Non-Marginal Cost-Benefit Analysis and the Tyranny of Discounting
AbstractThis paper uses the Kaldor-Hicks compensation principle to compute the present value (PV) of a non-marginal future event. Three theoretical results stand out: First, decreasing returns to capital create a wedge between the PV of future generations' willingness to pay (WTP) and the PV of their willingness to accept compensation (WTA); second, the discount rates implicit in the computation of the PVs are endogenous, and rising (declining) over time for the future generations' WTP (WTA); and third, decreasing returns to capital may make it impossible to compensate future generations according to their WTA, effectively defeating the tyranny of discounting. A back-of-the-envelope calibration suggests that this last result is realistic in the case of climate change. A cost-benefit analysis based on the Kaldor-Hicks compensation principle may therefore be impossible if futu re generations are entitled to a world without climate change; and an environmental trust fund - no matter how large it is - may be insufficient to adequately compensate future generations.
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Bibliographic InfoPaper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 13-203/VI.
Date of creation: 16 Dec 2013
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climate change; cost-benefit analysis; discounting; WTP; WTA;
Find related papers by JEL classification:
- D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
- E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
- H43 - Public Economics - - Publicly Provided Goods - - - Project Evaluation; Social Discount Rate
- Q51 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Valuation of Environmental Effects
- Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters
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