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Evaluation of Public Projects from the Viewpoint of Social Rate of Discount

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  • Jan Kubíček
  • Leoš Vítek
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    Abstract

    A social rate of discount is an important variable for cost-benefit analysis. Its size can be crucial for an approval (or disapproval) of the project under evaluation, therefore it is important to have a theoretically founded estimate of the discount rate. There are two main approaches to estimating the social rate of discount. The first one is a so called social time preference rate (STPR), which is composed of three components: pure time preference, mortality rate and a component reflecting secular growth of per capita consumption and wealth. We agree with other authors that although pure time preference is not in reality zero for individuals due to myopia and irrationality, it should be equal to zero from the point of view of the public sector. We have also shown why it is inconsistent to use mortality rate directly as a component of the STPR and why a somewhat lower rate should be used instead. These two components together with an estimate of gradually decreasing growth of per capita consumption give a gradually decreasing STPR for the Czech Republic starting at 5.4 % and converging in 40 years´ period to 2.8 % per year. The other approach to estimating the social discount rate is based on social opportunity costs (SOC). We used long-term bond yields for estimating a certainty equivalent social discount rate. We found gradually decreasing discount rate as appropriate, which starts at 3.2 % and declines by 0.016 percentage points per every year of duration of the project.

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    Bibliographic Info

    Article provided by University of Economics, Prague in its journal Politická ekonomie.

    Volume (Year): 2010 (2010)
    Issue (Month): 3 ()
    Pages: 291-304

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    Handle: RePEc:prg:jnlpol:v:2010:y:2010:i:3:id:731:p:291-304

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    Related research

    Keywords: social rate of discount; pure time preference; long-term bonds; intergenerational solidarity; cost-benefit analysis; certainty equivalence;

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    References

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    1. Weitzman, Martin L., 1998. "Why the Far-Distant Future Should Be Discounted at Its Lowest Possible Rate," Journal of Environmental Economics and Management, Elsevier, vol. 36(3), pages 201-208, November.
    2. Arrow Kenneth J, 2007. "Global Climate Change: A Challenge to Policy," The Economists' Voice, De Gruyter, vol. 4(3), pages 1-5, June.
    3. Kula, Erhun, 1984. "Derivation of Social Time Preference Rates for the United States and Canada," The Quarterly Journal of Economics, MIT Press, vol. 99(4), pages 873-82, November.
    4. Gollier, Christian, 2002. "Discounting an uncertain future," Journal of Public Economics, Elsevier, vol. 85(2), pages 149-166, August.
    5. Arrow, Kenneth J & Lind, Robert C, 1970. "Uncertainty and the Evaluation of Public Investment Decisions," American Economic Review, American Economic Association, vol. 60(3), pages 364-78, June.
    6. Shane Frederick & George Loewenstein & Ted O'Donoghue, 2002. "Time Discounting and Time Preference: A Critical Review," Journal of Economic Literature, American Economic Association, vol. 40(2), pages 351-401, June.
    7. David Evans, 2004. "A social discount rate for France," Applied Economics Letters, Taylor & Francis Journals, vol. 11(13), pages 803-808.
    8. Michael Spackman, 2004. "Time discounting and of the cost of capital in government," Fiscal Studies, Institute for Fiscal Studies, vol. 25(4), pages 467-518, December.
    9. David J. EVANS, 2006. "Social discount rates for the European Union," Departmental Working Papers 2006-20, Department of Economics, Management and Quantitative Methods at Università degli Studi di Milano.
    10. David Evans & Haluk Sezer, 2004. "Social discount rates for six major countries," Applied Economics Letters, Taylor & Francis Journals, vol. 11(9), pages 557-560.
    11. Marco Percoco, 2007. "A social discount rate for Italy," Applied Economics Letters, Taylor & Francis Journals, vol. 15(1), pages 73-77.
    12. Fama, Eugene F, 1996. "Discounting under Uncertainty," The Journal of Business, University of Chicago Press, vol. 69(4), pages 415-28, October.
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