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POLICY IMPLICATIONS OF ZERO DISCOUNTING: AN EXPLORATION IN POLITICS AND MORALITY
Published online by Cambridge University Press: 13 January 2004
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What are our political obligations to future generations? How does morality suggest that we weight current interests against future interests? Do politics or markets place greater weight upon interests in the very distant future? How should we discount future costs and benefits?
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- © 2004 Social Philosophy and Policy Foundation
I. Introduction
What are our political obligations to future generations? How does morality suggest that we weight current interests against future interests? Do politics or markets place greater weight upon interests in the very distant future? How should we discount future costs and benefits?
A ‘discount rate’, by definition, tells us how to compare future benefits to current benefits (or costs) in a consequentialist calculus. A zero discount rate means that the future counts for as much as the present. Insofar as the discount rate is high, we are counting future costs and benefits for less.
Elsewhere, I have argued that we should consider using a zero rate of intergenerational discount for well-being and sometimes for dollars as well.1
See Tyler Cowen and Derek Parfit, “Against the Social Discount Rate,” in Philosophy, Politics, and Society, 6th ser., Peter Laslett and James Fishkin, eds. (New Haven, CT: Yale University Press, 1992), 144–61; and Tyler Cowen, “Consequentialism Implies a Zero Rate of Intergenerational Discount,” in Philosophy, Politics, and Society, Laslett and Fishkin, eds., 162–68.
Economists, who tend to be market-oriented (at least relative to philosophers), usually resist the idea of zero discounting. They see market prices as prima facie indicators of the value of resources.2
See Robert C. Lind et al., Discounting for Time and Risk in Energy Policy (Washington, DC: Resources for the Future, 1982); and the essays in Paul R. Portney and John P. Weyant, eds., Discounting and Intergenerational Equity (Washington, DC: Resources for the Future, 1999).
Wilfred Beckerman presents one statement of a market-oriented view, critical of zero discounting, in Wilfred Beckerman, Through Green-Colored Glasses: Environmentalism Reconsidered (Washington, DC: Cato Institute, 1996).
My informal polling over the years suggests that many advocates of greater state spending—especially noneconomists—like the idea of a lower discount rate. These individuals typically would like the United States government to spend more money on education, infrastructure, and the environment. These individuals have not always worked through the technical, economic, and philosophical issues, but they see a lower discount rate as providing support for all of these policies. They believe that we are not caring enough about the future. Therefore, zero discounting serves as a “left-wing” view in most cases.4
See, for instance, Robert Solow, “The Economics of Resources or the Resources of Economics,” American Economic Review 64, no. 2, Papers and Proceedings of the Eighty-sixth Annual Meeting of the American Economic Association (1974): 1–14.
I argue that the current sociology of views on this issue does not match the reality. A zero rate of discount is likely to lend the most support to policies that favor a market economy, economic growth, and technological innovation. Indeed, some arguments for a market economy may require a zero or very low rate of discount. Positive rates of discount usually imply that we should grant considerable importance to the alleviation of immediate suffering. Market liberalizations, whatever virtues they may have in the long run, often increase immediate suffering. Furthermore, market economies tend to invest their surpluses in long-term growth rather than redistribute them to the suffering poor. Market economies and market reforms therefore look better, the greater the weight we place on the relatively distant future.
A zero rate of discount also boosts the more general case for a free society. A free society is better today than a corrupt and totalitarian alternative. But one hundred years from now, the difference in human welfare will prove far more pronounced. If we apply a positive rate of discount, then this future difference is not a big deal. If we apply a zero rate of discount, then the case for a free society becomes that much stronger.
Finally, a zero discount rate will have significant repercussions for ethical reasoning. In Section IV, I argue that zero discounting would help the prospects of utilitarianism, provide a new argument for rule-utilitarianism, and increase the weight of consequentialist factors, relative to deontology, in plausible versions of pluralism.
These arguments do not, themselves, either favor or damage the case for a zero rate of discount. We should not first look for the conclusions we want and then work backwards toward the assumptions. Nonetheless, a process of reflective equilibrium requires that we consider the implications of our beliefs. Toward this end, my investigation will illustrate how a zero rate of discount would accord, or not accord, with our other moral and practical intuitions. This investigation will improve our understanding of what is at stake in the discount rate debates. I hope to stimulate interest in these debates, shake up individuals on each side of the political spectrum, point out an unrecognized robustness of consequentialism, and improve our understanding of which policy recommendations are likely to fit together.
