With first Houston, then several Caribbean islands and Florida suffering dreadful flooding and destruction from Hurricanes Harvey and Irma, many are questioning whether more should be spent on flood prevention and reducing greenhouse gas emissions. Economists would normally argue that such questions are answered by conducting a cost–benefit analysis.
However, even if the size of the costs and benefits of such policies could be measured, this would not be enough to give the answer. Whether such spending is justified would depend on the social rate of discount. But what the rate should be in cost-benefit analyses is a highly contested issue, especially when the benefits occur a long time in the future.
I you ask the question today, ‘should more have been spent on flood prevention in Houston and Miami?’, the answer would almost certainly be yes, even if the decision had to have been taken many years ago, given the time it takes to plan and construct such defences. 
But if you asked people, say, 15 years ago whether such expenditure should be undertaken, many would have said no, given that the protection would be provided quite a long time in the future. Also many people back then would doubt that the defences would be necessary and many would not be planning to live there indefinitely.
This is the familiar problem of people valuing costs and benefits in the future less than costs and benefits occurring today. To account for this, costs and benefits in the future are discounted by an annual rate to reduce them to a present value.
But with costs and benefits occurring a long time in the future, especially from measures to reduce carbon emissions, the present value is very sensitive to the rate of discount chosen. But choosing the rate of discount is fraught with difficulties.
Some argue that a social rate of discount should be similar to long-term market rates. But market rates reflect only the current generation’s private preferences. They do not reflect the costs and benefits to future generations. A social rate of discount that did take their interests into account would be much lower and could even be argued to be zero – or negative with a growing population.
Against this, however, has to be set the possibility that future generations will be richer than the current one and will therefore value a dollar (or any other currency) less than today’s generation.
However, it is also likely, if the trend of recent decades is to continue, that economic growth will be largely confined to the rich and that the poor will be little better off, if at all. And it is the poor who often suffer the most from natural disasters. Just look, for example, at the much higher personal devastation suffered from hurricane Irma by the poor on many Caribbean islands compared with those in comparatively wealthy Florida.
A low or zero discount rate would make many environmental projects socially profitable, even though they would not be with a higher rate. The choice of rate is thus crucial to the welfare of future generations who are likely to bear the brunt of climate change.
But just how should the social rate of discount be chosen? The following two articles explore the issue.
Articles
How Much Is the Future Worth? Slate, Will Oremus (1/9/17)
Climate changes the debate: The impact of demographics on long-term discount rates Vox, Eli P Fenichel, Matthew Kotchen and Ethan T Addicott (20/8/17)
Questions
- What is meant by the social rate of discount?
- Why does the choice of a lower rate of social discount imply a more aggressive climate policy?
- How is the distribution of the benefits and costs of measures to reduce carbon emissions between rich and poor relevant in choosing the social rate of discount of such measures?
- How is the distribution of the benefits of such measures between current and future generations relevant in choosing the rate?
- How is uncertainty about the magnitude of the costs and benefits relevant in choosing the rate?
- What is the difference between Stern’s and Nordhaus’ analyses of the choice of social discount rate?
- Explain and discuss the ‘mortality-based approach’ to estimating social discount rates.
- What are the arguments ‘for economists analysing climate change through the lens of minimising risk, rather than maximizing utility’?
Many politicians throughout the world,
not just on the centre and left, are arguing for increased spending on infrastructure. This was one of the key proposals of Donald Trump during his election campaign. In his election manifesto he pledged to “Transform America’s crumbling infrastructure into a golden opportunity for accelerated economic growth and more rapid productivity gains”.
Increased spending on inffrastructure has both demand- and supply-side effects.
Unless matched by cuts elsewhere, such spending will increase aggregate demand and could have a high multiplier effect if most of the inputs are domestic. Also there could be accelerator effects as the projects may stimulate private investment.
On the supply side, well-targeted infrastructure spending can directly increase productivity and cut costs of logistics and communications.
