July 28, 2005

Discounting the Future

One longstanding concern of mine has been that Wall Street and most investors focus on the short-term, while social and environmental issues typically play out over long (sometimes multigenerational) time horizons. It's hard to believe that analytical techniques that are designed for short-term trading will be equally optimal for long-term decision-making. It turns out that there is a growing academic debate around this question, particularly over the use of discount rates. The process of discounting has been cricized by some as understating the value of future environmental cleanups and other socially beneficial activities. Martin Weitzman, a professor of Economics at Harvard, has said "to think about the distant future in terms of standard discounting is to have an uneasy intuitive feeling that something is wrong somewhere." This documentary on the BBC's Radio 4 does a nice job outlining the issues. Pay particular attention to the comments of economist Cameron Hepburn. I'm not usually a fan of theoretical economics, but this stuff is really good - Hepburn co-authored a very interesting paper on this that is worth looking at.

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