Throughout this essay, I couch the analysis in terms of utilitarianism. In particular, I consider the wealth-maximizing ordinal utilitarianism that one finds in economics, as well as interpersonal cardinal utilitarianism. I do not adhere to these views as our best moral theories, all things considered. Nevertheless, I adopt them as a working tool for two reasons. First, I am concerned with rebutting some common presumptions of economics, and thus I adopt this framework for heuristic reasons. Second, and more importantly, most plausible moral theories have a strong consequentialist element and must somehow compare present well-being to future well-being. Ordinal and cardinal utilitarianism are the only moral doctrines that offer a formal and generally accepted framework for such comparisons. I therefore use this framework simply because nothing better is available for the consequentialist part of our broader moral theory. Still, the results of this essay ultimately must be embedded in a deeper and more fully fleshed out pluralistic framework, where utilitarian results are but one factor in a broader assessment. My entire analysis of policy is subject to this important qualification.5
My current research seeks to argue that a broader pluralistic theory will likely track many of the utilitarian recommendations in these cases. Both pluralistic and utilitarian theories will be led to endorse policies that strengthen and extend the prospects of our civilization. See Tyler Cowen, “Civilization Renewed,” manuscript in progress (George Mason University, 2003). That longer manuscript will also consider how we might “discount” our deontological obligations through time. In my contribution to this volume, however, I offer only some general remarks on pluralism, at the end of Section IV.
In addition, I do not address as a separate issue how we might discount present versus future manifestations of other values, such as equality, justice, or community. Utility and wealth are the easiest values to study in this manner, and thus I start with them, but without denying the importance of a broader study for other values as well.
This essay proceeds as follows: Section II provides a brief look at (but not a complete resolution of) the debate on intergenerational discounting. Section III asks how a zero rate of discount would change our evaluation of various policies. I start with the general question of economic growth and then consider specific policies governing savings, welfare programs, and government versus market provision of goods and services. Section IV asks how a zero discount rate would influence current debates over utilitarianism. Section V offers some concluding remarks.
The survey in Section II uses some technical economic language, but the remainder of the essay, including my central arguments, remains intelligible to the general reader. So, I would urge readers to skip over any difficult passages in Section II rather than getting bogged down in them. The import of those arguments will, in any case, become clear in subsequent sections.
II. Arguing for a Zero or Lower Discount Rate
The arguments for a zero discount rate typically focus on the concept of well-being. Derek Parfit, for instance, has argued that there is no compelling moral reason for attaching a positive rate of intergenerational discount to benefits and costs in the distant future.6
Derek Parfit, Reasons and Persons (New York: Oxford University Press, 1986).
Cowen and Parfit, “Against the Social Discount Rate,” 145.
The following discussion in the text does not consider risk. There is unanimous agreement on discounting for risk: if a future event may not come to pass, then we should count it for less.
The following table shows some comparisons between present and future benefits, using various positive rates of intergenerational discount:
Estimated number of future benefits equal to one present benefit based on different discount rates
How would a zero rate of discount on well-being translate into a discount rate for dollars? Clearly a dollar today, if we invest it to yield $1.05 next year, is worth more than a dollar next year. This follows from the ‘dominance principle’, which states that more of a good thing is preferred to less. But this argument does not show that a dollar's worth of consumed resources, this year, is worth more than a dollar's worth of consumed resources next year. To address this comparison, we must consider the relative marginal utilities of consumption in each period, not the marginal product of capital or the rate of return on savings.
Economist John Broome articulates the strongest case for positive discounting. He argues for discounting dollar benefits, though not necessarily for discounting well-being. Economies typically grow wealthier over time. So a dollar today is worth more, at the margin, than a dollar in the future, for the same reasons that a rich Tyler values a dollar less than does a poor Tyler. This judgment does not require interpersonal comparisons of utility, but, rather, requires only that we can transfer dollars back and forth in time by borrowing and lending. In economic jargon, the positive interest rate equalizes marginal rates of substitution over time, or in other words, it expresses the value of a future dollar relative to a current dollar.9
John Broome, “Discounting the Future,” Philosophy & Public Affairs 23, no. 2 (1994): 128–56. See also Kenneth J. Arrow, William R. Cline, Karo-Goran Maeler, et al., “Intertemporal Equity, Discounting, and Economic Efficiency,” in James P. Bruce, Hoesung Lee, and Erik F. Haites, eds., Climate Change 1995: Economic and Social Dimensions of Climate Change (Cambridge: Cambridge University Press, 1996), chap. 4; and Thomas C. Schelling, “Intergenerational Discounting,” Energy Policy 23, nos. 4/5 (1995): 395–401.
The Broome argument does justify positive discounting of dollars for small policy changes, at least if we are willing to accept an economic framework more generally. But the argument does not necessarily justify using the observed market rate of discount when we consider significant changes in wealth. As with all cost-benefit methods, the argument takes the overall distribution of wealth as given and examines a small change in allocations, that is, small in value relative to the wealth of the individuals in question. But when wealth effects are large for the individuals involved, market prices no longer measure marginal rates of substitution for the two relevant outcomes. In other words, the market rate of interest measures the rate at which people are willing to trade off marginal dollars across time, but it does not measure the rate at which they are willing to trade off larger sums of money (i.e., infra-marginal dollars). Similarly, the market interest rate does not measure the value of a life today versus the value of a life tomorrow.
