Groupe d’études et de recherche en analyse des décisions

G-2017-85

Non-constant discounting, social welfare and endogenous growth with pollution externalities

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We analyze the effect of non-constant discounting on economic growth and social welfare in an endogenous growth model with pollution externalities. For time-consistent agents, the existence of a balanced growth equilibrium is characterized and compared with the equilibrium under standard exponential discounting. A decaying instantaneous discount rate leads to slower growth in a centralized economy, while its effect for a competitive economy is ambiguous. Interestingly, when comparing the planned and the competitive equilibria, the assumption of non-constant discounting may imply greater social welfare under the market equilibrium. This counterintuitive result requires two conditions. First, pollution externalities should lead the central planner to slow down growth to below the growth rate in the market economy. Secondly, individuals' degree of impatience should decrease sharply with the time distance from the present. Contrarily, when the centralized economy welfare dominates the market economy, introducing policy instruments is less effective than under constant discounting.

, 32 pages