RQ | Environmentalism and the Discount Rate

Alex Epstein, in his new book “The Moral Case for Fossil Fuels” has a fantastic quote (HT: Bryan Caplan). Epstein writes:

It is only thanks to cheap, plentiful, reliable energy that we live in an environment where the water we drink and the food we eat will not make us sick and where we can cope with the often hostile climate of Mother Nature. Energy is what we need to build sturdy homes, to purify water, to produce huge amounts of fresh food, to generate heat and air-conditioning, to irrigate deserts, to dry malaria-infested swamps, to build hospitals, and to manufacture pharmaceuticals, among many other things. And those of us who enjoy exploring the rest of nature should never forget that energy is what enables us to explore to our heart’s content, which preindustrial people didn’t have the time, wealth, energy, or technology to do.

Or, as Caplan puts it in his annotation,

Epstein’s second key claim is normative: Human well-being is the one fundamentally morally valuable thing.  Unspoiled nature is only great insofar as mankind enjoys it:

This allows us to characterise environmentalism and other conservationist movements through one simple factor – the Discount Rate. Let me explain.

Essentially, let us assume that we are optimising for aggregate human well-being. So we are optimising for the aggregate of the well-being of all humans today, all humans tomorrow, 10 years from now, 100 years from now and so forth. Now, if we try to optimise for short term well-being beyond a point (extracting too much oil, for example, or burning too much fossil fuel or cutting down too many trees), the well-being of future generations gets affected in a negative manner. If we are more conservative (and conservationist) now, future generations will get to enjoy greater well-being.

So, looking at the problem from the assumption that we want to “maximise aggregate human well-being”, the problem boils down to one “simple” tradeoff between well-being of human beings today and well-being of human beings at a later point in time. And it is precisely for answering questions on such inter-temporal tradeoffs that the world of economics and finance introduced the concept of a “discount rate”!

Finance assumes that rational human beings like to consume today compared to tomorrow, but only up to a point – you don’t want to consume so much today that there is nothing left to consume tomorrow. This leads us to indifference curves between today’s and tomorrow’s consumption, and if we add to this the resource constraint, we get the “discount rate” (the actual derivation is beyond the scope of this blog post).

The discount rate essentially gives us a tool to compare consumption today to consumption at a point of time in the future and make a decision on which one is more valuable. The higher the discount rate, the greater importance we give today’s consumption vis-a-vis tomorrow’s. A lower discount rate gives greater weight to tomorrow’s consumption compared to today’s.

So coming back to conservationism, the question finally boils down to “what is our discount rate”, or to track back one step “how do we value today’s well-being vis-a-vis well being at a point of time in the future”. If you assume a high discount rate, that means you give more importance to today’s well-being. A discount rate of zero gives equal importance of well-being today compared to well-being a few generations down the line. The discount rate in this case can even be negative – where you give greater importance to the well-being of humans of a future generation than to current well-being!

So the debate on fossil fuel consumption and carbon emissions and suchlike can be characterised by this one factor – what is our discount rate? And it is a disagreement on this that leads to most debates on this topic. Conservationists usually have a very low (or even negative discount rate), and they tend to play up the risks to well-being of future generation humans. The opposite side works with a much higher discount rate and argues that we should not ignore the well-being of current generations vis-a-vis the future. And the battle rages on.