A simple example will clarify the point for those who are unfamiliar with economic jargon. A man wandering lost in a desert probably has a higher marginal value of water than I do, sitting in my suburban Virginia home. But this does not give us any information about how to forecast the relative values of “I lose all my water” against “He loses all his water.” Either he or I would die without water, and the value of his life may be greater than, less than, or equal to mine. The original difference in marginal values for water does not measure or forecast, even imperfectly, the comparative value of our two lives. The two concepts are entirely distinct. In similar fashion, the market rate of interest measures the value of small changes across time, but not large ones (i.e., infra-marginal changes). The difference between marginal and infra-marginal effects is recognized in the theory of cost-benefit analysis, but it is commonly neglected when intergenerational discount rates are discussed or applied.10
On small versus large changes, see the survey of Jean Drèze and Nicholas Stern, “The Theory of Cost-Benefit Analysis,” in Handbook of Public Economics, vol. 2, ed. Alan J. Auerbach and Martin Feldstein (Amsterdam: North-Holland, 1987), 909–89. We might try to save the positive discounting argument by invoking transitivity. This claim would run as follows: if we are willing to discount dollars at a positive rate, then we must discount lives at the same rate. At the margin we can always invest dollars to save lives. Differential discount rates for dollars and lives thus suggest an unexploited opportunity to improve social welfare. This argument, however, begs the question. It suggests that we should invest more dollars to save future lives. It does not show that a life today is worth more than a life tomorrow, taking the extent of investment as given.
Many intergenerational policies—including those regarding the environment, health, and genetic engineering—involve significant changes in wealth for many of the individuals involved. Such policies constitute large rather than small changes. For the purposes of cost-benefit analysis, a change can be large in the relevant sense even if it is small relative to total national output. Cost-benefit analysis refers to individual valuations, and the measured changes must be small for each affected individual if market prices are to yield an accurate cost-benefit measure.11
The requirement that we examine “small changes to wealth” is extremely restrictive in the intergenerational context, given the compound nature of discounting. The relevant cost or benefit must be small, not only in present value terms, but also when it arrives in the future. If we compare a small benefit today to a temporally distant benefit of equivalent present value, the future benefit, when it arrives, will not be small for those who experience it. The future benefit, when it arrives, will involve significant changes in the marginal utility of money, again vitiating the arguments for positive discounting.
Finally, when considering large policy changes, it should be noted that not everyone in the future will be richer than everyone in the present. The large policy changes, if enacted, might make some people in the future very poor. Man-made environmental catastrophe is a simple example here. So the characterization of the future as full of richer people, even if true in general, does not necessarily hold for the individuals in question. To the extent that the relevant future individuals are poorer than current individuals, this suggests negative discounting of dollars, not positive discounting.
The debate on intergenerational discounting is stuck at these points. Positive discounting of dollars, using the risk-adjusted market rate of interest, is appropriate for “small” policies. It is not necessarily appropriate for large policies that affect the marginal utility of money. In these cases we do not know the correct rate of discount for dollars. Some philosophical arguments, such as those I discussed above, suggest zero discounting for well-being, but this does not determine a discount rate for dollars. If we match dollars to welfare, one-to-one, the zero-discounting argument would apply to dollars as well, but we cannot make this cardinal judgment very easily. We are thus left with the following:
- For small changes in wealth, discount dollars by the (risk-adjusted) market rate of interest.
- For changes in well-being, use a discount rate of zero.
- For large changes in wealth, try to figure out how well-being maps into dollars. This may imply a positive, negative, or zero rate of discount.
As a practical matter, we usually do not have a very good idea of how well-being maps into dollars. For instance, we do not know the identities of future generations, much less their utility functions. At the same time, we must devise some simple and workable rule for judging large policies that affect the distant future.
I wish to consider the rule of a zero discount rate—as applied across dollars—in this context. We do know that such a zero rate cannot be correct for small decisions at the margin, for the reasons given in Broome's argument. Provided that capital is productive, an extra dollar today will be worth more than an extra dollar in the future. Nonetheless, a zero discount rate remains a possible option for large-scale changes, especially if they involve significant changes in wealth and span many generations. For these questions we have no answer that proves superior to the zero rate concept.
Rather than pursue the debate further at a philosophical level, I wish to see what policy implications would follow from a very low discount rate of this nature, be it zero or something very close to zero. We must, however, keep in mind that this zero rate is for large projects and changes only.
III. What Policies Would Follow?
Zero discounting would shape our views of numerous economic policies. The first policy recommendation would be to approach the maximization of the sustainable rate of long-run economic growth.12
Note that we should not strictly maximize the rate of economic growth. At the maximum, there will always exist some small increase in current consumption that will lower growth yet improve welfare, given Broome's argument. Nonetheless, in a long-run context we should come close to growth maximization. The following discussion in the text is therefore approximate rather than exact.
The importance of a high rate of economic growth increases, the further into the future we look. If a country grows today at two percent, as opposed to growing at one percent, the difference in welfare is relatively small. Over time, however, the difference becomes very large. For instance, had America grown one percentage point less per year between 1870 and 1990, the America of 1990 would be no richer than the Mexico of 1990.13
Tyler Cowen, “Does the Welfare State Help the Poor?” Social Philosophy & Policy 19, no. 1 (2002): 36–54.
