Social Discount Rate - Calculation

Calculation

The SDR is directly analogous to concepts found in corporate finance such as the hurdle rate or the project appropriate discount rate; so the mathematics are identical. The benefit or cost per dollar can be calculated by

where r equals the SDR and t equals time. For benefits or costs that have no end it is just

A higher SDR makes it less likely a social project will be funded. A higher SDR implies greater risks to the assumption that the benefits of the project will be reaped. A small increase in the social discount rate can matter enormously for benefits far into the future so it is very important to be as accurate as possible when choosing which rate to use.

There is a strong case for factoring in the equity issue when discounting benefits and costs of intergenerational projects such as those designed to combat climate change and environmental degradation.

The social discount rate is a reflection of a society's relative valuation on today's well-being versus well-being in the future. The appropriate selection of a social discount rate is crucial for cost-benefit analysis, and has important implications for resource allocations. There is wide diversity in social discount rates, with developed nations typically applying a lower rate (3–7%) than developing nations (8–15%).

The subject of a social discount rate, always a source of fierce debate between economists, has become highly controversial since the publication of the Stern Review on the Economics of Climate Change. The publication exploded on the global warming scene in 2006 with its dire warning that global gross domestic product (GDP) was at future risk of a 20% reduction if there was a failure to invest 1% of world GDP now to reduce global warming. However, critics questioned the findings on the basis that they were arrived at using an extremely low discount rate of 1.4% used in economic modeling.

There is no consensus among economists and, according to the survey, no “one-size-fits-all” solution to the choice of social discount rate, owing to national variations. A regular reassessment and readjustment of the social discount rate used by each country is therefore required.