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

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  • Koen Vermeylen

    (University of Amsterdam)

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.

Suggested Citation

  • Koen Vermeylen, 2013. "Non-Marginal Cost-Benefit Analysis and the Tyranny of Discounting," Tinbergen Institute Discussion Papers 13-203/VI, Tinbergen Institute.
    • Handle: RePEc:tin:wpaper:20130203
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    More about this item

    Keywords

    climate change; cost-benefit analysis; discounting; WTP; WTA;
    All these keywords.

    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 and their Management; Global Warming

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