Note that maximizing the long-run rate of growth refers to gross domestic product (GDP) as properly understood, and not necessarily as currently measured. ‘True GDP’, if I may use this term, includes leisure time, household production, and environmental amenities, which are not always measured correctly in current GDP statistics. Current GDP statistics have a bias toward what can be measured, rather than what contributes to human welfare. For this reason, “maximizing the rate of growth” does not mean that everyone should work the maximum number of hours in a day. A twenty-hour workday might maximize measured GDP, but certainly would not maximize sustainable true GDP, once we take into account the value of leisure.
Economists do not always agree on which policies will maximize the growth rate. Almost all economists agree, however, that a stable market order, private property, and the rule of law are conducive to economic growth, at least for measured GDP. Statistical studies of economic growth find that market-oriented policies are generally conducive to growth.14
The classic study here is Robert J. Barro, “Economic Growth in a Cross Section of Countries,” Quarterly Journal of Economics 106, no. 2 (1991): 407–43. See also Kevin B. Grier and Gordon Tullock, “An Empirical Analysis of Cross National Economic Growth 1951–1980,” Journal of Monetary Economics 24, no. 2 (1989): 259–76; and Paul G. Mahoney, “The Common Law and Economic Growth: Hayek Might Be Right,” Journal of Legal Studies 30 no. 2, pt. 1 (2001): 503–25.
Note that maximizing the rate of economic growth is not the same as choosing the policies that yield the highest observed growth rate. Arguably, it is possible to exceed today's maximum observed growth rates. A government could introduce freer markets, greater encouragement to savings, or other policies. A zero rate of discount would provide force to each of these recommendations.
Considering true GDP, rather than measured GDP, may lead us to revise some of the recommendations for maximizing growth. In particular, current GDP statistics may understate the value of the environment. (I return to environmental questions below in this section.) That being said, growth-enhancing policies also tend to give us more leisure time, which is a real, if not fully measurable, contribution to human welfare.
Economists still disagree about other growth-related questions. It is unclear how subsidies to technology affect the rate of growth, or how fixed and floating exchange rates affect the rate of economic growth. In these regards agnosticism is called for.16
On technology issues, see Linda R. Cohen and Roger G. Noll, eds., The Technology Pork Barrel (Washington, DC: Brookings Institution, 1991).
Note that we wish to maximize the growth rate over time, not just for a single year. Maximizing the sustainable rate of economic growth does not imply pursuing immediate growth at the expense of all other values. The key word here is sustainable. Policies that seek growth at breakneck speed are frequently unstable in both economic and political terms. Until his forced exile in 1979, Mohammed Reza Shah Pahlavi, the Shah of Iran, tried to bring his country into the modern world as rapidly as possible. Growth rates were high for a while but in the longer run could not be maintained. Since the Iranian Revolution, Iran has had, for the most part, strongly negative rates of growth. The Shah's forced modernization did not, in fact, maximize economic growth, and a more cautious set of policies likely would have been better.
More generally, maximizing the rate of sustainable growth typically implies an economically healthy present as well as a very rosy future. Current wealth and future wealth are highly correlated. So the best way for a society to be wealthy in the future, for the most part, is to be relatively wealthy and stable now. Current economic sacrifices, if they are truly impoverishing, tend to wreck political stability and destroy social capital, damaging all future generations. Well-functioning institutions are the greatest gift that we can leave to future generations. For this reason, producing wealth across generations is more akin to a positive-sum cooperative game than to a war or a fight for spoils. Therefore, we should not expect a zero rate of discount to ruin current prospects for a prosperous and livable country.
John Rawls shies away from a zero rate of discount on the grounds that it may require unacceptable sacrifices from the current generation in the form of excessive savings.17
See John Rawls, A Theory of Justice, rev. ed. (Cambridge, MA: Harvard University Press, 1999), 252.
To further address this concern, consider bequests. The material sacrifice of a generation is determined not by how much it saves at a given point in time, but, rather, by how much it bequeaths to the next generation, in lieu of consumption. Now, bequests are a one-time wealth transfer, which do not raise the rate of growth permanently or even in the short run. So, if a generation matures in a society with a high rate of growth, we should not look to bequests as the cause of their good fortune. Instead, the older generation has given the greater gift of growth-conducive institutions. The postwar Japanese generation did not leave enormous bequests to its children. The key gift was not based on total abstinence from consumption, but, rather, was based on wise investments, good rules of conduct, good political institutions, good values, and so on. Growth-enhancing institutions do require hard work from the people who produce them, but, again, we should not think of the investment as a pure zero-sum game across generations. Bequests do have a potential zero-sum element: Should I spend a dollar or leave it for my heirs? However, bequests are precisely not what accounts for a high rate of ongoing growth.
