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6.2 Reflecting time preference

The SRTP approach to determining discount rates is a direct way of trying to think about the considerations that are relevant to determining a decision-maker's time preference. However, actually specifying these considerations requires subjective decisions about somewhat abstract concepts. These issues are discussed below when looking at the measurability of the two approaches. Furthermore, although the underlying theory used to formulate the version of SRTP presented above is widely used and cited, it involves a number of assumptions which need to be scrutinised.

On the other hand, using a market-based SOC to determine public sector discount rates (whether this is based on share market returns or risk-free rates, or a combination of the two) assumes that market rates of return contain all relevant preferences about how the future should be traded-off versus the present in all cases. That is, a market-based SOC imposes the value judgement that political decision makers should trade-off the future for public investments in the same way that individuals or businesses do when making decisions about their own personal consumption and investment.

This might be appropriate for some government investments whose principal purpose is to earn a financial rate of return for society, for example the New Zealand Superannuation Fund, and some investments by state-owned enterprises. However, the relevant question to ask is whether individuals would trade-off the future for, say, publicly-funded health, education, arts and community projects in the same way that they do for decisions about their own personal consumption and investment. That is, would individuals demand the same rate of return in order to sacrifice a unit of present consumption for a social investment, as that which they demand for a private investment?

It is possible that individuals in their political roles as citizens might be more concerned about future social outcomes than is reflected in their day-to-day decisions about their own personal consumption and investment. Specifically, people may care about the wellbeing of current and future generations from both a financial and social justice perspective (involving intra-generational and inter-generational equity). These preferences are unlikely to be reflected in market-based instruments, the primary purpose of which is to shift private consumption through time. If this were the case, it would mean that individuals would be more willing to invest in public sector projects than is implied by market rates of return. That is, individuals would be willing to invest in public projects up to a point where the rates of return on public investments are lower than those observed in financial markets. This would mean that the discount rate implied by a market-based SOC would be too high for certain public projects, particularly in the social sector, as it would overlook preferences that would tend to lower the discount rate. An SRTP approach is a direct way of trying to capture these preferences.

A separate issue is whether government agencies are able to value all relevant costs and benefits, including social costs and benefits, when carrying out cost-benefit analyses (CBA) of policy initiatives. The current New Zealand Treasury approach assumes that this is the case.[23] As mentioned earlier, the question of whether all costs and benefits can be measured in money terms is outside the main focus of this project. However it is recognised that this is likely to be a strong assumption, and that if some of these benefits cannot be valued, or are otherwise systematically undervalued in CBA, then a dollar yield on a public sector project is not equivalent to a dollar yield on a private sector investment. Under these circumstances it is sometimes argued that it is appropriate to trade-off the future for social sector projects differently than for private sector projects. In other words, it is argued that the required rate of return for some public investments might be lower than that implied by a market-based SOC.

It is certainly important to know whether some types of cost and benefit might be systematically under- or over-estimated in CBA. However, it is not usually advisable to try to correct for these biases through the discount rate. The wrong assessment of costs and/or benefits could go in either direction, and they are likely to vary widely from project to project.


  • [23]The New Zealand Treasury's CBA guidance states, ‘assuming all benefits have been valued correctly, we should be indifferent between one kind of benefit and another if their value is the same'.
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