The combination of the demand- and supply-side effects could increase both potential and actual output and reduce unemployment.
So, if infrastructure projects can have such beneficial effects, why are politicians often so reluctant to give them the go-ahead?
Part of the problem is one of timing. The costs occur in the short run. These include demolition, construction and disruption. The direct benefits occur in the longer term, once the project is complete. And for complex projects this may be many years hence. It is true that demand-side benefits start to occur once construction has begun, but these benefits are widely dispersed and not easy to identify directly with the project.
Then there is the problem of externalities. The external costs of projects may include environmental costs and costs to local residents. This can lead to protests, public hearings and the need for detailed cost–benefit analysis. This can delay or even prevent projects from occurring.
The external benefits are to non-users of the project, such as a new bridge or bypass reducing congestion for users of existing routes. These make the private construction of many projects unprofitable, except with public subsidies or with public–private partnerships. So there does need to be a macroeconomic policy that favours publicly-funded infrastructure projects.
One type of investment that is less disruptive and can have shorter-term benefits is maintenance investment. Maintenance expenditure can avoid much more costly rebuilding expenditure later on. But this is often the first type of expenditure to be cut when public-sector budgets as squeezed, whether at the local or national level.
The problem of lack of infrastructure investment is very much a political problem. The politicians who give the go-ahead to such projects, such as high-speed rail, come in for criticisms from those bearing the short-run costs but they are gone from office once the benefits start to occur. They get the criticism but not the praise.
Articles
Are big infrastructure projects castles in the air or bridges to nowhere? The Economist, Buttonwood’s notebook (16/1/17)
Trump’s plans to rebuild America are misguided and harmful. This is how we should do it. The Washington Post, Lawrence H. Summers (17/1/17)
Questions
- Identify the types of externality from (a) a new high-speed rail line, (b) new hospitals.
- How is discounting relevant to decisions about public-sector projects?
- Why are governments often unwilling to undertake (a) new infrastructure projects, (b) maintenance projects?
- Is a programme of infrastructure investment necessarily a Keynesian policy?
- What accelerator effects would you expect from infrastructure investment?
- Explain the difference between the ‘spill-out’ and ‘pull-in’ effects of different types of public investments in a specific location. Is it possible for a project to have both effects?
- What answer would you give to the teacher who asked the following question of US Treasury Secretary, Larry Summers? “The paint is chipping off the walls of this school, not off the walls at McDonald’s or the movie theatre. So why should the kids believe this society thinks their education is the most important thing?”
- What is the ‘bridge to nowhere’ problem? Why does it occur and what are the solutions to it?
- Why is the ‘castles in the air’ element of private projects during a boom an example of the fallacy of composition?
The UK government has finally given the go-ahead to build the new Hinkley C nuclear power station in Somerset. It will consist of two European pressurised reactors, a relatively new technology. No EPR plant has yet been completed, with the one in the most advanced stages of construction at Flamanville in France, having experienced many safety and construction problems. This is currently expected to be more than three times over budget and at least six years behind its original completion date of 2012.
The Hinkley C power station, first proposed in 2007, is currently estimated to cost £18 billion. This cost will be borne entirely by its builder, EDF, the French 85% state-owned company, and its Chinese partner, CGN. When up and running – currently estimated at 2025 – it is expected to produce around 7% of the UK’s electricity output.
On becoming Prime Minister in July 2016, Theresa May announced that the approval for the plant would be put on hold while further investigation of its costs, benefits, 
security concerns, technological issues and safeguards was conducted. This has now been completed and approval has been granted subject to new conditions. The main one is that the government “will be able to prevent the sale of EDF’s controlling stake prior to the completion of construction”. This will allow the government to prevent change of ownership during the construction phase. Thus, for example, EDF, would not be allowed to sell its share of Hinkley C to CGN, which currently has a one-third share in the project. EDF and CGN have accepted the new terms.