In sum, maximizing the sustainable rate of growth of true GDP is a plausible policy recommendation. It is usually good for the present, and it will make the future a very rosy place. Using a zero rate of discount does not give rise to any obviously unacceptable or counterintuitive conclusions in this regard. Given the nature and causes of economic success, it will not place the interests of different generations in extreme conflict. Good institutions are the most important “bequest” a generation can leave to the future. With this general background in mind, let us next consider some specific policies in detail.
A. The welfare state
Arguments continue over the proper size and scope of the welfare state. I do not wish to engage the entire debate, but a zero rate of discount would matter at the margin for how we think about the issues.
More specifically, a zero discount rate will tend to weaken the case for an extensive welfare state. To some extent, a welfare state can be justified as a long-run investment in social capital. It may preserve political stability or enable individuals to get better education, both of which involve payoffs in the long run. Nonetheless, most welfare states have expanded beyond this point. Most welfare states offer payments that create some short-run benefit, such as the immediate alleviation of poverty, at the expense of long-run economic growth and job creation. Most of the Western European polities, for instance, fit this pattern. There is little doubt that the welfare state benefits the citizenry in the current period. Recipients enjoy more security and providers get a feeling that they are helping their fellow citizens. For these reasons, extensive welfare states have proven very popular with Western European voters.
The long-run consequences of these welfare states, however, tend to be severe. Many Western European economies have had double-digit rates of unemployment for the better part of two or three decades. Rates of job creation have been correspondingly low. Western Europe also has experienced recurring bouts of very sluggish growth. While the welfare state is not the only culprit here, even left-wing European parties commonly recognize that their welfare states are a drag on long-run growth and economic performance.
The longer we look into the future, the more serious the negative effects of slower economic growth. (I have already explained the logic of compounding.) For this reason, a zero rate of discount tends to militate against extensive welfare states, at least welfare states that extend beyond the point where they build up social capital and encourage growth.
B. Savings
Savings in a modern economy typically yield a positive rate of return. The riskless rate of return, as we might find on short-term government securities, tends to run slightly over one percent in the United States. The question then arises whether the government should subsidize a higher rate of savings. If a savings decision yields more than one percent, but we evaluate the investment at a zero percent rate of discount, then arguably we are not saving enough money. Additional investment would bring a yield greater than what is required to justify the investment.
Currently the U.S. tax system discourages savings. Savings income is doubly taxed, once in the form of regular income and a second time as interest income. Capital gains face double taxation as well, albeit at lower effective real rates than savings income. The corporate income tax discourages investment through the corporate form and involves double taxation as well, given the corporate tax and the tax on dividends when distributed to individuals. Inflation often operates as a tax on savings. Using a zero rate of discount would imply that we should eliminate such penalties on savings and investment. We might apply a broader public choice perspective to the question and ask whether governments, on net, tend to encourage or discourage savings. Since most governments tend to discourage savings, there is a case for laissez faire in this realm.
We also might go further and institute a tax subsidy for savings. Individuals who save could be granted some form of tax deductibility, just as they currently receive tax deductibility for charitable donations. Japan has had such a policy for most of its post–World War II history. Similarly, we might choose to apply the subsidy on the demand side, such as having an investment tax credit, as the United States did through part of the 1980s. Using a zero discount rate will cast such policies in a more favorable light.
It does not necessarily follow, however, that an optimal subsidy will drive the real interest rate down to zero. Any subsidy, whether implicit or explicit, strains the government budget. At some point a subsidy would consume too much government revenue, or so impoverish the current real economy as to destroy social capital and thus imperil future economic growth. In sum, some subsidy to savings and investment is likely called for, though we do not know exactly how much.
More generally, we should not draw hasty conclusions from simple economic models of savings and investment.18
Rawls (A Theory of Justice, 251–53) surveys some of these models.
C. The environment
We should be especially concerned about environmental problems that lower the long-run rate of growth. Many scientists, for instance, believe that the greenhouse effect will increase the number of virulent and persistent storms. These storms will come only in the long run, but a zero rate of discount means that we must pay great heed to these future consequences. More generally, many environmental problems hurt the prospects for long-run growth, especially once we include suitable measurements for environmental amenities into true GDP.
At the same time, a zero rate of discount does not give environmental policy total priority over all other concerns. An obsessive focus on preserving the environment would damage seriously the long-run rate of growth and thus would not be recommended. When we look at particular environmental investments, the zero discount rate often tends to favor the environment. This is one reason why economists get nervous about a zero rate of discount. When we look at overall patterns of investment, however, we are again led to favor maximizing the sustainable growth rate of true GDP, which leads to reasonable limits on environmental protection.
In some cases a zero rate of discount will militate against environmental concerns. Return to the greenhouse effect. Many of the costs of the greenhouse effect appear to be “one-time” in nature, such as the costs of relocating coastal and inland settlements. In long-run equilibrium, transition effects aside, it is no worse and arguably better for the world to have a warmer climate (since we spend more resources warming space than cooling it). At the same time, stopping the greenhouse effect might permanently lower the rate of economic growth. When the rate of discount is zero, maximizing the growth rate tends to take priority over avoiding one-time expenditures and one-time adjustments. Even if these one-time expenditures are large, we will back that value over time, due to the logic of investment compounding.
