Economists say long-term investments can become more equitable

When we discuss climate action, pensions reforms or investments in technology, we are really talking about a big question: how to distribute advantages and costs between generations?

In a new study published on the Ssrn The prior server, two economists from the University of Copenhagen and the University of St. Gallen created an innovative framework to understand and assess this issue.

“We distinguish between two key considerations which are often confused: how we weigh future generations compared to current generations, and how we deal with inequalities between generations. We are the first to have managed to do so for all possible attitudes towards time and inequalities”, explains Frysje Nesje, associated professor in the Department of Economy of Copenhagen.

A modular vision of justice

Researchers present what they call modular approaches to intergenerational justice. This means that attitudes towards time and inequalities can be analyzed and adjusted separately – in two distinct modules:

“The updating of time concerns how less the well-being of future generations in relation to the present,” explains Nesje.

“The module of inequality is to know how much we care about the differences in well-being between generations-for example, between a poor present and a richer future. While previous theoretical frameworks are concentrated only on the differences in well-being between generations, we can let attitudes depend on the whole of the intergenerational distribution of well-being.”

By separating these two dimensions – which have often been mixed – we can avoid involuntary prejudices and obtain a more precise image of the values ​​that really underlie political decisions. Attitudes towards time and inequalities can also be adjusted to better reflect people’s opinions on the issue.

The theoretical framework is based on a technical innovation which converts the calendar time into a so -called equivalent time by lengthening or shortening the time axis. Normally, in other theoretical frameworks – such as those used by the Ministry of Finance in the cost -to -service analysis – The value of future well -being is adjusted downwards by updating and calculating current values. The approach of the new study consists in maintaining the level of well-being and adjusting instead the time axis.

“The new approach works like this: over time, it is as if future people lived shorter lives. This insight can be used to adjust the time axis so that, in principle, all points over time are attributed the same value.

It is this way of thinking that opens up new possibilities. Precisely because the level of well-being itself does not change, it is easy to express attitudes towards greater equality of well-being between generations.

“For the first time, it is also possible to express measures for the distribution of well -being between generations, such as the Gini coefficient. The study also has results on the way the balance between the total distributed well -being – the size of the cake – and the equity of the distribution – the split of the cake – can be evaluated”, explains Nesje.

New tools for political analysis

Economists believe that almost all existing theories on intergenerational justice – including the classic Ramsey rule found in the Department of Finance Ministry on Cost -A further – can be understood as specific cases of their new modular approach. But more importantly, the new theoretical framework opens up simple combinations previously neglected which can be both better and more realistic.

“The new approach can be used to calculate a social discount rate which takes into account time and inequalities – and thus provides a more nuanced base for climatic calculations, for example”, underlines Nesje.

“At a time when we assess long -term investments in the climate, it is crucial to have clear and transparent principles on how we assess future consequences.”

Researchers believe that their theoretical framework can help decision -makers to make more ethically informed choices and avoid involuntary prejudices.

“Our approach makes it possible to reflect the values ​​that people really have – and not only those that are easy to calculate,” concludes Nesje.

The study, entitled “Intergenerational delivery and inequality”, was written by Nesje in collaboration with Paolo G. Piacquadio.

What is the social discount rate?

The social discount rate determines how much we appreciate gains or future losses compared to those we live today.

Because we generally prefer to get something good now rather than later, economists reduce the value of future consequences – EG, climate action – by a rate. This is called the reduction of time.

Another reason is inequality aversion. If future generations should be richer than us, economists reduce the value of future consequences.

The method is used in cost-to-dispatches to determine how much it is worth investing today to obtain advantages far in the future.

What does the discount rate in practice mean?

Imagine that the company plans to invest 1 billion DKK in a climate project which will have its full effect only in 100 years – EG, by reducing emissions or preventing floods.

If we use a social discount rate of 5%, the value of the future gain today would be very low, or about 7.6 million DKK. This means that we attribute low value to future generations.

But with a discount rate of 1%, the same future gain is estimated at around 370 million DKK today. It makes much more attractive to invest in the future – and more reflects the emphasis on the needs of future generations.

These differences are even more austere when the time horizon is longer. At a discount rate of 1%, 1 billion DKK for one year from today are just as precious as a 1 billion DKK for three years from 100 years. At a discount rate of 4%, 1 billion DKK for a year from now on are always more precious than 1 billion DKK from 100 years, it doesn’t matter how long it lasts. So, even if the DKK 1 billion is appreciated forever in 100 years, it is better to enjoy a billion DKK today for only a year.