THE WORLD BANK Public Disclosure Authorized RESEARCH OBSERVER Public Disclosure Authorized 176 18 Development, the Environment, and the Social Rate of Discount Anil Markandya and David W. Pearce Reaching the Rural Poor through Public Employment: Arguments, Evidence, and Lessons from South Asia Martin Ravallion Cash Flow or Income? The Choice of Base for Company Taxation Public Disclosure Authorized Jack M. Mintz and Jestus Seade The Market for Developing Country Debt: The Nature and Importance of Its Shortcomings John Wakeman-Linn The Relative Efficiency of Private and Public Schools in Developing Countries Emmanuel Jimenez, Marlaine E. Lockheed, and Vicente Paqueo NX Reform of Trade Policy: Recent Evidence S from Theory and Practice Public Disclosure Authorized Vinod Thomas and John Nash A. THiE WORLD BANK RESEARCH OBSERVER EDITOR Ravi Kanbur COEDITORS Vitrorio Corbo, Shahid Yusuf CONSULTINGEDITOR Philippa Shepherd MEIMBERSOF THE EDITORIAL BOARD Angus Deaton (Princeton University, United States), Shantayanan Devarajan (Harvard University, United States), Mark Gersovitz (University of Michigan, United States), Shuja Nawaz (International Monetary Fund), Vittorio Corbo, Dennis N. de Tray, Enzo Grilli, Ravi Kanbur, Peter Muncie, George Psacharopoulos, William Tyler, Shahid Yusuf The World Bank Research Observer is published twice a year, in January and July, by the International Bank for Reconstruction and Development (the World Bank). It is man- aged in the Office of the Senior Vice President, Policy, Research, and External Affairs, and the editorial board is drawn from across the Bank and the international community of economists. 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The World Bank encourages dissemination of its work and will normally give permission promptly and, when the intended reproduction is for noncom- mercial purposes, without asking a fee. Permission is not required to make photocopies for classroom and similar immediate use. The World Bank Research Observer is indexed by the Journal of Economic Literature, the Standard Periodical Directory, the Public Affairs Information Service, Inc., and, online, by the Economic Literature Index and DIALOG. It is available in microform through University Microfilms, Inc., 300 North Zeeb Road, Ann Arbor, Michigan 48106, U.S.A. THE WORLD BANK RESEARCH OB1SERVER VOLUME 6 NUMBER 2 JULY 1991 Development, the Environment, and the Social Rate of Discount Anil Markandya and David W. Pearce 137 Reaching the Rural Poor through Public Employment: Arguments, Evidence, and Vessons from South Asia Martin Ravallion 153 Cash Flow or Income? The Choice of Base for Company Taxation Jack M. Mintz and Jesus Seade 177 The Market for Developing Country Debt: The Nature and Importance of Its Shortcomings John Wakeman-Linn 191 The Relative Efficiency of Private and Public Schools in Developing Countries Emmanuel Jimenez, Marlaine E. Lockheed, and Vicente Paqueo 205 Reform of Trade Policy: Recent Evidence from Theory and Practice Vinod Thomas and John Nash 219 Cumulative Index, 1986-1991 241 DEVELOPMENT, THE ENVIRONMENT, AND THE SOCIAL RATE OF DISCOUNT Anil Markandya David W. Pearce This articleexamines the role of the discountrate in makingdecisions that will have significantimplications for the environment.The authorsbegin by pro- vidinga rationalefor discountingin generaland by describingthe main factors that determinethe discountrate. These factors-the privateand socialrates of time preference,the opportunitycost of capital,risk and uncertainty,and the interestsof futuregenerations-all have an environmentaldimension. The ar- ticle goes on to examinethat dimensionand to explore the connectionsbe- tween the choice of the discountrate and environmentalconcerns, such as excessiveexploitation of naturalresources, inadequate investment in conserva- tion, and insufficientattention to the irreversibleloss of certainenvironmental resources. The authorsconclude that, in general,environmental concerns are not best addressedby loweringthe discountrate-an actionthat might haveboth ben- efits and costs for the environment.A more promisingcourse would be to incorporatea criterionof sustainabilityinto certainaspects of decisionmaking. How such a criterioncould be madeoperational is touchedupon but not de- velopedin this article. M any environmentalistsfear that the useof discountingin formulating economicpolicies that will affectthe controland use of the earth's natural resourcesmay be against the interestsof the natural envi- ronment. They contend that the higher the discountrate, the less long-run The World Bank Research Observer, vol. 6, no. 2 (July 1991), pp. 137-152 © 1991 The International Bank for Reconstruction and Development/THE WORLDBANK 137 environmental damage will appear to matter, and the less attractive will invest- ments designed to conserve the environment for future generations appear to be. Furthermore, the resulting accelerated depletion of natural resources will leave those generations with an inadequate natural capital stock to serve their needs. This article examines these concerns and evaluates them systematically. We consider environmental questions in the context of choice through time and discuss whether, and in what way, the future should be discounted in policy areas with a significant environmental dimension. The article begins by describ- ing the rationale for discounting and the main factors that determine the dis- count rate. There is considerable debate within the economics profession as to how relevant or significant each of these factors should be in calculating the rate. Each, moreover, has an environmental dimension. The article goes on to describe and evaluate that dimension. Thus the connection between the basis of discounting and environmental concerns is explored. The connection also works in the other direction-from specific environ- mental issues to the role of discounting within them. The third part of the article deals with this link by examining two important areas where choice of discounting is crucial: projects that will bring irreversible damage to the environment, and policies concerning the management of natural resources in general. Our review of the debate over discounting and the environment leads us to conclude that, although the desire to "do something" to the discount rate for environmental reasons at first sight seems eminently reasonable, it is nearly always unworkable in practice-and often would not be the best solution in any case. Instead, the problem might better be tackled by developing the con- cept of sustainability as a specific policy instrument. The last part of the article describes how that might be done. The Rationale for Discounting The process of discounting can be understood by looking at the familiar mechanism of compound interest. If $1 is invested at 5 percent annually com- pounded, it will be worth $1.63 in ten years time. By the same token, 61 cents invested now, at the same rate of interest, will be worth $1 in ten years time. We would then refer to 0.61 as the present value factor for a ten-year period when the discount rate is 5 percent. Given this direct relation between discount- ing and compound interest, it is evident that the higher the discount rate, the lower the discount factor, and the faster the fall of the discount factor, as the time horizon is extended. The practice of discounting in assessing projects or policies arises because individuals attach less weight to a benefit or cost in the future than they do to a benefit or cost now. Impatience, or "time preference," is one reason; another 138 The WorldBank ResearchObserver, vol. 6, no. 2