As a sociological matter, we typically find that market-oriented economists, and conservatives more generally, are skeptical about investing to prevent long-run environmental damage. These same individuals are likely to herald the praises of economic growth and to favor a positive discount rate. Environmentalists usually hold a different bundle of positions. They believe that the environment needs special protection for its long-term health, but they place a lower value on the long-run benefits of growth, while discounting the future much less than do conservatives and market-oriented economists.
The analysis of this essay suggests a different approach. We should worry more about environmental problems that lower the rate of true GDP growth and worry less about environmental problems that involve one-time expenditures and adjustments. Furthermore, if environmentalists invoke a zero rate of discount in their favor, they should also pay more heed to maximizing the sustainable rate of economic growth.
D. Economic “shock therapy”
Most shock therapies have taken far longer to succeed than had been expected by their advocates. When Communism fell as of 1991, it was a common belief that the former Soviet Union and its satellites would need only a few years of shock therapy before they would become normally functioning market economies. It is now early in the twenty-first century and not all of these economies have turned the corner. Some may never become healthy. Arguably the reformers have not “done enough,” but what they have done has taken far longer to pay off than had been expected.
Market-oriented reforms in Chile and New Zealand also took a long time to bring prosperity. The New Zealand reforms did not start until 1984. As of the early 1990s, the economy was just emerging from continued recession. Apart from a short boom in the mid-1980s, New Zealand experienced almost a decade of serious adjustment problems, despite having done things “the right way,” by most accounts. The Chilean experience is comparable. President Augusto Pinochet's reforms started in the early 1980s and, despite their radical nature, took the better part of a decade to turn the economy around.
We see many cases where shock therapy brings a decade or more of suffering and inferior economic performance. Given the costs of the previous regimes, shock therapy might still be worth it, even with a positive discount rate. Nonetheless, positive discounting places the case for shock therapy in some jeopardy. A zero discount rate makes the case for shock therapy much stronger, provided that such reforms pay off at some point in the future with a higher rate of economic growth.
E. Market vs. government provision of goods and services
A common question is whether the market or government should supply a particular good or service. Many considerations enter into play here, such as whether we are dealing with a public good, the extent of corruption in the government, the extent of trust and social capital in the private sector, and so forth. I will not attempt to address these numerous and complex issues. Instead, I will argue that, all other things being equal, a zero rate of discount tends to tilt in favor of private sector provision.
The arguments for a zero discount rate do imply some degree of market imperfection, especially for actions that affect the very distant future. Overall, however, a zero discount rate may reflect favorably on markets, relative to government. Market practice comes much closer to a zero discount rate than does governmental practice.
Markets for short-term high-quality securities in the United States generate implicit (near) riskless discount rates between one and two percent. The federal government gives several indications of using higher discount rates. At typical interest rates, governments are typically net borrowers and the private sector is typically a net lender. (Of course, governments sometimes run measured surpluses, as did the United States for a few years under President Clinton, but deficits have been far more common for many decades.) The magnitude of government borrowing is far greater when we consider the unfunded liabilities of the government, such as we find in social security and health programs. Some of these unfunded liabilities, when they come due, will be paid off with taxes, rather than by borrowing. Such unfunded liabilities suggest that the federal government is keen to make current promises, with less thought of how to pay them off in the future.
Anecdotal observation also suggests that politicians frequently behave with very high discount rates. Reelection is considered a dominant motive of politicians, if only for evolutionary reasons. (Politicians who do not pay heed to reelection do not “survive.”) Electoral cycles range from two years to six years in the United States, which comes close to the world average for democracies. Washington politics is obsessed with the here and now: solving immediate problems, responding to the evening news, and tracking short-term opinion polls. It is not oriented toward the long haul. Nor do voters use especially farsighted criteria for evaluating politicians. Many voters do care that their lives are improving, or that the economy is prospering at the current moment, but they pay little attention to long-run trends or complicated long-term effects of policies. It is well known that most voters cannot name their representatives or do not understand how policies work. If things are going well now, most voters simply do not have the information to form a pessimistic prognosis for the longer horizon. Politicians, therefore, focus on the current moment to the neglect of the distant future.
The self-reported discount rates of government agencies also tend to be higher than market rates of interest. We should take this evidence with a grain of salt, however, as agencies do not always use the rates that they report. (To provide one example, the Office of Management and Budget reports a discount rate of seven percent.) It is not always clear how much these rates contain an adjustment for risk, if at all, or whether government should discount for risk.19
On risk, see Kenneth J. Arrow, Essays in the Theory of Risk-Bearing (Amsterdam: North-Holland, 1971).
