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Musings on the Social Discount Rate1

Published online by Cambridge University Press:  20 March 2015

Arnold C. Harberger  and
Glenn P. Jenkins
Arnold C. Harberger*
Affiliation:
University of California, Los Angeles, California, USA, e-mail: [email protected]
Glenn P. Jenkins*
Affiliation:
Department of Economics, Eastern Mediterranean University, Northern Cyprus Queen’s University, Canada, e-mail: [email protected]
*
*e-mail: [email protected], [email protected]
*e-mail: [email protected], [email protected]
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Abstract

This paper is mainly concerned with weighted-average measures of the social discount rate, where the components of the average are the marginal productivity of investment (measured by its gross-of-tax rate of return), and the marginal rate of time preference (measured by the net-of-tax yield of capital). We believe that these components should best be measured using data (the national accounts) that span the whole economy and reflect the product actually produced and the rewards actually perceived. We use a methodology based on just four familiar parameters to generate productivity estimates applicable to a wide range of countries. In the process, we make an adjustment for infrastructure investment, also excluding income from land, monopoly markups, supra-marginal returns due to increases in total factor productivity (TFP), and returns to capital in financial intermediation. The end products are estimates of social discount rates averaging around 8% for the advanced countries, and 10% for healthy developing countries and Asian Tigers.

Type
Articles
Information
Journal of Benefit-Cost Analysis , Volume 6 , Issue 1 , Spring 2015 , pp. 6 - 32
Copyright
© Society for Benefit-Cost Analysis 2015 

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References

2 This assumes that either the displaced investment was a perpetuity, or (much more plausibly) that the assets in question would be replaced as they depreciated by new ones of similar yields (i.e., using depreciation allowances to pay for them rather than tapping the market). Thus a sequence of one-year assets costing 1000 in year T and generating 1100 in year T + 1 would yield the same net profile (−1000, +100, +100, …) as a single investment of 1000 with a perpetual yield of 100. Obviously, any pattern of investment flows over time can be simulated by a sequence of one-year flows, so our conclusion applies so long as depreciation allowances are reinvested. Note that this reinvestment issue applies not to a project’s own investment profile but rather to the investments that are displaced by new demands in the capital market.

3 The oft-cited one quarter share of capital in some advanced countries usually refers to net income as a fraction of national income, the same figure for depreciation being excluded from both the numerator and denominator.

4 In a competitive industry the return to capital is driven to its long run competitive level. Thus $S_{k}g_{({\it\rho}+{\it\delta})}$ tends to zero, and the equation becomes ${\it\lambda}=S_{L}g_{w}-g_{P}$ . Thus in the “average” industry ${\it\lambda}=S_{L}g_{w}$ (i.e., wage growth is determined by the average rate of TFP improvement), and its relative price does not change, while relative prices will tend to rise in industries with lower than average real cost reduction, and to fall in industries with ${\it\lambda}$ above average.

5 The growth model tells us that wage rates will rise by ${\it\lambda}/S_{L}$ per year. This is fully compatible with the innovators of each year gaining ${\it\lambda}Y_{t-1}$ , because in that same year the innovators of the previous four years are losing ${\textstyle \frac{1}{4}}{\it\lambda}Y$ . So a sort of churning takes place among cohorts of innovators, the amount of $2.5{\it\lambda}Y$ being passed each year from earlier cohorts to their successors. We have chosen a very simple allocation of the fruits of innovation. The same general conclusions would follow, however, from more complicated ones, as long as the extra rewards to innovations follow a humped shape. For example, the extra rewards from innovations might grow over three years, and only then drift downward to zero. That would make our calculation more complicated, but the main conclusion would be the same. The innovators of this and possibly prior years would together reap a total sum, which would be a constant fraction of GDP in the growth model. But this sum would be churned each year between those newer innovators whose ${\it\rho}$ values would be rising and those earlier innovators whose ${\it\rho}$ values would be declining back to their normal levels.