David Willetts

David Willetts enters the debate over social discount rates and welfare functions in the Stern Review and supports the case for backing Stern’s conclusions as part of a wider intergenerational obligation.

“Almost exactly a year ago David Cameron gave a powerful speech to this very audience on Modern Conservatism. I should know, I was there! Today I want to carry forward that important statement of principles. David set out two key themes in contemporary Conservatism – shared responsibility and trusting people. Those two principles can be applied to what I believe is the biggest issue in British politics today – what we owe future generations. What kind of responsibility do we have for them?

This is becoming one of the central issues in British politics – the challenge of ensuring fairness across the generations. In the old days we used to think of our society as divided by class and economic interests. Now we increasingly worry about divisions based on identity and culture. There is another division, and one which we politicians need to tackle – a clash of generations. It is the theme behind today’s shocking report from UNICEF – are we doing enough for our children? It also lies behind Nick Stern’s report on climate change – are we doing enough for our children and our children’s children. This is the moral challenge facing the baby boomers,

There are deep issues here which have been brought to the surface in the fascinating debate on Sir Nicholas Stern’s report on climate change. The scientific evidence assembled in that report shows pretty clearly that something very significant is happening to our climate and that it is very strongly associated with human activity since the industrial revolution. Oddly enough for a report by an economist it is the layman’s summary of the science which has helped push us over the tipping point to recognising what is going on. It is the economics, however, has proved much more controversial. Nick Stern forces us to confront the question what costs we should be willing to incur today for possible benefits way out in the future. What do we owe future generations? How do we value the future?

Nick Stern had to reduce to a value today flows of benefits and costs way out into the future. There are a number of powerful tools used by economists to do this; the first is the social discount rate.

The social discount rate is the way economists describe how much a pound in a year’s time should be worth to you now.

A way of thinking about the social discount rate is to imagine a world with no inflation and no risk. If, under these conditions, you attach the same value to £100 today as you would to £105 in a year’s time then you have got a social discount rate of 5%. It is an essential tool for any economist trying to work out what the payback is from any kind of investment.

Nick Stern sets a very low social discount rate of 0.1% in his report. He is saying that £1,000 in 50 years’ time is worth about as much as £1,000 today. If he had used a much higher discount rate of, say, 5% then benefits out in 50 years’ time would be discounted down to pretty much nothing. We would attach little value to them. But because he has used such an exceptionally low discount rate these long-term benefits loom very large. In fact Nick Stern’s social discount rate would be zero. He argues, as a moral principle really, that we should give no higher value to our income today than to the income of future generations. It only becomes 0.1% because, being the rigorous economist that he is, he wants to allow for the modest risk of the extinction of the human race. The 0.1% is to allow for the slight chance of there being nobody around to enjoy it. This is in itself a little alarming. The Stern Review suggests it is 27 times more likely that the human race will be extinct than that I will win the lottery if I buy a lottery tcket every week for the next ten years.

I personally salute Nick Stern’s moral judgement that we cannot value future generations any lower than ourselves. By and large the moral philosophers would say that we haven’t got any basis for preferring our pleasure now to the pleasure of our great-grand-children. So far so good. But it gets trickier when you add a second assumption – that as our economy grows so there will be a lot more money. That means that future generations will be much richer.

But how much extra happiness does Nick Stern think this will bring us? When our descendants are all multimillionaires, how much will another 1% more income be worth to our richer descendants as against 1% of our income today? Nick Stern’s model suggests that the value of both should be the same. By selecting what economists call a value for the elasticity of the marginal utility of consumption (usually called the ‘eta’ in the literature) of 1, Stern has assumed that an extra 1% of GDP now is equal in psychological value to an extra 1% of GDP in the future.