Many market decisions reflect a higher rate of discount than we find in the market for Treasury bills. Evidence on consumer expenditures often suggests much higher implicit rates of discount. A typical study of this kind would examine, for example, whether consumers are willing to invest in energy-efficient appliances. Typically the consumer would have to pay more now, but would receive energy savings in the future. Commonly, the implicit rates of discount associated with such expenditures run in the range of twenty to thirty percent, but sometimes the rates run as high as three hundred percent. Such studies, however, do not typically present a truly risk-free expenditure. Rightly or wrongly, many consumers may be skeptical as to whether they will actually reap the energy savings. They do not always believe the claims made by suppliers. Furthermore, very high discount rates tend to cancel or disappear in an aggregate market setting. Individuals may show high discount rates in particular choice settings, but their regular market behavior differs, as measured by going rates of return.20
See George Loewenstein and Richard H. Thaler, “Anomalies: Intertemporal Choice,” Journal of Economic Perspectives 3, no. 4 (1989): 181–93. Venture capitalists also commonly use high hurdle rates for evaluating an investment, often in the neighborhood of twenty to thirty percent, although, again, these figures may reflect risk or agency problems within the firm and within project evaluation (perhaps managers are too eager to start new projects).
A closer look at these studies also shows that very high discount rates are context-specific. When individuals are considering a future pain or burden, they typically discount negatively, not positively. They would prefer that the costs arrive sooner rather than later. Arguably, anticipation of future costs involves psychological pain, so many people prefer to go to the dentist now and get it over with. Studies also find very low discount rates when the cost or benefit is large, or when the cost or benefit lies very distant in the future.21
See Shane Frederick, George Loewenstein, and Ted O'Donoghue, “Time Discounting and Time Preference: A Critical Review,” Journal of Economic Literature 40, no. 2 (2002): 351–401.
IV. Debates on Utilitarianism and Obligation
In addition to its implications for policy, a zero discount rate may have implications for philosophical debate as well. More specifically, a zero discount rate may make utilitarian theories more plausible. Furthermore, the argument for redistribution is likely to shift. Contrary to common philosophical opinion, the case for redistribution depends more on “here and now” considerations, and less on impersonal consequentialism.
Many utilitarians believe that they are forced to take extreme positions on our obligations to the current poor. Today several billion people stand just at or below the poverty line. Millions of children die each year from malnutrition, diarrhea, malaria, AIDS, and other avoidable maladies. If maximizing aggregate utility is our goal, then it would appear that we who live in affluent societies should devote considerable resources to assisting these individuals. Our marginal dollar buys an ice cream cone, a newspaper, or pet food. We could be half as rich and our marginal dollar would still purchase a luxury rather than a necessity of life. Some consequentialists have welcomed this line of reasoning. They believe that we have strong obligations to redistribute a significant portion of world income.22
See Peter Singer, Practical Ethics (Cambridge: Cambridge University Press, 1993); and Shelley Kagan, The Limits of Morality (Oxford: Oxford University Press, 1991).
Critics such as Bernard Williams suggest, instead, that this example provides a strong counterexample to utilitarian reasoning. Were we true utilitarians, all of the able people of the world would become “slaves” to the misery of the very poor. The demands of the suffering are so enormous that few individuals would be able to carry out their life projects. We can imagine, for instance, that every individual would be obliged to work for charity, or to send most of his or her income to India or Haiti. A mother might have to abandon her baby in order to send food to the babies of others, and so forth.23
See J. J. C. Smart and Bernard Williams, Utilitarianism: For and Against (Cambridge, MA: Cambridge University Press, 1973).
Examining the implications of a zero rate of discount may offer a fresh perspective on this debate. A healthy, growing economy brings a very large stream of future benefits. It will take in large numbers of immigrants, elevate many people from poverty, and yield significant technological innovations. In the more distant future it may generate space colonies, artificial intelligence, or other extraordinary benefits. As long as we expect the wealthy society to survive a reasonably long time, it will produce a very large expected value in terms of utility. We can think of any pocket of self-sustaining productive investment as bringing enormous value over time.
A poorer society is, virtually by definition, less productive. Investing in the poorer society will save lives today but will yield a lower return in the future, relative to investing in the richer society. If we look far enough into the future, this difference in productivity, through compounding, may swamp the current higher return from giving to the poor society.
It is now easy to see how the choice of discount rate will have bearing on this debate. If we discount the future at a positive rate, the long-term benefits of investing in the wealthier society will become very small, the further we look into the future. It will be that much harder to justify investing in the wealthy society, relative to the alleviation of immediate suffering. Alternatively, a zero discount rate places greater weight on the very distant future. In this case, long-run capacities play a much greater role in determining the correct utilitarian allocation of resources.
A zero discount rate does not prove that selfish investment brings more aggregate utility than does massive charity. Depending on the values of the particular parameters, such as the expected lifespan of the more productive economy, it still may be the case that the utility returns to immediate charity are higher. Nonetheless, a zero discount rate implies that current suffering has a much smaller impact on the utilitarian calculus, relative to long-run investment in highly productive societies. It becomes more likely that a utilitarian can favor investment over massive redistribution.24
It is easy to find one case where the investment always dominates. If the world will continue forever (or at least for a very long time), and the rich have a roughly constant marginal utility of money, then there is always some investment that welfare-dominates the redistribution. The logic of potential compounding kicks in here. Note that the argument requires that poor countries do not have access to the same investment opportunities as do rich ones.
