Recently I received a check in the mail from the US Treasury. This was not a tax refund, nor money that they owed. They just sent it to me. On the bottom of the check it says, "2008 ECONOMIC STIMULUS PROGRAM."
The stimulus check, which went to millions of Americans, was obviously not sent out to fatten our grandchildren's college fund. The idea is give people free money to spend, now. Spend on what? Well, the answer is: spend it on anything. It doesn't really matter; it's "good for the economy."
With the recent economic crisis, consumer spending is down, which makes the situation worse. The problem here is that strong and growing consumer spending, while good for the "economy," is not making many Americans much happier. Meanwhile, mounting evidence shows that our mass consumption society is rapidly destroying the natural resources and living ecosystems of the Earth. In particular, we can't continue to consume at high and growing levels here in America, and the rest of the world can't catch up with our habits—as US population grows to 450 million by 2050, and world population grows to 9 billion—without burning vast amounts of energy, and at the same time using up mineral and biological resources at an ever-increasing rate.
Evidence is mounting that we are pushing up against some real limits to growth, notably the problems of depletion of energy resources, symbolized by "peak oil," and the potentially catastrophic effects of global warming.
An interesting aspect of the growth problem was highlighted recently in a review article in the New York Review of Books (NYRB). The review, published on June 12, 2008, was authored by Freeman Dyson, identified by the NYRB as "Professor of Physics Emeritus at the Institute for Advanced Study in Princeton." Dyson is a theoretical physicist and mathematician. He supports the basic thesis of human-caused global warming, but is skeptical of climate models and predictions, and has generally advocated for social and economic expenditures to help today's poor, as against a costly program to stop long-term global warming. In the review, Dyson considers William Nordhaus's book, A Question of Balance: Weighing the Options on Global Warming Policies. Nordhaus is professor of economics at Yale University, and co-author, with Paul Samualson, of a popular economics textbook. Nordhaus has focused a large part of his work on the economics of climate change, and is an influential analyst of climate change policy.
Weighing the Options is a cost-benefit study of various broad policies that might be adopted to combat global warming. Nordhaus accepts that warming is real, and will impose real costs upon our society. The questions he addresses are: how much will it cost, and what is it worth spending, in pure economic terms, to limit the potential damage? In particular, what is it worth spending today to remedy damages that may occur as much as 100 years into the future?
Norhaus describes in his book a complex model, run on a computer program that he developed, which allows him to project hypothetical gains and losses from various policy options that may be adopted to fight global warming. In the end, his model favors, fairly, only modest expenditures today and in the near future, in order to avoid what may be large losses a hundred or more years from now.
Why is this so? As Dyson says, "The most crucial question facing the policymaker is then how to compare present-day gains and losses with gains and losses a hundred years in the future."
In economic terms, what Nordhaus has done is to discount the long-term potential costs of global warming. His model relies on a fairly common business practice used to analyze a project, which is to estimate the hypothetical positive and negative cash flows out into the future for the life of the project. Future cash flows are discounted in accord with the theory that you can put your money into a bank, or say a Treasury bill, at some "safe" rate of return, which for present purposes we will say is 4% per year (this 4% is the figure that Nordhaus actually uses, for reasons that will be clear shortly). So, for example, if you were planning to invest $100 in a project today, you would want compare the projected return on that investment after one year to the $4 that you know you would make at the end of the year in your safe investment. Therefore, you would discount your projected year-end return by 4%; i.e., mathematically, you would divide it by 1.04. So, if your estimated return after the first year was $6, the discounted, or present value of that return would be 6/(1.04), or $5.79.
As the years go on, the discounts multiply. In year two, you divide by 1.04 times 1.04, or 1.082, in order to get the present value of a cash flow discounted by 4% per year. The future cash flows discounted may be positive—i.e. profits or benefits, or negative—i.e. losses or costs. After ten years at 4%, you divide by 1.48, after 25 years, by 2.66, and after 100 years, by 50. This latter figure, it turns out is just the very modest number 1.04 multiplied by itself 100 times. This means that a $50 return 100 years from now is only worth $1 today. In other words, it wouldn't pay for you to spend more than $1 today to get a $50 return in a hundred years. Likewise, a cost of $50 in 100 years is only worth spending $1 on today to avoid; to avoid a dollar cost in 100 years you would be justified in spending $.02 today.
Here's where Nordhaus comes back into the picture. His model makes some assumptions about how much benefit will accrue from various levels of expenditure on global warming avoidance today. These expenditures all include putting a "price" on CO2 emissions, and they are all expensive. However, that's not the part of the model that I want to focus on here. My interest is in the discount rate that Nordhaus chooses to evaluate future costs from global warming.
