Risk, inequality and time in the welfare economics of climate change: is the workhorse model underspecified?
Cameron Hepburn, Hakon Sælen, Giles Atkinson, Simon Dietz,
Jennifer Helgeson
Abstract
In the workhorse model of welfare economics, the elasticity of marginal utility, often denoted as η, serves simultaneously to represent aversion to risk, aversion to spatial inequality, and preferences for intertemporal substitution. While Kreps-Porteus-Selden and Epstein-Zin preferences enable risk to be separated from intertemporal substitution, no model enables all tlhree concepts to be disentangled. This theoretical lacuna is important, particularly for the economics of climate change, which is a global, long-run, uncertain externality. Much debate, for instance in the wake of the Stern Review (Stern, 2007a) has focused on the appropriate value for η. This paper tests the suitability of the workhorse model for climate change economics, by surveying the attitudes of over 3000 people to risk, time, and income inequality. The results show that individual attitudes to the three are only weakly correlated. This suggests that because the three concepts are captured by a single parameter, the model is underspecified and a richer model should be considered.
Keywords: Climate Change, Discounting, Cost-Benefit Analysis, Risk Aversion, Intertemporal Substitution, Inequality Aversion, Intergenerational Equity
Date: July 2008 | Reference number(s): 400
Series: Department of Economics Discussion Paper Series
JEL Classifications: D01, D63, C90, Q51