We can also see the circumstances under which the utilitarian should favor large-scale redistribution toward the very poor. It might be the case that, for whatever reason, the world was going to end in the very near future. Under these circumstances, the redistribution would stand a much greater chance of being favored in utilitarian terms.
Note also that a zero discount rate does not affect the comparison between current consumption (buying an ice cream cone) and current charity. The act of benevolent charity likely remains more important in utilitarian terms. We need not, however, give away so many aggregate resources that it hurts the capacity of the richer society to invest or to generate useful incentives for wealth creation. In this regard the obligations of the richer society can remain limited.
In other regards, a zero discount rate may make life more difficult for utilitarian reasoning. The epistemic critique is one of the classic objections to utilitarianism. It is very difficult to calculate the expected value of most individual actions, given the extensive chain reactions that they set off. Utilitarianism, therefore, may fail to provide useful guidance in many (most? all?) cases.
Calculating consequences becomes much more difficult when the rate of discount is zero. At positive rates of discount, most future consequences cease to matter much within a thirty-year horizon or so. With a zero rate of discount, welfare-relevant consequences seem to go on forever, or at least until the end of the world. What if I bend down to pick up a banana peel? If nothing else, this will likely affect the identities of all my future children, if only by changing the timing of future conceptions by a slight amount.25
See Parfit, Reasons and Persons.
Believers in a zero discount rate might then be plagued with a kind of extreme moral nervousness. Under this worldview, virtually every action has truly enormous consequences for our future. And our estimates of welfare consequences will have very high standard errors. We realize that any moment we might be doing something that will lead to truly terrible results, or lead to truly wonderful results.
One response to these calculation problems might be a greater reliance on rules of thumb. If the consequences of particular acts are so very difficult to calculate, then perhaps we must rely more on rules and general principles. This conclusion may well be true, but, of course, the consequences of any rule will be hard to calculate as well. Extreme moral nervousness will remain. And rule-utilitarianism will have won only a partial victory. Ironically, we find that the more necessary rules become, the less we can be sure that these rules are a good thing. We become extremely nervous about any rule we might choose. This same nervousness, of course, may explain why it is so hard to adhere to rules-based prescriptions, whether in politics or in the realm of personal life.
Finally, a zero discount rate has implications for many pluralistic moral theories. A pluralistic moral theory typically counts several values as values that matter. In particular, let us focus on pluralistic theories that give weight to both deontological and consequentialist considerations. A theory of this kind might embody the following: “Consequences matter, but so do rights violations. We should violate rights only if it brings some very large potential benefit or avoids some very large potential cost. Otherwise rights are sacrosanct.” I believe that many people, both among philosophers and among the general citizenry, hold views of this form.
A zero discount rate will shift the balance toward consequentialist considerations, at the expense of deontology. Recall from the above discussion that even very small actions can have very large expected values, given that the future matters as much as the present. Any small but perpetual improvement, for instance, will involve a very large present value. Given the theory I expressed above, therefore, we should be willing to violate rights to bring a small but long-lasting improvement. Our longer time-horizon makes rights violations easier to justify in a pluralistic theory, at least provided that the relevant acts have long-term consequences.
This shift in emphasis arises from the very nature of deontology. Deontological considerations simply tell us “do” or “do not,” but they do not weigh competing values. So a change in the discount rate will affect the weight of consequentialist considerations, but not the weight of deontological considerations. With a zero discount rate, consequentialist considerations will tend to swamp deontological ones, again provided that the relevant time-horizon is sufficiently long.26
Deontologists do not typically claim that “a rights violation tomorrow is less bad than a rights violation today.” This kind of thinking in terms of trade-offs is precisely what deontology rejects. Deontology simply tells us “don't infringe rights,” albeit with a potential caveat for extreme consequences.
V. Concluding Remarks
I have examined a number of implications of adopting a zero rate of discount. Most of all, a zero rate of discount suggests that having a (broadly) free society is more important than many people think. A zero rate of discount also directs our attention toward the importance of economic growth, a healthy long-run environment, favorable treatment for savings, and economic “shock therapy.” A zero rate of discount increases our skepticism of government provision of goods and services, large welfare states, and global charitable obligations toward the very poor. It also makes consequences more important, makes utility more difficult to calculate, provides a greater rationale for rules, but plagues us with moral nervousness at the unknown and manifold implications of even our most mundane acts.
The case for a zero rate of discount is strongest either when we consider well-being directly or when we consider policies that have very large effects on individuals' wealth. In any case, examining the discount rate issue forces us to refine our intuitions, our policy positions, and our assessment of utilitarian calculation.
Footnotes
I thank Bryan Caplan, Christian Gollier, Robin Hanson, Ellen Frankel Paul, and fellow contributors to this volume for their useful comments on an earlier draft of this essay.
Estimated number of future benefits equal to one present benefit based on different discount rates
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