s perfectly simple. We used a time discount rate of 1.5 per cent per year. So over 50 years, a unit of your future welfare worked out to about 0.985 to the power of 50 = about 0.46. A 50% discount.

But why shouldn’t I count just the same as you?

Well some people suggested that we use a 0% discount so that the future would count just as much as the past. But other people said* that because people didn’t care much about the future, it would be wrong for politicians to care about the future either. 

So how did you come up with a 1.5% discount rate?

We worked that out from the capital market.

The capital market?????!!!!!

Yes. To calculate the discount rate people used, we looked at capital market returns, because that’s where people’s rational behaviour reveals their true long-term preferences.

Wow. And when did you work all this out?

About at the time of the Great Financial Crisis.


Well, let’s get back to Mother for dinner.

Grandpa, one day can we use the worms to catch fish?

Nonsense! Worm soup is good for you.**

* Ungated version here.