The problem of discounting benefits and costs in cost-benefit analysis has caught the attention of several prominent economists during many decades without resulting in any clear consensus. We present and discuss the two methods most frequently proposed today: 1) "The Presciptive Approach", which bases the discounting on a society's marginal rate of substitution in consumption between different time periods and 2) "The Descriptive Approach" which uses the pre-tax social rate of return on private investment. Several objections to the descriptive approach are raised. One of the most important of these objections is that the approach discriminates against long-term investments. The same discrimination problem arises if one uses the borrowing rate on the international financial markets as the discount rate, as some economists propose as a third approach. The background for this method is the higher degree of capital mobility in international markets and the fact that a project with an internal rate of return higher than the borrowing rate will fulfil the Kaldor-Hicks compensation criteria. However, at Ieast some projects with an internal rate of return lower than the international interest rate will nevertheless also fulfil the Kaldor-Hicks criteria, and they are not necesserily inferior. This is because one must normally take the distribution effects of the analysed projects into consideration when one tries to assess their total social value. Finally we explain why the distributionary effects are extraordinary important, if a project extensively affects generations in the far future.
|Place of Publication||Frederiksberg|
|Publisher||Copenhagen Business School, CBS|
|Number of pages||18|
|Publication status||Published - 2004|
|Series||Working Paper / Department of Economics. Copenhagen Business School|