Planetary boundaries and climate finance: Declining social discount rates

How should governments discount the present costs of long-term public projects, especially those that affect future generations? The core principle of finance holds that the present cost of the future benefit is worth less the longer investor should wait to receive it. Capital investment literature implicitly assumes that exponential growth of consumption can last indefinitely into the future. However, in the context of climate finance with benefits on current investments deferred to centuries from now, this process is fundamentally constrained by finite biophysical resources of Earth. Similarly to population dynamics, a negative feedback mechanism will eventually prevent unlimited growth of consumption and reduce its rate. We apply this basic insight to valuation of long-term social discount rates. Combining the Ramsey optimal growth framework with the marginal-utility approach and the Verhulst logistic model, we demonstrate that inevitable slowing down of consumption growth leads to a declining long-term tail of the discount curve. This dynamic effect becomes stronger than the well-known ‘precautionary’ effect related to uncertainty of a social planer in future growth rates of consumption in the relatively near future, which has been estimated here as about 100 years from now (the lower boundary). Our formulation yields remarkably simple expressions for time-declining discount rates which generalize the classic Ramsey formula. The derived results can help to shape a more realistic long-term social discounting policy. Furthermore, with the obvious redefinition of the key parameters of the model, the obtained results are directly applicable for estimations of the expected long-term population growth curve in stochastic environments.