Each of these assumptions has its own logic. We can have a social discount rate close to zero so £1,000 now will be worth £1,000 in the future. We can also assume that we will get the same amount of utility from an extra 1% of GDP today as we will from an extra 1% of GDP in the future. It is when we combine these two assumptions that difficulties begin. The low discount rate means we are willing to incur costs today for benefits out in the future. The assumption about marginal utility says that wherever you are on the income scale, now or in the future, the psychological damage of losing 1% of your income is the same. A society which lived by these two assumptions would have very high savings (one economist suggests 31%), because it would be willing to sacrifice a lot of money today to provide for the future. It would never say that we do not need to worry about people in the future because they will be richer – that is the eta assumption – but it would say that benefits in the future are worth as much as benefits today – that is the discount rate assumption.

But that isn’t how we behave. That we save so little reveals that we are not valuing the future in the way which Nick Stern’s model suggests. This is the key critique from DeLong, Nordhaus, Weitzman and Dasgupta. He has not just offered a neutral economic analysis; he has in effect called for us to attach more value to the future than we do at the moment. That is why he hasn’t just moved from science to economics, but also to political economy. Behind the technical analysis there is a powerful moral appeal.

This is my attempt to put in layman’s terms what seems to me to be the fundamental economic and political issue underlying Sir Nicholas Stern’s report. It gets to the heart of the question how we value the future.

There are two responses to this challenge. One response, set out in the Financial Times by Martin Wolf, is to argue from the precautionary principle. Money that we spend now either on averting or adjusting to climate change is a kind of insurance premium. The costs of the insurance premium, as set out by Nick Stern, are not too great for modern economies to bear – they are about the same as the difference between Gordon Brown’s growth projections and the real growth rate in 2005. Martin Weitzman has also suggested that because of uncertainty around the really nasty low probability events which the Review acknowledges in the prose (rather than the fairly moderate likely outcomes which it focuses on), we should also be willing to bear these costs on behalf of our children.

This is an attractive argument but it raises again the fundamental question of whether and why we should pay an insurance premium now for future generations.

To tackle that question we need to recognise that there is an inter-generational contract. We have benefited from previous generations much poorer than us and we discharge our debt to them by in turn making sacrifices for generations as yet unborn. The great mediaeval church builders didn’t say there was no need to build a cathedral for the future because by then people would be able to afford something much better. The Victorians didn’t say there’s no reason to build sewers and buildings that would last 100 years because future generations would be able to do something much more efficiently.

There is not just a difference of principle here but a difference of temperament. One view of the world is that the future can take care of itself and anyway future generations are probably going to be better off than we are. But that is like a relay runner, saying it doesn’t matter how fast he runs his lap because later laps are going to be run even faster. There is a web of obligations that link us between generations that came before us and generations yet to come. Surely one of the most powerful obligations that we are under is to want to pass something on to our children and grandchildren. It is a powerful and admirable desire to want to help your own family. But we also want to pass on something better to future generations as a whole. That is one of the important things that nations and governments try to do.

This argument is the thread linking so many different issues in British politics today. The latest UNICEF report tells us we aren’t investing enough in our children or valuing their futures. There is the argument about how much we are investing in the British economy. There is not a right amount of investment that any central planner could determine – far from it. But if you know roughly the growth rate of your economy and if you know how much is your stock of capital across your economy then you can calculate how much you need to invest in order to sustain your growth rate. Over the past decade or more the British economy has achieved the unusual feat of sustaining quite a high rate of growth with quite a low level of investment. This is partly because British capitalism, because of the strength of the City, is good at extracting high rates of return from our investments. So far so good. But there is another much more worrying explanation of what is going on. We are investing in kit that doesn’t last very long but yields a high return for a short period of time. We aren’t investing in the kit that lasts much longer and gives a good total return but at a lower annual rate.

The Government tends to treat all investment the same. But in reality there is a big difference between investing a million pounds in an IT system which will last 4 years or in building a new office which will last 25 years. By and large the investment we are making is in short-term stuff that isn’t going to last very long and will need to be rapidly replaced. Some of our conventional analysis of investment can’t tell the difference between buying a fridge and building a sewage system. This means that we are not passing on to the next generation the same quality of capital stock as we have inherited. When the Victorians were building their sewage system they reaped some of the consequences for themselves then, but we are still reaping the benefits to this day. We are good at high pulse high return investment, we are less good at low pulse long-term investment.