After Hinkley the government will have a ‘golden share’ in all future nuclear projects. “This will ensure that significant stakes cannot be sold without the Government’s knowledge or consent.”
In return for their full financing of the project, the government has guaranteed EDF and CGN a price of £92.50 per megawatt hour of electricity (in 2012 prices). This price will be borne by consumers. It will rise with inflation from now and over the first 35 years of the power station’s operation. It is expected that the Hinkley C will have a life of 60 years.
Critics point out that this guaranteed ‘strike price’ is more than double the current wholesale price of electricity and, with the price of renewables falling as technology improves, it will be an expensive way to meet the UK’s electricity needs and cut carbon emissions.
Those in favour argue that it is impossible to predict electricity prices into the distant future and that the certainty this plant will give is worth the high price by current standards.
To assess the desirability of the plant requires an assessment of its costs and benefits. In principle, this is a relatively simple process of identifying and measuring the costs and benefits, including external costs and benefits; discounting future costs and benefits to give them a present value; weighting them by their probability of occurrence; then calculating whether the net present value is positive or negative. A sensitivity analysis could also be conducted to show just how sensitive the net present value would be to changes in the value of specific costs or benefits.
In practice the process is far from simple – largely because of the huge uncertainty over specific costs and benefits. These include future wholesale electricity prices, unforeseen problems in construction and operation, and a range of political issues, such as pressure from various interest groups, and attitudes and actions of EDF and CGN and their respective governments, which will affect not only Hinkley C but other future power stations.
The articles look at the costs and benefits of this, the most expensive construction project ever in the UK, and possibly on Earth..
Articles
Hinkley Point: UK approves nuclear plant deal BBC News (15/9/16)
Hinkley Point: What is it and why is it important? BBC News, John Moylan (15/9/16)
‘The case hasn’t changed’ for Hinkley Point C BBC Today Programme, Malcolm Grimston (29/7/16)
U.K. Approves EDF’s £18 Billion Hinkley Point Nuclear Project Bloomberg, Francois De Beaupuy (14/9/16)
Hinkley Point C nuclear power station gets government green light The Guardian, Rowena Mason and Simon Goodley (15/9/16)
Hinkley Point C: now for a deep rethink on the nuclear adventure? The Guardian, Nils Pratley (15/9/16)
Hinkley Point C finally gets green light as Government approves nuclear deal with EDF and China The Telegraph, Emily Gosden (15/9/16)
UK gives go-ahead for ‘revised’ £18bn Hinkley Point plant Financial Times, Andrew Ward, Jim Pickard and Michael Stothard (15/9/16)
Hinkley Point: Is the UK getting a good deal? Financial Times, Andrew Ward (15/9/16)
Hinkley Point is risk for overstretched EDF, warn critics Financial Times, Michael Stothard (15/9/16)
Hinkley C must be the first of many new nuclear plants The Conversation, Simon Hogg (16/9/16)
Report
Nuclear power in the UK National Audit Office, Sir Amyas Morse, Comptroller and Auditor General (12/7/16)
Questions
- Summarise the arguments for going ahead with Hinkley C.
- Summarise the objections to Hinkley C.
- What categories of uncertain costs and uncertain benefits are there for the project?
- Is the project in EDF’s interests?
- How will the government’s golden share system operate?
- How should the discount rate be chosen for discounting future costs and benefits from a project such as Hinkley C?
- What factors will determine the wholesale price of electricity over the coming years? In real terms, do you think it is likely to rise or fall? Explain.
- If nuclear power has high fixed costs and low marginal costs, how does this affect how much nuclear power stations should be used in a situation of daily and seasonal fluctuations in demand?
- How could ‘smart grid’ technology smooth out peaks and troughs in electricity supply and demand? How does this affect the relative arguments about nuclear power versus renewables?
It doesn’t seem long ago that we were looking at the prospects of Brazil for hosting the Football World Cup. Now, we turn to the same economy, but this time for the Olympics. It is often the case that hosting big global sporting events can give a boost to the host nation, but is Brazil prepared for it? Did the World Cup bring the expected economic boosts? Some argue that the Olympics is just what Brazil needs, but others suggest it will only worsen the economic situation in the world’s seventh largest economy.
