BOX 5-1 Does Discounting Harm the Future?

The discounting of future benefits and costs is a practice introduced from financial analysis to account for the productivity of capital. In recent years, some environmental economists have been swayed by critics who worry that discounting implies that the concerns of the future (perhaps only a few decades hence) count only trivially in the calculations of the present. Thus, we have the discounting paradox: we must discount, it is claimed, to avoid damaging the future by making wasteful commitments of capital to unproductive projects; and we must not discount, it is also claimed, to avoid trivializing future demands for present conservation.

The paradox can be resolved in the following way. We can be reasonably confident of two propositions: if the problem is simply to determine the rate of consumption from an endowment (the "cake-eating problem"), a society with a positive discount rate will choose a consumption path relatively high at the outset and declining over time (Page 1977); and if capital is productive and the young need to borrow it to produce efficiently, equilibrium interest rates will be positive and a policy of repressing the interest rate (undertaken, one imagines, to protect the future) will actually depress the trajectory of future welfare (Farmer and Randall 1997). That is, in a cake-eating economy, discounting is destructive of future welfare, but in a productive economy it is not.

This resolution of the discounting paradox directs our attention to the real question: are we, or are we not, operating in an economy that is ultimately cake-eating? If capital accumulation is sufficiently high, renewable resources are managed carefully, capital and renewable resources are adequately substitutable for exhaustible natural resources, and technological development tends to enhance the substitutability of plentiful resources for those which are most scarce, the cake-eating problem can be avoided. In that case, concerns that discounting inherently damages the future are misplaced. It can also be argued that such policy interventions as the safe minimum standard, which address directly crucial natural resources, provide a more appropriate response to conservation crises within otherwise productive economies than would repression of the discount rate.

that realistically high discount rates discourage wasteful investments that would actually harm future prospects. Current writers are skeptical about the wisdom of using low discount rates to achieve policy goals, preferring more direct approaches to the concerns of environmentalists. For example, Howarth and Norgaard (1991) argue that balancing equity among generations should be addressed by intergenerational transfers of resources, and Farmer and Randall (1997) suggest that targeted conservation policies provide the appropriate remedy to the extent that particular natural resources are both necessary for human welfare and threatened with exhaustion.

Cost-effectiveness analysis can be useful in guiding decisions toward the



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