We have to be careful here. I don’t believe the government can set a right level of investment. But there is a role for public policy in at least trying to create the climate in which we remove obstacles to investment, anything from heavy-handed planning rules through to complicated and burdensome taxation to make that choice easier. We would not be just making life easier for ourselves, we would be making it better for future generations as well. We can endow them with more capital to use more productively.

The most important single thing going wrong with our country is that we, by which I mean above all the baby boomers, are not doing enough for the generations coming after us. Look at how we got started early on the housing ladder and are now sitting on big increases in the value of our houses while the younger generation find it harder than ever to get started with the average age of a first-time buyer now over 30. Look at the effect of the crisis in our pensions. Many middle-aged people and older have a funded pension that is now regulated more tightly than ever. But firms are giving up on providing decent funded pensions for the next generation. As pension schemes close it is harder and harder for them to get started on the pensions savings ladder as well. For me, shadowing education, the biggest single challenge is to try to reverse the catastrophic damage done to educational standards by the progressive fashions of the 1960s and 70s. We clearly have a responsibility and we aren’t discharging it properly.

There is a connection between these different arguments. They are all ultimately about how much we value the future. This is not simply a debate amongst economists. I believe it’s a common thread linking a lot of people’s day to day worries. My generation, the baby boomers, have enjoyed extraordinary opportunities compared with previous generations. If we bought our house a while back we are sitting on enormous gains in its value. By and large we built up some funded pension rights before the pensions crisis. We went to school before Britain was an open and mobile society. When I read about the anxious middle classes I think the biggest single anxiety is whether we are going to ensure the next generation have the same kind of opportunities that we had.

It is not just a matter of obligations from our generation to future generations. It is also a matter of us being able to live for our own futures and not just in the present. Logically claims of future generations present very different problems than balancing our own interests over our own lives. Surely as adults we can at least be trusted to get that judgement right. But even here we seem to be more and more living in the present. One of the most interesting and revealing social science experiments is to present some children with the choice of one biscuit now or two biscuits later. One of the best single predictors of who would go on to at least worldly success was whether they were able to turn down the prospect of a biscuit now in order to enjoy returns in the future. My fear is that both as individuals and as a society as a whole we have found it harder and harder to make that trade-off.

These arguments are not simply about economics. They go back to one of the fundamental questions about a modern society – how much we are willing to change our behaviour now to make a commitment for the future. So one issue is how much we value the rights of future generations. It is wrong to live for today if it deprives them in the future. But this isn’t just a matter of redistribution across the generations. We aren’t even very good at deferring gratification for ourselves later in life. As Avner Offer argues in his interesting book, we have seen a weakening of our ability to commit to the future. We have one anguished debate about growing childhood obesity. It is just so seductive to eat those sugary foods, and to keep on eating them. Then there is another debate about the explosion of personal borrowing. It is just so seductive to use that credit card, and keep on using it. What strikes me about the debate on childhood obesity is that it is so similar to the debate about personal borrowing. They are both about the difficulty we all face in trying to resist our appetites of today in the cause of something better in the future. That is why what David Cameron said in his powerful speech at the Party Conference last October about commitment struck such a chord because when we commit ourselves, and above all to another person, we move beyond living for the present.

Some economists will say why should we worry about the future – future generations will be much richer than we are. I hope they will be. But we do have a kind of obligation to them which cannot just be captured through calculations of future income. It is why David Cameron’s concept of general wellbeing is so important. But what people haven’t grasped is that it is not a selfish concept – about my happiness. It is a social concept about the happiness of others, including generations as yet unborn.

There is the L’Oreal philosophy which focuses on me here now – ‘because I’m worth it.’ But we should be guided by a much higher principle, the opposite of L’Oreal’s, ‘because they’re worth it.’

