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8 Conclusions

The purpose of this paper has been to explain the alternative ways of thinking about public sector discount rates, and thereby provide the basis for a rational debate. It has been shown that there are two main ways of thinking about public sector discount rates. These depend largely on the assumption regarding the way the resources would otherwise be used in the absence of the public project being considered. They are as follows.

  • The social opportunity cost of capital approach - the rate of return that a decision-maker could earn on a hypothetical next best available alternative (or the opportunity cost of a public project)
  • The social rate of time preference - the rate of return that a decision-maker requires to sacrifice a unit of present consumption in order to invest in a public project.

It has been stressed that neither approach offers an objective way of determining public sector discount rates. Value judgements are inevitable.

SOC-based approaches are traditionally regarded as being more objective, based as they are on observable market returns. However, the very decision to select a SOC-based approach carries a number of implicit assumptions. These include assumptions that market-based counterfactuals provide an appropriate counterfactual for public projects, public projects fully crowd-out private sector projects of equal magnitude, political decision-makers should trade-off the future in the same way that individuals and businesses do when making decisions about their own personal consumption and investment - or all relevant preferences are measurable and accounted for in CBA cash flows. Also it is assumed that the way markets evaluate and price risk are also how governments evaluate and price risk.

SRTP-based approaches require explicit statements of the decision-maker's value judgements. Indeed, the necessity to specify these aspects explicitly, rather than concealing them, may be considered a strength of the approach. Only very limited information can be drawn from financial markets to help calibrate SRTP. Nevertheless, the determination of the appropriate discount rate involves complex concepts that are not easy to specify precisely.

It has been seen that there is no unambiguously clear answer to the question of what public sector discount rate to use. The choice depends on a complex range of technical judgements as well as value judgements, so it is not surprising that widespread agreement about the rate is very difficult, if not impossible, to achieve. After first making a decision regarding the general approach to be taken, many further questions remain involving orders of magnitude of crucial variables. It is hoped that the present paper can contribute to rational policy analysis by clarifying the essential features of alternative approaches and highlighting the central role of value judgements.

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