Social discount rate policy Presenter: Chris Parker, Chief Economist To: NZ Association of Economists When: Friday 3 June 2015

What I’ll cover Presentation to Auckland Council’s Executive Leadership Team in March 2015 Some further elaboration for an economics audience

The presentation to ELT

Purpose Issue: Council has no policy on what weighting should be given to future welfare impacts when appraising policy or spending What I want: That council develops a ‘social discount rate policy’ of 4% real Use 4% (i.e. so $100 of benefit in 30 years’ = $0.31 now) Seek from you, ELT: I wish to inform you of issues and risks I can answer your questions Invite input from your teams Receive advice on how to make progress

Issues for decision makers Council focus on: delivering great value-for-money quality policy advice Social cost-benefit analysis helps to appraise welfare trade- offs Some trade-offs differ over time; e.g. cost now, benefit later How do we balance future impacts against current?

The social discount rate The reverse process of compound savings in a bank

1.High rate –Based on private sector investment (6%–10%) –Jargon: Social opportunity cost rate 2.Low rate –Judge the welfare trade-offs that feel right to make (2%–5%) –Jargon: Social rate of time preference NZ Treasury use 8% for reasons that are unclear Two approaches

Recommend policy of 4% What: Use 4% social rate of time preference Why: Vast bulk of welfare economics literature carefully explains that we should use a ‘social rate of time preference Will prevent underinvestment, myopia, and long-term risks from high costs in future Support: –2 NZIER reports to Council –Survey of Councillor’s ‘intertemporal welfare judgements’ –Prevailing approach overseas Risks: see next slide

The policy risk Criticism we should expect: “It would seriously reduce such degree of rationality as we have been able to introduce into government investment decision making and would point the way to a marked and quite unjustified expansion of the public sector” B Tyler, NZ Treasury (1971) This issue is well addressed by requiring that the wider costs on private investment are factored in –I.e. the shadow price of capital

End of ELT preso

Some further elaboration

Competing principles to determining the discount rate

The concepts and the conundrum Vertical axis is future consumption, and horizontal axis is current consumption A perfect textbook world Complicated textbook world: SRTP ≠ SOC

The bulk of the welfare economics literature is clear cut

Overseas practice is clear too

The social rate of time preference

Shadow price of capital estimated to be 1.50 if a 4% social rate of time preference

Thanks