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Sep 30Liked by Dave Heatley

One thing that is not discussed here is whether the discount rate is a contributor to the short-termism endemic in New Zealand public policy making. Why value policies that pay off in the future when the discount rate - indeed the entire theoretical and philosophical background to the rationale for a discount rate - is that we should and will prefer current expenditure pay-off versus a pay-off that may be quite a way down the track, including for future generations? Think infrastructure, think ferries, think national super, think water quality, think climate change, think urban sprawl. All of these, and more, ask us to defer immediate gratification for future generations and a desirable future state for New Zealand. Could it be that the discount rate as constituted is an ideological bias towards presentism that is foisted onto us by the great intellects of economics past and present? Yet the young will have to live through the future we are bequesting them (and which we will not have to face)!

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Thanks for your comment Peter. It is true that reducing the discount rate would support a higher level of investment. And many people believe that society underinvests, particularly in areas like infrastructure.

In any case, even if government does want to increase the level of investment, it should still choose to make the investments that provide the highest long term social and economic returns. In the past, the Treasury has argued that because the government has the option of investing in the private sector (e.g. through the NZ Super Fund) and earning a private rate of return (say 8.0%), any public sector project should provide a rate of return that is at least as high. This is the 'social opportunity cost' argument I mention in the post.

I completely agree with the points in Dave's comment too - it's not a simple matter!

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A great question Peter. As per your examples, the public-sector discount rate is most often applied in situations in which costs are in the near future and benefits are realized later. Such projects are more likely to pass a cost-benefit test with a low discount rate, and less likely with a higher rate.

Someone smarter than me described high discount rates as “tyranny of the present” because they largely ignore benefits to future generations. The flip side is that low discount rates represent a “tyranny of the future”, because the costs to current generations get swamped by the benefits to (multiple) future generations. Discount rates on a continuum between those extremes can be understood as different allocations of “caring” between current and future generations.

A complicating factor is that when we do such cost benefit calculations, it is the current generation making assumptions about what future generations will actually benefit from. This might be incorrect. To take one counter example, very low public sector discount rates might have encouraged even more “Think Big” projects in the 1970s/80s, on the basis that that generation were bequeathing valuable assets to future generations. We are those future generations, and ideas about what is valuable have changed significantly. It might be prudent to be humble about our ability to predict what future generations will (or won’t) value.

Seen this way, “caring” might push towards a lower discount rate, but “humility” might push towards a higher rate.

Moreover, if a project is debt funded, then future generations may value the asset they receive at less than the cost (to them) of the debt we have burdened them with. Avoiding that outcome also counts as caring in my book.

This is perhaps a long way of saying that the intergenerational ethics of discount rate selection are a more complex than a simple ideological choice. The future is uncertain, and (higher) discount rates are an imperfect way of bringing that uncertainty into our decision making.

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