Wrong about "Copenhagen Consensus"
page 2
 
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The importance of the discount rate
    Those issues that were treated at the conference were issues involving widely different time scales. The costs of the AIDS epidemic may be met now, whereas most of the costs of climate change need only be met in 100 years´ time or more.
    There is no unequivocal method to evaluate what is more important, a cost now or another cost in a far future. Nevertheless, economists try to do this, by using a tool called discounting. Let us take the estimate (made with the RICE model by Nordhaus & Boyer) that the total costs of climate change up to 2100 would correspond to a one-off expenditure of 650 trillion dollars (in present-day prices). We could in principle invest a sum of money in a "climate fund". If the amount invested grows at 5 % compound interest, then it would suffice today to reserve 5 trillion dollars, because with this rate of interest, this amount will have grown to 650 trillion dollars in 2100. Economists therefore discuss  the "present value" of the costs of climate change to be defrayed in 100 years from now, and with a 5 % discount rate this present value is 5 trillion dollars.
    Thus, if different future costs are all discounted to obtain a "present value", then they may be directly compared, even though the costs will arise at different times in the future. And this is the kind of comparisons that were made in the Copenhagen Consensus conference.
    However, the relative importance of different expenditures defrayed at different points in time depend very much on the discount rate used in the calculations.
    This is illustrated by the following example. The exact figures are not important: they are just made up to illustrate the general point. Let us imagine that the AIDS epidemic, if not combated, will necessitate the spending of 10 billion dollars in 10 years´ time, and that climate change, if not combated, will necessitate the spending of 100 billion dollars in 100 years´ time.
     To compare the costs, we discount the 10 billion dollars with a rate of 5 % over 10 years. This gives a sum of 6.1 billion dollars to be invested today in the AIDS fund, because this will grow to 10 billion dollars in 10 years. And the sum to be invested as a climate fund today will have to be 0.74 billion dollars, because this will grow to 100 billion dollars in 100 years. The conclusion is that the AIDS epidemic will be the more costly to us, and therefore it will be wiser to fight AIDS, rather than to fight climate change. This can be illustrated as follows:

5 % discount rate
Amount now
In 10 years
In 100 years
Priority
AIDS fund
$6.1 billion
$10 billion

Higher
Climate fund
$0.74 billion

$100 billion


    Next, we do the same comparison with a 1 % discount rate. This time we find that we have to place 9 billion dollars in the AIDS fund, and 37 billion dollars in the climate fund. So climate change has now become the largest expenditure, and consequently, we will choose to fight climate change rather than AIDS.

1 % discount rate
Amount now
In 10 years
In 100 years
Priority
AIDS fund
$9 billion
$10 billion


Climate fund
$37 billion

$100 billion
Higher


    So when we lower the discount rate, two things will happen. First, future costs appear larger. Second, and more importantly, the order of priority is reversed. With a 5 % discount rate, AIDS is the more important, but with a 1 % discount rate, climate change is the more important. The rate applied is subjective. In choosing the rate to aplly you effectively choose the end result - and can therefore choose which issue appears to be the more important. The whole procedure becomes a trick.
    This is probably the most important reason why it is not generally advisable to analyse with the aid of discounting, when issues to be compared appear at different time scales (unless one provides unequivocal reasons for choosing one particular discount rate). 

      
To read more detailed explanations on discount rates and what they mean, proceed to this page.

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