Saving the World but Saving Too Much? Time Preference and Productivity in Climate Policy Modelling

Discounting the distant future has periodically been a controversial topic in welfareeconomics but the evaluation of climate change policy and particularly the SternReview have given the debate a new relevance. The parameters in a standard socialwelfare function that determine the path for the discount rate are also important indetermining the time path of saving, and several prominent economists have criticisedthe values used in the Review specifically because they imply excessively high optimalsaving rates, from either a positive or normative perspective. The fact that near-zerorates of pure time preference do not necessarily lead to absurdly high saving rates hasbeen known for some time. However, in the context of climate change policy, this pointhas been made using inappropriate models or specific numerical examples with a ratherarbitrary value for the rate of growth of total factor productivity (TFP). Given theattention that the ‘unreasonable saving rates’ debate has received in the climate changeliterature, there is a role for a rigorous presentation of the determinants of saving rates inmodels used to evaluate climate change policy, using values for TFP growth informedby recent historical experience. I show that both in theory and practice, optimal savingrates in the presence of near-zero pure time preference are far from the near-100 percent ones obtained from simpler models. In the widely used Dynamic Integrated modelof Climate and the Economy (DICE) model, optimal rates are close to 30 per cent for arange of values of the elasticity of marginal utility of consumption, and for Stern’srevised central value for that parameter they do not exceed 31 per cent. While the roleof TFP growth in lowering optimal saving rates in the presence of near-zero rates ofpure time preference may have been overplayed in some previous work, TFP growth isa key determinant of output and hence emissions and climate damage, so working withrealistic values of TFP growth remains crucial.