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We see here that the choice of the discount rate is one of the key elements in the definition of the notion of sustainable development, just as the interest rate is the key economic variable for economic growth. If we are very uncertain about the sustainability of our development, it would be advisable to reduce the discount rate—and especially the rate at which distant cash flows are discounted—in order to induce more investment for the (distant) future.

Growth uncertainty thus needs to be analyzed as well. This is required for the sake of realism, and it is essential if one wants to provide a credible economic approach to the notion of sustainable development. Instrumental to the standard analysis is the concept of prudence, which refers to consumers’ willingness to save more in the face of an increase in their future income risk. Indeed, people are generally willing to sacrifice current consumption when their future becomes uncertain. Macroeconomists who have been measuring the precautionary saving motive can tell us much about how cautiously people spend when their own future becomes uncertain. This well-documented observation justifies selecting a smaller social discount rate, implying more investments for the future. In The Economics of Risk and Time, which I wrote in 2002, I explain how the benefits of these investments should be targeted for the time horizons with the largest uncertainty, ceteris paribus. This provides an argument for implementing a decreasing term structure of the discount rate, if the precautionary effect dominates the wealth effect for longer time horizons.

The existing literature is based on a completely standard expected utility modelling, whereby the welfare of each future generation is evaluated by computing its expected utility based on a probability distribution for the GDP per capita that it will enjoy. A major difficulty, however, is that these probability distributions are ambiguous, in the sense that they are not based on scientific arguments, or on a database large enough to make them completely objective. Indeed, more than one stochastic process is compatible with existing methods for describing economic growth. The Ellsberg paradox tells us that most human beings are averse to ambiguity, which means that they tend to overestimate the probability of the worst-case scenario when computing their subjective expected utility. This suggests that agents systematically violate Savage’s “Sure Thing Principle” (Savage, 1954). More precisely, it seems that the way we evaluate uncertain prospects depends on how precise our information about the underlying probabilities is. Hence, a natural question to ask is, Given ambiguity aversion, does a standard subjective utility model systematically underestimate (or overestimate) the socially efficient discount rate?

As explained in Hogarth and Kunreuther (1989), Kunreuther, Hogarth, and Meszaros (1993), and Kunreuther et al. (1995), introducing ambiguity aversion into a discussion of the discount rate is crucial if one wants to have evaluation tools that are compatible with social welfare. It is also appealing as a normative concept to transform the precautionary principle into an operational rule that distorts collective beliefs in a pessimistic way. The degree of ambiguity aversion will determine the intensity of the pessimistic bias in the socially efficient collective evaluation of uncertain prospects compared to their objective equivalent risky prospect. The problem is that we don’t have any clear indication of the degree of ambiguity to be applied in the calibration of our evolution models.

THE PROBLEM OF DYNAMIC RISK MANAGEMENT

Most environmental projects have uncertain future benefits. For example, according to the Stern Review, the best estimate for losses in the year 2200 is 13.8 percent of GDP, with a 90 percent interval of confidence that the true loss will be between 2.9 percent and 35.2 percent of GDP. Because future generations are risk averse, the certainty-equivalent