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Non-Marginal Cost-Benefit Analysis and the Tyranny of Discounting

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  • Koen Vermeylen

    (University of Amsterdam)

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    Abstract

    This 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 Info

    Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 13-203/VI.

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    Date of creation: 16 Dec 2013
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    Handle: RePEc:dgr:uvatin:20130203

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    Web page: http://www.tinbergen.nl

    Related research

    Keywords: climate change; cost-benefit analysis; discounting; WTP; WTA;

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    References

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    1. Gollier, Christian & Weitzman, Martin L., 2010. "How should the distant future be discounted when discount rates are uncertain?," Economics Letters, Elsevier, vol. 107(3), pages 350-353, June.
    2. Douglas Gollin, 2001. "Getting Income Shares Right," Department of Economics Working Papers 2001-11, Department of Economics, Williams College.
    3. Newell, Richard G. & Pizer, William A., 2003. "Discounting the distant future: how much do uncertain rates increase valuations?," Journal of Environmental Economics and Management, Elsevier, vol. 46(1), pages 52-71, July.
    4. Christian Gollier & Richard Zeckhauser, 2005. "Aggregation of Heterogeneous Time Preferences," Journal of Political Economy, University of Chicago Press, vol. 113(4), pages 878-896, August.
    5. 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.
    6. Cameron Hepburn & Phoebe Koundouri & Ekaterini Panopoulou & Theologos Pantelidis, 2006. "Social Discounting Under Uncertainty: A cross-country comparison," The Institute for International Integration Studies Discussion Paper Series iiisdp177, IIIS.
    7. Christian Gollier, 2011. "Discounting and risk adjusting non-marginal investment projects," European Review of Agricultural Economics, Foundation for the European Review of Agricultural Economics, vol. 38(3), pages 325-334, August.
    8. Christian Gollier, 2008. "Discounting with fat-tailed economic growth," Journal of Risk and Uncertainty, Springer, vol. 37(2), pages 171-186, December.
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