Building on Ramsey’s (1928) 88 pioneering work, Dasgupta (2008) 89 set out the logics of a longer- term perspective on NPV calculations, emphasising that the discounting of future net benefits is grounded in intergenerational welfare considerations. Ramsey’s approach was to apply a discount rate for future consumption, while also recognizing that future generations will be wealthier, so that the marginal benefit to them of consumption foregone today will be low because the incremental amount will be small relative to a much bigger total. Over the years the topic has attracted substantial attention from a wide range of leading economists as the reasoning has been tested and become more refined, often employing complex mathematical proofs (Nordhaus, 1994, 90 Stern 2007, 91 Weitzman 2012 92 ).
The formula for the consumption adjusted discount rate, often referred to as the ‘Social Discount Rate’ (SDR) is referred to as the Ramsey Rule and defined as follows:
SDR = ρ + ηg 93
Where: •
ρ is the pure rate of time preference. o Sometimes adjusted to ρ i = δ + L, where δ = pure time preference and L = risk adjustment. • η is the elasticity of marginal utility of consumption. • g is annual per capita growth of consumption. Unlike market-based approaches, which treat r as exogenous, the Ramsey Rule grounds the discount rate in welfare economics, explicitly linking it to intergenerational trade-offs. It adjusts r or SDR, according to three components outlined above. This framework places intergenerational equity at the centre of discounting debates because each parameter of the Ramsey Rule encodes ethical choices about how we value future generations. The pure rate of time preference (ρ) reflects how much more or less we value future welfare simply because it is in the future; the elasticity of marginal utility (η), combined with expected growth (g), captures how diminishing returns affect the equitable weighting of consumption between richer future generations and poorer current ones. Together, these parameters make clear that discounting is not a neutral technical exercise but rather a normative decision about how costs and benefits should be shared across time. If future consumption is expected to grow rapidly, then the marginal utility deriving from an investment today will be small and the second term will be larger, justifying the social planner 94 in taking less account of future benefits. If, however, future consumption, or by extension, economic growth, does not grow (a zero or negative value for g ) then the discount rate would fall.
The critical debates around this formula have focused on how to allow for the uncertainties and long timescales associated with the economic effects of climate change, prompted by Stern’s (2007,
88 See Newbery, D.M., 1987. Ramsey model. In The New Palgrave Dictionary of Economics (pp. 1-6). Palgrave Macmillan, London. 89 Dasgupta, P., 2008. Discounting climate change. Journal of risk and uncertainty , 37 , pp.141-169. 90 Nordhaus, W.D., 1994. Expert opinion on climatic change. American scientist , 82 (1), pp.45-51. 91 Stern, P.C. and Dietz, T., 1994. The value basis of environmental concern. Journal of social issues , 50 (3), pp.65-84. 92 Weitzman, M.L., 2012. GHG targets as insurance against catastrophic climate damages. Journal of Public Economic Theory , 14 (2), pp.221-244. 93 Frank P. Ramsey (1928), “A Mathematical Theory of Saving,” Economic Journal , 38(152), pp. 543–559; Arrow, K. J., & Kurz, M. (1970). Public Investment, the Rate of Return, and Optimal Fiscal Policy. Baltimore: Johns Hopkins University Press; Stern, N. (2007). The Economics of Climate Change: The Stern Review . Cambridge: Cambridge University Press, (originally commissioned by HM Treasury and published in 2006; Cambridge UP published the extended version in 2007). 94 The social planner is a theoretical figure in economics who makes decisions to maximize the overall welfare of society, rather than responding purely to market forces or individual self-interest.
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