Global warming: discounting is not the issue, but substitutability is

Abstract

The cost-benefit study of Nordhaus (1994) is representative for the neoclassical approach towards global warming. Nordhaus found that no substantial emission cuts are warranted. Most of his critics have concentrated on the issue of discounting and demanded that a lower discount rate should be applied. These criticisms first miss the point and second lead to ethically dubious, inconsistent conclusions and inefficient policy choices.They miss the point because the real problem of Nordhaus's methodology is his implicit underlying assumption of perfect substitutability between natural and other forms of capital. Given the validity of this assumption, lowering the rate of discount is inconsistent with current savings behaviour, is ethically dubious because future generations will be much richer than the current one anyway, and is inefficient because scarce financial resources are channelled into emissions abatement that exhibits rates of return far inferior to alternative public investments. Any call for aggressive emission abatement must therefore directly attack the perfect substitutability assumption of neoclassical economics and show that man-made capital and natural capital are complementary. The real disagreement is about whether consumption growth can compensate for environmental degradation caused by global warming. Discounting is not the issue, but substitutability is. Unfortunately, proponents of aggressive emission abatement have so far failed to provide either convincing evidence or conEnergy Policy Substitutability, not discounting, is the issue.3 vincing a priori reasons that man-made capital and natural capital should indeed be regarded as complements rather than substitutes. AcknowledgementI thank James Putzel, Michael Jacobs, Christian Azar, Clive Spash and Lord Meghnad Desai and an anonymous referee for helpful comments.

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