There is a real danger that as a country we live for the present rather than respecting the claims of the future. It is not much of a caricature of the political argument to say that one of the biggest problems with this Labour Government is all they ever do is live for the present. As David Cameron said in his speech here last year, ‘Tony Blair wants results fast. He wants results visible. He wants results that are visibly the results of his actions. So he is not really interested in long-term changes of culture if they do not produce short-term effects.’ The reason why no initiative is never sustained and no programme gets long-term commitment is they haven’t got a time horizon much beyond tomorrow’s headlines. Labour have got away with living in the present because people thought Tories were stuck in the past. The challenge for us is to be the Party of the future.

One of the important ideas that we have brought to the fore over the past year is social responsibility. Part of this is the responsibility that every professional has to live up to the standards of his or her profession. We want to trust our great professions like medicine and teaching much more. One reason we are willing to trust them is that we think they have professional standards which provide an inner compass. But what about politics as a profession? What is the social responsibility of a politician? What are the underlying principles that should shape what a politician does? You might say that there aren’t any shared principles because political argument is about the principles we disagree on, but that isn’t the whole story. I hope we share a belief in the basic principles of a modern liberal democracy. Can we go beyond that? What is it that enables us to distinguish between a good politician, a statesman if you like, and a bad one who is just playing the game? Let’s look at some of the obvious historical comparisons. Why is Pitt the Younger a greater figure than Walpole? Why is Attlee a greater figure than Wilson? Why is Thatcher a greater figure than Macmillan? The explanation is that the great leaders did far more to shape the future of our country. They saw politics as about a contract between the generations in which the interests of the present generation should not automatically come first. It is perhaps a recognition of this which lies behind Tony Blair’s belated preoccupation with his legacy. A socially responsible politician is one who maintains the contract across the generations.

Looking back on the two departments that I have been most involved in – education and pensions – I am particularly aware of this issue. Both pensioners and children have a claim on us, the baby boomers in the middle. Sometimes hard-pressed baby boomers feel these claims have all got too much. We have all heard the story of the middle-aged member of the Salariat staggering back into the office after the Christmas holidays completely exhausted by the combined responsibility of caring for the parents and the in-laws. Often it has been women who hold together this contract across the generations in the most personal and direct way of all. As they enter (or perhaps on a longer view, re-enter) the market economy, it is wrong to expect women to carry out this social function for all of us. But we can’t just leave it to individuals. It is a social obligation and it’s a social obligation which is being eroded as society becomes more divided up, generation by generation. We need greater contact across the generations.

One survey by the Chartered Institute of Personnel Development showed more and more people were in a workplace surrounded by people of the same age group. There is much less inter-generational working than there used to be. There was another fascinating study of the problems on Britain’s toughest estates. It showed that these had concentrations of young people who had themselves contributed to disorder. It is often public sector housing allocation policies that put people into age-related ghettos. We can break down those ghettos and the evidence is that we should achieve much greater social order as a result.

The other week I visited a marvellous social enterprise near Bradford trying to help people build up their skills and get into work. They aim to help everyone from 9 to 90. But they have come up against rules from the Learning and Skills Council which meant there was no funding for older students. But they found that mixing up the ages made learning a lot better. The pensioner helps the young person with his spelling while he helps her master IT.

These contracts aren’t just across the three generations we know. They extend way beyond into the future to generations as yet unborn. Edmund Burke understood this obligation.

‘Society is indeed a contract. Subordinate contracts for objects of mere occasional interest may be dissolved at pleasure – but the state ought not to be considered as nothing better than a partnership agreement in a trade of pepper and coffee, calico or tobacco, or some other such low concern, to be taken up for a little temporary interest, and to be dissolved by the fancy of the parties. It is to be looked on with other reverence; because it is not a partnership in things subservient only to the gross animal existence of a temporary and perishable nature. It is a partnership in all science; a partnership in all art; a partnership in every virtue, and in all perfection. As the ends of such a partnership cannot be obtained in many generations, it becomes a partnership not only between those who are living, but between those who are living, those who are dead, and those who are to be born.’

That’s the challenge we need to rise to.”