UK professor at the heart of US climate policy

Mark Freeman is quite happy to admit that his work as a financial economist may appear to many as “rather dull” and confesses to be a “bit of nerd” when it comes to percentage points. But it is precisely this laser-focus on the percentages of social discounting policy that has put this English academic at the heart of influencing Joe Biden’s latest multi-billion-dollar economic policy on US climate change mitigation and the way US Federal cost-benefit analysis is undertaken. “These percentages matter,” he says.

Freeman is Professor of Finance at the University of York’s School for Business and Society, where he specialises in intergenerational finance and in particular social discounting. These are the calculations designed to balance the inevitable trade-offs between how we commit resources to the billions alive now and to the billions who will be alive in the future. Saving the planet for future generations, for example, means money being spent now that can’t be spent on other things that would benefit people today in other ways.

Governments are impatient and, according to most economic forecasts, societies are expected to get wealthier in the future. As a consequence, a benefit today is valued more than the same benefit in the future. Quantifying this effect lies at the heart of social discounting. Governments must address both ethical and financial questions to resolve these matters and the social discounting choices they make are particularly relevant for the economic analysis of climate change mitigation proposals.

Freeman would argue that not enough emphasis is put on economics in the mainstream media when reporting on climate change, but now his work on the subject has been used in support of a proposed massive shift in US government policy, he hopes that may change. Citing work by him and his colleagues, the Biden administration is proposing to change how it handles the numbers when it comes to calculating the social cost of carbon, which puts a monetary value for the economy, the environment and human welfare to every ton of carbon we pump into the atmosphere. Their work, including a recent review of social discounting published in the Annual Review of Resource Economics, has also been cited recently in proposed updates to the way that the US Federal government more generally undertakes such analysis.

“It’s basic cost-benefit analysis,” says Freeman. “We are looking at what we would be prepared to pay today to avoid having to spend billions in the future.”

The maths here is important as economists like Freeman use complex mathematical formulae – resulting in those important percentages – for policymakers to use in calculating social discount rates, and thus the social cost of climate change.

“The discount rate reflects the amount you value next year compared to today and may appear to be a very dry and technical variable,” explains Freeman. “But, as this brings in compound interest, it really matters when you start doing long-term infrastructure and climate mitigation projects.”

He uses a simple analogy of his credit card to explain compounding further. “If my credit card interest rate is 10 per cent rather than 8 per cent and I don't pay it off after a year, the slightly higher interest rate makes a bit of a difference to me, but not that much. The longer I go into the future without paying the loan off, however, the more the interest compounds and the bigger the difference it makes.

“It is exactly the same thing here - small changes to the social discount rate over the many hundred years that carbon remains in the atmosphere result in huge differences in the perceived value of investing today in climate mitigation, and that is why these small percentage shifts really, really matter.”

For a green policy to be implemented it needs to clear the cost-benefit hurdle set by the social discount rate. The problem is that the current cost-benefit analysis used in the US downplays the importance of future benefits compared to current costs. In the jargon of Freeman’s world, the social discount rate that is being applied is too high. This makes it very difficult for policy makers to do anything on things like climate change, because most green proposals just don't get past the cost-benefit hurdle.

Freeman uses electric cars to show how this all works, explaining that if a regulation was imposed that required people to buy electric vehicles rather than petrol cars there are clear costs and benefits – the cost of buying new and more expensive cars alongside a reduction in carbon emissions.

“In the US, Federal Agencies are required by law to do a cost-benefit analysis for any regulation like this to be introduced,” he explains. “So, if you're valuing carbon savings that are valued at $190 per ton under the new Biden proposal which applies a low social discount rate, as opposed to $4 per ton, which it was under the Trump administration under a much higher social discount rate, it is going to make it much easier to pass that type of legislation.”

This calculation is worked out on the amount of carbon dioxide being put out multiplied by the monetary value and that gives you the benefit. Using rough figures, Freeman shows that if a petrol car pumps out five tons of CO2 emissions a year, under the new proposals you would multiply that by $190 giving you roughly $1,000 per year of carbon benefits by changing to electric. If a car lasts 10 years, that would be a benefit of $10,000 over that time. If the cost of changing to electric is less than $10,000, the regulation can be passed.

During the Trump administration, the five tons of carbon dioxide a year would have been valued at only $20, given the $4 tariff. Over 10 years that is a cost benefit just $200 and, therefore, the cost of changing your car would have to be less than $200 for the regulation to pass.

