Abstract
Discounting is a tool used by economists to make tradeoffs over time. Discounting is relevant to disaster risks because they are generally low-probability and hence are not likely to occur immediately. The combination of low probability and the on-going nature of the risks make discounting especially salient for large-scale disasters. Because infrastructure can last for many decades in the future, the choice of discount rates can significantly affect assessments of the value of increased safety measures. An emerging consensus among economists calls for applying discount rates that are lower for risks farther in the future as compared with harms in the immediate future. The rationale is that long-term investments provide a hedge against uncertainty regarding future economic growth. Declining rates are also justified when portions of the population have low prospects for income growth compared with other societal groups. Inequality, particularly the future economic prospects of poorer individuals, matters in terms of discounting. Fixed discounting rates such as those now used by the U.S. government may undervalue disaster risks by using too high a discount rate. The implication is that society has been underinvesting in infrastructure resiliency.
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Notes
- 1.
One common argument for discounting is that individuals do not place as much importance on future harms as on present harms, and infrastructure planners and policy makers should defer to this preference. Another is that people in the future are likely to be wealthier due to economic growth, and we should be reluctant to transfer money from the people today to people in the future who will be relatively wealthy by comparison (Sunstein and Rowell 2007; for a contrasting view, see Carey 2014). One common argument for discounting is that spending money has an opportunity cost, on the assumption that money can be invested elsewhere and made to grow. I will argue has little relevance to selection of the discount rate.
- 2.
For the sake of simplicity, also assume that the monetary costs of the two proposals are equal, and that construction of either repository would be completed in a single year.
- 3.
Note that the assumption is continued long-term growth at a constant rate, which may not be realistic in a world of limited resources and environmental sustainability (Cooke 2012).
- 4.
In this context, “safe” means either that the return is certain or that any risks are completely diversifiable.
- 5.
In the limited legal literature discussing the topic, there is a tendency to phrase the issue as involving uncertainty about interest rates. But the issue is not volatility in financial markets as such. Rather, it is uncertainty about economic fundamentals.
- 6.
Of course, if the government could completely redistribute wealth in each time period, the disparity in income growth would not exist. But to raise this possibility is also to show its irrelevance.
- 7.
In addition, growth rates have been much more volatile in developing countries than in developed ones, requiring a lower discount rate to hedge against the increased level of risk (Gollier 2013).
- 8.
Recent evidence suggests that developing countries are no longer catching up with developed ones (Economist 2014b).
- 9.
It is worth noting that disasters often disproportionately strike disadvantaged groups. For instance, in the case of Hurricane Katrina, among displaced blacks in Orleans parish, over a third were estimated to be poor. The poor were disproportionately able to evacuate because they lacked access to automobiles. In addition, “over 30 % of the most impacted population had incomes below one-and-one-half times the poverty line and over 40 % had income below twice the poverty line” (Farber et al. 2010). Thus, it may well be true that safety measures benefit the poor more than the rich.
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Farber, D.A. (2016). Discount Rates and Infrastructure Safety: Implications of the New Economic Learning. In: Gardoni, P., Murphy, C., Rowell, A. (eds) Risk Analysis of Natural Hazards. Risk, Governance and Society, vol 19. Springer, Cham. https://doi.org/10.1007/978-3-319-22126-7_4
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