ARI Seminar:       Harvard Economics Professor Robert J. Barro

Title:                  Environmental Protection, Rare Disasters, and Discount Rates
Date:                  June 3, 2014
Venue:                Room 201, College of Political Science and Economics, Korea University

Organizers:   The Asiatic Research Institute and the Department of Economics, Korea University

World-renowned economist Robert J. Barro, professor of economics at Harvard University and a senior fellow at Stanford University’s Hoover Institution, gave a lecture on his recent research, titled “Environmental Protection, Rare Disasters, and Discount Rates.” The event was organized jointly by the Asiatic Research Institute and the Department of Economics at Korea University on June 3, 2014.

Professor Barro began his lecture by criticizing the assumption made by Stern Review in regards to near-zero discount rates in environmental protection investments and the assumption that as the pure rate of time increases, the discount rate increases, and, subsequently environmental investment decreases. Adopting a principle set out by Martin Weitzman, Professor Barro analyzed optimal choice in environmental policy to determine the amount of investment needed in order to lessen the potential impact of natural disasters.

Professor Barro raises two questions, including the degree to which reducing the probability of environmental disasters is worthwhile as well as the extent to which investments can lower this probability. By focusing on the impacts that environment investment can have on the probability of environmental disasters, Professor Barro has come up with new models that capture the dynamics of disasters.

Departing from Stern Review’s analysis, Professor Barro focused on his main model which states that as risk aversion increases, the probability of disasters decreases, meaning that an increase in return on equity would increase the size of environmental investment. In his new analysis, the optimal environmental investment ratio and the associated disaster probability are constant, since the ratio of investment for environmental protection slowly increases up to a steady state value. Therefore, granted that these variables remain constant, Professor Barro argued that when the pure rate of time preference is low, all expected real rates of return are also low; consequently, investment in relation to GDP increase and the probability of disasters, in turn, become smaller

In conclusion, what Professor Barro gathered from his research was that optimal environmental investment is correlated to both relative risk aversion and to a decrease in the probability and average size of environmental disasters; however, this correlation decreases with higher degrees of uncertainty towards policy effectiveness. The two key parameters that must be determined beforehand are, first, the proportionate effect of environmental investment on the probability of environmental disaster and, second, the baseline probability of environmental disasters.

The seminar was held for approximately two hours, followed by a Q&A session. Professor Barro voiced the hope that his new analysis can ultimately contribute to environmental protection.