Brazil’s economic performance in the past year was not good. In fact, it was one of the worst performing nations of any major economy, with GDP falling by 3%. This is a very different country from the one that was awarded this biggest of sporting events. Despite these difficult times, Brazil’s government maintains that the country is ready and that the games will be ‘spectacular’.
Key to hosting a sporting event such as the Olympics is the infrastructure investment and as a key component of aggregate demand, this should be a stimulant for growth and job creation. However, with the economy still struggling, many are concerned that the infrastructure won’t be in place in time.
Other benefits from this should be the boost to growth driven by athletes and spectators coming from around the globe, buying tickets, memorabilia, accommodation, food and other items that tourists tend to buy. A multiplier effect should be seen and according to research has the potential to create significant benefits for the whole economy and not just the local regions where events take place. You can look at similar analysis in blogs written about Tokyo: 2020 Tokyo Olympics and London: The London Olympics legacy: a cost–benefit analysis and Does hosting the Olympics Games increase economic growth?
But, is this really likely to happen, especially given the somewhat lacklustre boost that the Brazil World Cup gave to the economy? The following articles consider this.
Rio 2016: Can Games bounce back from Brazil economic woes? BBC News, Bill Wilson (11/03/16)
Does hosting the Olympics actually pay off? It’s the economy, Binyamin Applebaum (5/08/14)
Rio Olympics no help to Brazil economy based on World Cup Bloomberg, Raymond Colitt (16/01/15)
The economic impact of Brazil’s 2014 World Cup and 2016 Olympics Saxo Group, Trading Floor, Sverrir Sverrisson (27/08/12)
Special Interview: Cost–benefit analysis of hosting the World Cup, Olympics Al Arabiya, Ricardo Guerra (3/7/14)
Questions
- How might you carry out a cost–benefit analysis to decide whether to host a big sporting event?
- Are there any externalities that might result from hosting the Olympics? How easy is it to estimate their monetary value? Should this be taken into account by a country when making a decision?
- Why might there be a boost to aggregate demand prior to the Olympics?
- Why might there be a multiplier effect when a nation hosts the Olympics or another sporting event?
- Might there be benefits to Brazil’s neighbours from its hosting the Olympics?
At the G7 conference in Bavaria on 7 and 8 June 2015, it was agreed to phase out the use of fossil fuels by the end of the century. But despite this significant objective, there were no short-term measures put in place to start on the process of achieving this goal. Nevertheless, the agreement contained commitments to further developments in carbon markets, elimination of fossil fuel subsidies, incentives for the development of green energy and support for developing countries in reducing hydrofluorocarbons.
The agreement also sent a strong message to the 21st United Nations International Climate Change conference scheduled to meet in Paris from 30 November to 11 December 2015. The G7 communiqué states that binding rules would be required if the target was to be met.
The agreement should enhance transparency and accountability including through binding rules at its core to track progress towards achieving targets, which should promote increased ambition over time. This should enable all countries to follow a low-carbon and resilient development pathway in line with the global goal to hold the increase in global average temperature below 2°C.
But many environmentalists argue that a more fundamental approach is needed. This requires a change in the way the environment is perceived – by both individuals and politicians. The simple 
selfish model of consumption to maximise consumer surplus and production to maximise profit should be rejected. Instead, the environment should be internalised into decision making.
What is more, there should be an integral ecology which brings together a wide range of disciplines, including economics, in analysing the functioning of societies and economies. Rather than being seen merely as a resource to be exploited, respect and care for the environment should be incorporated into our whole decision-making process, along with protecting societies and cultures, and rejecting economic systems that result in a growing divide between rich and poor.
