At what cost? Calculate the impact of climate change

Droughts. Flooding. Storms. These are just some of the impacts of climate change, with experts at the United Nations warning that the social and economic consequences are already affecting the lives of billions of people. Yet if the immediate impacts of rising temperatures are clear enough from California forest fires to melting Arctic ice caps, the long-term reverberations are far harder to gauge – and getting it wrong risks undermining schemes that could secure the prosperity of our children. 

Central to this controversy is a formula called the social discount rate (SDR). Useful for understanding the ultimate value of an investment, rather like a traditional risk analysis but encompassing longer timespans and bigger costs, governments use the SDR when deciding to build ports, hospitals, railways and more.

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Investments designed to fight climate change, everywhere from wind turbines to air carbon capture, rely on the SDR too. But with finance ministries unsure of the right figure to use across projects, or if multiple figures are even needed, the SDR remains one of the most divisive questions in economics. Once you factor in the potential social and financial costs of doing too little – by 2100, climate change could render global GDP 37% lower than it would otherwise have been – and the SDR becomes one of the most consequential too. No wonder Christian Gollier, Frederick van der Ploeg, and Jiakun Zheng, a trio of economists, recently developed a new survey to understand their field’s attitudes to the SDR, with their findings posing significant questions for academics and policymakers alike.

Discounting the climate

Cost-benefit analyses are a staple across economics. The SDR represents something similar: an attempt to calculate the social benefits of a project far into the future, with the results translated into today’s currency. A low discount rate (like 2%) assumes that the benefits of a project will dissipate slowly over time, making it valuable for longer. A higher discount rate (like 7%) assumes the opposite. Implicit here is the importance of tweaking the SDR to individual projects. Given the impact of climate change, for instance, a nuclear plant should surely enjoy a lower rate than a coal mine. But between institutional inertia and decentralisation, bureaucrats have typically used a single SDR across government. Even partial exceptions tend in this direction.

The consequences of inflexibility are stark. Relying on too high an SDR needlessly inflates risk, meaning vital projects may never be approved. The reverse, for its part, is also true. Too low an SDR could waste resources on projects that finally prove fruitless. Fundamentally, that’s down to the deep uncertainty around the whole topic. For if some experts are basically pessimistic about global warming, others are far less convinced.