Discounting for time and space in infrastructure appraisal (25)

Theme Track: Transportation - Infrastructure and Regional Development

Author:
Percoco, Marco

All infrastructure projects have some environmental effects, either positive or negative, since either directly or indirectly all projects will create some demand on natural resources and some waste products to be assimilated by the environment. Recent policy discussion have stressed the importance of environmental sustainability to ensure that projects do not make demands on the environment that are excessive relative to the current stock of natural capital. However, whether or not environmental considerations are important for a particular project will vary with its characteristics; a simple classification may serve to illustrate the point. We can think: 1. projects where the main objective is to produce an environmental benefit, either in terms of an improvement to the environment or the avoidance of damage that would otherwise occur; 2. projects with non-environmental objectives but with significant environmental effects (this is the main case for the transport infrastructure); 3. projects with non-environmental objectives and relatively minor environmental effects. If environmental effects can be quantified and valued they must be incorporated in a project analysis in the same way as other benefits and costs. This requires their reduction to present values through the procedure of discounting: however the use of ordinary discount rates to adjust environmental effects remains controversial. This paper focus on two main aspects of modern theory of discounting: a) time inconsistency of consumers and b) spatial discounting. a) Most discounting models are based on the behavioural assumption that people prefer to experience pleasurable experiences as soon as possible and to delay painful experiences. While the first hypothesis, impatience, seem fairly robust to empirical observation and experimental tests, the second one, procrastination of pain, is more controversial. It will be shown that different sets of behavioural assumptions generate different types of discounting models. Besides, if agents are uncertain about their discount rates, it may be rational for them to discount the distant future hyperbolically than exponentially. Such findings may rationalise a common observation in experimental work, which indicates that people discount the future at hyperbolic rates. b) Decision makers tend to discount not only over time but across space so that just as time discounting has implications for intergenerational equity, geographical discounting has implications for intragenerational equity. Positive rates of spatial preference imply an ethical judgement about the responsibility of the decision maker for the welfare of others. More particularly, positive rates imply that people care more about those who are close to them than about those who are distant. Both arguments a) and b) have strong implications for environmental appraisal of infrastructure. In fact, the basic concepts of intergenerational and intragenerational equity imply sustainable investment and policy. Hence the main finding of the paper is that there is a well-defined sense in which the 'lowest possible' interest rate should be used for both time and spatial discounting for environmental effects generated by an infrastructure.

Keywords: infrastructure investment appraisal, environmental effect discounting, geographical and time preference

JEL classification: C9, D91, E21

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