In his latest encyclical, On care for our common home, Pope Francis considers integral ecology, not just in terms of a multidiciplinary approach to the environment but as an approach that integrates the objectives of social justice and care for the environment into an overarching approach to the functioning of societies and economies. And central to his message is the need to change the way human action is perceived at a personal level. Decision making should be focused on care for others and the environment not on the selfish pursuit of individual gain.
With a change in heart towards other people and the environment, what would be seen as externalities in simple economic models based on rational self-interested behaviour become internal costs or benefits. Care and compassion become the drivers for action, rather than crude self interest.
A key question, of course, is how we get here to there; how society can achieve a mass change of heart. For religious leaders, such as the Pope, the approach centres on spiritual guidance. For the secular, the approach would probably centre on education and the encouragement for people to consider others in their decision making. But, of course, there is still a major role for economic instruments, such as taxes and subsidies, rules and regulations, and public investment.
Articles
G7 leaders agree to phase out fossil fuels by end of centuryEU Observer, Peter Teffer (8/6/15)
Integral Ecology Approach Links ‘Welfare of God’s People and God’s Creation’ Catholic Register (11/6/15)
President’s Corner Teilhard Perspective, John Grim (May 2015)
In his encyclical on climate change Pope Francis reveals himself to be a master of scientific detail Washington Post, Anthony Faiola, Michelle Boorstein and Chris Mooney (18/6/15)
Pope Francis Calls for Climate Action in Draft of Encyclical New York Times, Jim Yardley (15/6/15)
Pope Francis letter on climate change leaked: Draft Vatican encyclical released three days early Independent, Kashmira Gander and Michael Day (15/6/15)
The Pope is finally addressing the gaping hole in the Judaeo-Christian moral tradition Independent, Michael McCarthy (15/6/15)
Pope Francis warns of destruction of Earth’s ecosystem in leaked encyclical The Guardian, Stephanie Kirchgaessner and John Hooper (16/6/15)
Explosive intervention by Pope Francis set to transform climate change debate The Observer, John Vidal (13/6/15)
Pope Francis’ Leaked Encyclical Draft Attributes Climate Change To Human Activity Huffington Post, Antonia Blumberg (15/6/15)
Pope Francis’ Integral Ecology Huffington Post, Dave Pruett (28/5/15)
Videos
Pope Francis: Climate change mostly man-made BBC News, Caroline Wyatt (18/6/15)
Pope urges action on global warming in leaked document BBC News, Chris Cook (16/6/15)
Questions
- What do you understand by ‘integral ecology’?
- Is an integrated approach to the environment and society consistent with ‘rational’ behaviour (a) in the narrow sense of ‘rational’ as used in consumer and producer theory; (b) in a broader sense of making actions consistent with goals?
- Can cost–benefit analysis be used in the context of an integrated and cross-disciplinary approach to the environment and society?
- What types of incentives would be useful in achieving the approach proposed by Pope Francis?
- Why do many companies publicly state that they pursue a policy of corporate responsibiliy?
- To what extent does it make sense to set targets for the end of this century?
- In what crucial ways might GDP need to be adjusted if it is to be used as a measure of the success of the approach to society, the economy and the environment as advocated by Pope Francis?
With first Houston, then several Caribbean islands and Florida suffering dreadful flooding and destruction from Hurricanes Harvey and Irma, many are questioning whether more should be spent on flood prevention and reducing greenhouse gas emissions. Economists would normally argue that such questions are answered by conducting a cost–benefit analysis.
But if you asked people, say, 15 years ago whether such expenditure should be undertaken, many would have said no, given that the protection would be provided quite a long time in the future. Also many people back then would doubt that the defences would be necessary and many would not be planning to live there indefinitely.
However, it is also likely, if the trend of recent decades is to continue, that economic growth will be largely confined to the rich and that the poor will be little better off, if at all. And it is the poor who often suffer the most from natural disasters. Just look, for example, at the much higher personal devastation suffered from hurricane Irma by the poor on many Caribbean islands compared with those in comparatively wealthy Florida.
