groom - Environmental Resource Economics(2005 32 445493 DOI...

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Declining Discount Rates: The Long and the Short of it BEN GROOM 1 ; ± , CAMERON HEPBURN 2 , PHOEBE KOUNDOURI 3 , and DAVID PEARCE 4 1 Department of Economics, School of Oriental and African Studies, London, UK; 2 St Hugh’s College, Environmental Change Institute and Department of Economics, Oxford University, UK; 3 Department of Business, Department of Economics, Reading University, UK; 4 Department of Economics, University College London, UK; ± Author for correspondence (e-mail: [email protected]) Accepted 14 March 2005 Abstract. The last few years have witnessed important advances in our understanding of time preference and social discounting. In particular, several rationales for the use of time-varying social discount rates have emerged. These rationales range from the ad hoc to the formal, with some founded solely in economic theory while others reflect principles of intergenerational equity. While these advances are to be applauded, the practitioner is left with a confusing array of rationales and the sense that almost any discount rate can be justiFed. This paper draws together these different strands and provides a critical review of past and present contributions to this literature. In addition to this we highlight some of the problems with employing DDRs in the decision-making process, the most pressing of which may be time inconsistency. We clarify their practical implications, and potential pitfalls, of the more credible rationales and argue that some approaches popular in environmental economics literature are ill-conceived. ±inally, we illustrate the impact of different approaches by examining global warming and nuclear power investment. This includes an application and extension of Newell and Pizer [‘Discounting the beneFts of climate change mitigation: how much do uncertain rates increase valuations?’ Journal of Environmental Economics and Management 46 (2003) 52] to UK interest rate data. Key words: global warming, intergenerational equity, social cost beneFt analysis, time inconsistency, uncertainty, time varying discount rates 1. Introduction Debates about discounting have always occupied an important place in environmental policy and economics. Like all other investments, investment in the environment involves incurring costs today for beneFts in the future. Whether a public investment is efficient or not is determined by social cost beneFt analysis (CBA). Where welfare is Utilitarian, the socially efficient level of investment is attained by investing in projects where the net present value Environmental & Resource Economics (2005) 32: 445–493 Ó Springer 2005 DOI 10.1007/s10640-005-4681-y
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(NPV), determined by discounting costs and benefts at the social discount rate (SDR) over the time horizon, is greater than zero. 1 It Follows that the level oF the SDR is critical in determining whether an individual public investment or policy will pass a CBA test.
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groom - Environmental Resource Economics(2005 32 445493 DOI...

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