The incorporation of the intergenerational equity objective has rendered the traditional Cost–Benefit Analysis (CBA) approach obsolete for the evaluation of projects presenting an important number of environmental externalities and for those whose impacts extend throughout a long period of time.
Based on the assumption that applying a discount rate rewards current consumption and, therefore, that it is only possible to introduce a certain intergenerational equity in a Cost–Benefit Analysis, in this work we propose an approach to discounting based on a different rationale for tangible and intangible effects. We designed two indicators of environmental profitability: a) the Intergenerational Transfer Amount (ITA), which quantifies in monetary units what the current generation is willing to pass on future generations when an environmental restoration project is carried out, and b) the Critical Environmental Rate (CER), measures the implicit environmental profitability.
These concepts were tested through an empirical case study pertaining to the assessment of an Erosion Control Project in the southeast of Spain. The results yield traditional profitability indicators that are higher — and probably closer — to the real values set by the contemporary society. The information provided by the environmental profitability indicators proposed renders more transparency to the quantification of the levels of intergenerational equity applied, thereby facilitating the difficult reconciliation of the CBA technique with the objective of sustainability.
The incorporation of the intergenerational equity objective has turned the traditional Cost–Benefit Analysis (CBA) approach into an obsolete tool for the evaluation of certain types of projects, particularly those exhibiting many environmental externalities and those whose effects extend throughout a long period of time. A series of changes in the CBA is being proposed in the literature, in order to adapt the analytical context to the demand for sustainability, resulting in what is alternatively denominated Extended or Environmental Costs Benefits Analysis (ECBA).
From an analytical point of view, changes in the CBA are taking place in a twofold way: Firstly, by developing new tools for the economic valuation of environmental externalities that were traditionally left out of the analysis. Secondly, through an in-depth revision of the theoretical foundations underlying the traditional approaches to discounting, since the repercussions of decisions that are presently being debated will extend to a distant future (in some cases for centuries), whereas in the classical CBA we deal with few decades at best. Therefore, many authors are stressing the need for a modification of the Social Discount Rate (SDR) by questioning the assumptions that are traditionally taken for granted and applied in its calculation.
The present work begins with some reflections on the discounting problem drawn from a review of the different approaches found in the literature. Subsequently, we propose a number of methodological approaches and report on their application for the economic valuation of an environmental improvement project designed to stop the desertification processes in an area of south eastern Spain: The Watershed Restoration and Control Erosion Project of Lubrín (Almería, Spain).
Extending CBA analysis to include intangible (non-market) effects, even those spanning very long periods of time, such long-term environmental impacts, demands a reassessment of the classical arguments on discounting.
Attempts to justify scenarios of full intergenerational equity in the CBA analysis are hard to take on. We must not forget that this tool is based on the Economic Theory of Welfare, which is based in turn on the Theory of Utility, an admittedly anthropocentric approach.
That is to say, the CBA selects, at best, our own intergenerational ethics, expressing what our present generation is willing to pass on to future generations, but we will most likely never find a way to reasonably include future generations' preferences in our formulations.
The controversy about whether or not to adjust the Social Discount Rate for intergenerational equity reasons stems from different concepts of sustainability. This is the reason why the various positions are almost impossible to reconcile, thus the bottom line is that the debate does not deal with technical but rather with ethical issues.
If, in spite of the previous limitations, one is still to use CBA, the inclusion of a certain level of intergenerational equity, as one of the valuation criteria of a project, entails the need to use lower discount rates. Furthermore, the different logics that we adopt in managing goods with and without a market must be mirrored through the use of different discounting logics.
For all these reasons, we propose the use of the common Social Discount Rate for market goods and a lower discount rate (environmental discount rate) for non-market goods, to be used simultaneously in the same CBA exercise.
By quantifying and stating clearly the degree of intergenerational equity implicit in an environmental project, the indicators of environmental profitability proposed elicits more transparency, helps in reconciling the CBA technique with the objective of sustainability and may be useful in public decision-making.
Obviously, our proposal does not claim to solve all the problems in applying CBA to projects highly irreversible and with large intergenerational impacts, which should be studied and previously decided on the basis of criteria external to the analysis. Neither is this a closed proposition since there are number of aspects that were left unaddressed. But we do argue that, as compared to the various options available and revised here, this proposal, without adding complexity to the current methodologies, does increase rationality and contributes to reconcile sustainability and discounting in Cost–Benefit Analysis.