It turns out that for evaluating really long-term investments, like those involved in global warming, the choice of discount rate is all important. If we use a low rate, say 2%, we will conclude that it is worth spending $1 today to avoid $7.20 in 100 years; in other words, $.138 today to avoid $1. As discount rates get lower, the effect is to make it worth spending more and more today. At 1%, we would spend $.37 today to avoid a dollar loss in 100 years. The ultimate is a zero discount rate, which says future losses are worth as much today as they are in the future; in other words, with zero discount, there is no difference between now and the future: you would be justified in currently spending up to amount of the future loss, no matter how far into the future it occurs.
On the other hand, a high discount rate encourages us to place a lower value on future losses. A high discount rate says, in effect, "let the future take care of itself." This makes sense if we have confidence that we can get good returns on our investments, year after year, equal to the high discount rate, because that just means that when the losses occur, we will have the money to pay for them. At 10%, for example, the division factor for losses after 100 years is 13,780! This means that it is worth spending only $.0001 today to avoid a $1 loss in 100 years at this rate; this is equivalent to spending just $1 to avoid a $10,000 loss.
How does Nordhaus get his discount rate, which we have said is 4%? Let's quote Dyson:
Here [Nordhaus] is following the conventional wisdom of economists. Four percent is a conservative number, based on an average of past experiences in good and bad times. Nordhaus is basing his judgment on the assumption that the next hundred years will bring to the world economy a mixture of stagnation and prosperity, with overall average growth continuing at the same rate that we have experienced during the twentieth century. Future costs are discounted because the future world will be richer and better able to afford them.
To be clear about this, a four percent exponential growth rate is very significant, when looked at from the viewpoint of human history. It means a doubling of the size of the world economy every 17-1/2 years. So, by 2108, 100 years from now, we would have 5.71 doublings, or about 52 times our world economy's present size. Current worldwide Gross Domestic Product (GDP or total value of all goods and services produced) is now about $54 trillion Grow that by 4% a year for a hundred years and you get a world GDP in 2108 of $2,827 trillion. This is an enormous amount of growth. Consider that industrial output grew by about 35 times during the 20th century—starting from a much smaller base in 1900. Can we almost double that amount of growth in the 21st century?
Now, admittedly, there are different kinds of economic growth. In response to criticism about the negative effects of growth, much has been made of the possibility of growth without the kind of ecological damage we have seen in the past. This new kind of growth would use technology to provide the "goods" that people want in endless supply, without using up the materials and energy, and turning them into waste, at the present rate. So we might have widespread recycling, reuse, energy efficiency, the turn to solar or wind power, and so on.
The holy grail of growth without pain would require some kind of limitless energy source that would create no waste and no pollution, which could support a continuous recycling of materials. We are currently far from that dream. Growth today and for the foreseeable future means more stuff, more carbon burned, more pollution, and the continuous conversion of resources into waste, all on a massive and increasing scale.
This brings me back to the problem I have with the economic stimulus program. Clearly, kind of growth we are trying to stimulate means the production of more of the same stuff we are consuming today. Under current and reasonably foreseeable conditions, we need this production to keep our economy growing. We assume that everything depends upon it, from eliminating poverty, to fighting disease, to having a good life for all. And we need this growth worldwide. A four percent growth rate—"the same rate that we have experience during the twentieth century"—seems our birthright.
The problem, however, is that the Earth is no way big enough to accommodate this kind of growth for much longer. Already we are over full: of people, of things, of waste. How can we grow the world economy by 52 times in the next 100 years?
The only way is some combination of policies that produce clean energy, eliminate waste, control population, and preserve the natural world. This implies that the rate of growth in its present form cannot increase indefinitely.
It may be possible for our descendants a hundred years from now to be much richer than we are, but they will have to be richer in a different way. We will have to "decarbonize" our economy, and in some way "dematerialize" it , too. We will have to turn to conservation and increased efficiency, rather than the production of more stuff, to make us better off.
The likelihood of slower growth then implies that we should adopt a much lower discount rate, and as a consequence that we should act soon to avoid future losses. As the costs of climate change, waste, and ecological destruction mount, it is likely that growth will slow anyway, and we will be less and not more able to pay for the harm.
Furthermore, it appears that much of the damage that may be caused by our destruction of the Earth's support systems will be irreversible. Species extinction is a clear example. All the money in the world won't bring lost species back in a hundred years. Global warming itself has an enormous momentum that will be difficult if not impossible to turn around if we don't act very soon. In the past, economists have tended to look at environmental problems as analogous to "messes" that we can choose to clean up a later date.
Current problems, with their irreversible threshold effects and massive scale, cannot be fixed in this way. We can no longer treat the destruction of the Earth's biological and physical support systems as a problem to be put off, to be solved by someone else, at a distant time, in another place. We have to act now.