The proposed hurdle has changed enormously in terms of where it becomes efficient to introduce regulation to require you to change your petrol car to electric, and Freeman believes that the President’s proposals will make a more significant impact across all climate and infrastructure projects. “The headline here is that these proposals will make it easier to justify government regulation on long-term projects, and this matters for green projects in particular,” he says.

The Biden administration has tackled this issue in two ways, issuing two mandates that are of relevance. The first was Executive Order 13990, which required Federal Agencies to review the prevailing cost that they ascribed to greenhouse gas emissions in regulatory analysis (the Social Cost of Carbon).  This turned out to be legally contentious, when the Court of Louisiana ruled that it was unlawful after it had been challenged by eleven Republican States. President Biden and his Federal Agencies, however, successfully appealed this ruling through the Fifth Circuit Court of Appeals, a ruling that was then confirmed in the Supreme Court. 

Following this legal wrangling, in September last year the US Environmental Protection Agency (EPA) issued draft updates of the Social Cost of Carbon and it is in connection with this review that Freeman’s work has been used – in a preliminary draft update document (Technical Supporting Document) and also as part of the current draft update that the EPA released last year. Freeman has also led two public consultation submissions on this process.

“Under the Obama administration, carbon emissions were priced at $43/ton. This dropped to $4/ton under the Trump administration, before Biden raised it to $51/ton as an interim measure. The proposed new EPA value, at $190/ton, will significantly enhance the cost-benefit analysis case for Federal climate change mitigation policies. Changes to discounting policy - which is where my work fits in - is the single greatest, but not only, reason for these changes in value.” 

President Biden has also introduced a directive on Modernizing Regulatory Review, which determines how cost-benefit analysis is undertaken for regulatory purposes and in relation to the spending of Federal grant income.  This stresses that it is updates to discounting practices that are most significant in these changes and Freeman is once again cited.

Meanwhile, a letter in the journal Science published this week relates to these proposed changes in Federal cost-benefit analysis and is signed by Freeman and other experts in social discounting from all over the world.

Freeman believes there are still rocky political and legal roads ahead for this policy. “There are very important ethical considerations to consider, which relate to that balance between what we spend now to save future generations and what we spend now on current populations,” he says.

“We need to be sure that regulations don’t adversely affect people now,” he continues. “Regulating businesses to pay for climate mitigation measures that put them out of business is not going to work. Where is the balance between benefiting us now and saving people in the future? How do we strike that balance? Putting many people out of business by having to put carbon capture on their roof to help people in the future may turn out to be unfair.”

Freeman uses two more analogies to highlight the difficulty of these important questions.

“Everybody wants to save people dying from climate change,” he says, citing estimates from the World Health Organisation that 250,000 people will die per year from climate change between 2030 and 2050, and that this is clearly something we should do something about.

“But at the moment, about half a million children a year die from diarrhoea,” he continues. “That is an observed fact and every dollar that we give to climate change, we are not giving to helping people to survive diarrhoea. How do we make these stark choices?

“What it ultimately comes down to is that the easier you make it to introduce regulation on climate change, the more it will distract policymakers’ attention from other things they might be focused on. That doesn't mean it's wrong, but we have to make balanced choices.”

Climate change, he suggests, is not only a science issue but one also about the law, politics and economics – and Freeman believes not enough attention is paid to this.

“When I teach this to students, I ask them a version of the classic trolley problem - how many people they would hypothetically not save now from diarrhoea so that resources can be used instead to save 1,000 lives from climate change in 100 years’ time?".

“Every policy choice addresses this type of consideration. The only question is whether you do it explicitly or implicitly. People duck the explicit but policy choices still have to be made. Take road deaths, for example. How many deaths are we prepared to accept on the road? Are a thousand deaths on the road next year acceptable because the cost of saving these thousand lives is better spent on the health service, saving more lives? These aren't impossible questions, but they are questions that we prefer to tackle implicitly.

“Ultimately, fundamental policy decisions are made through economic consideration rather than pure science alone. Science plays a crucial role in informing the decision, but the decision must also be made on one or two nerdy percentage points here or there.”

· A letter has been published in Science broadly supporting President Biden’s proposals for changes in regulation, which relies on the work of Professor Freeman and his colleagues. The letter has been signed by Freeman and around 20 other experts on social discounting from around the world.

· Professor Freeman is available for interview and for comment.

· For more information or to arrange an interview, please contact William Davis on 07875 138 147 or wdavis@insightm.co.uk