Sultan Qaboos University College of Engineering Department of Electrical

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Sultan Qaboos UniversityCollege of
EngineeringDepartment of Electrical Computer
Engineering

• DISCOUNTING THE FUTURE A NEED FOR A FRESH LOOK
• Presented by
• Arif S. Malik
• Associate Professor

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• Objective of the Presentation
• What is Sustainable Development?
• What is Discounting?
• Rationale for Discounting
• Discounting Effects on Project Selection
• Arguments in Favor of Discounting
• Arguments Against Discounting
• Systems Thinking and Discounting
• Conclusion

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What is Sustainable Development?

• Development that meets the needs of the present
  without compromising the ability of future
  generations to meet their own needs. (Brundtland
  Commission, 1987).
• A minimum conditions for developments to be
  sustainable, is the requirement that the combined
  capital stock (man-made and natural) should not
  decrease over time.
• Natural capital stock, in this context, is the
  stock of all environmental and natural resource
  assets, from oil in the ground to the quality of
  soil and groundwater, from the stock of fish in
  the oceans to the capacity of the globe to
  recycle and absorb carbon.

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What is Sustainable Development? (Contd)

• Conserving the natural capital stock will serve
  the following goals
• Justice in respect of the socially disadvantaged
• Justice between generations
• Justice to nature
• Economic efficiency
• Aversions to risks (such as droughts, severe
  weather conditions etc.) which may arise if the
  environment is left for degradation.

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What is Sustainable Development? (Contd)

• The emphasis on sustainability implies a greater
  concern for the future and for the future
  generations.
• The past models of the development process
  assumed that the future will look after itself,
  whereas, the sustainable development approach
  acknowledges that the ability of the future to do
  this can be seriously impaired by actions taken
  now.

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What is Discounting?

• Discounting is a standard technique used for
  making inter-temporal decisions in which future
  is given less weight than the present.
• Discounting procedures are fundamentals to the
  theory and practice of cost-benefit analysis,
  which is based on the premise that individual
  preferences as measured in monetary term are
  the appropriate standard for evaluating proposed
  projects and public policies.
• The discount rate is the rate at which society as
  a whole is willing to trade off present for
  future benefits

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Rationale for Discounting?

• The usual and most common argument given is
  because a dollar received today is more valuable
  than one received in the future. There are
  generally three main reasons used for applying a
  positive discount rate.
• Pure Time Preference humans are generally
  impatient and prefer instant gratification to
  waiting for long-term benefits.
• Opportunity Cost or Marginal Productivity of
  Capital dollars can be invested today, earning a
  positive rate of return.
• Risk there is uncertainty surrounding the
  ability to obtain promised future income. That
  is, there is the risk that a future benefit will
  never be realized.

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Effect of Discount Rate on project selection
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Effect of Discount Rate
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Arguments in Favor and Against Discounting (Pure
Time Preference)

• Arguments Against

• Arguments in Favor

• Empirical evidence suggests that humans value
  immediate or near-term resources at higher levels
  than those acquired in the distant future.
• It is further argued that society, which consists
  of sum of its living individuals, also prefers
  the present to the future.

• The individual time preference is not necessarily
  consistent with individual lifetime welfare
  maximization.
• There is a more general view shared by many
  economists that there seems to be no "ethical"
  justification for putting a utility discount into
  the social welfare function

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Arguments in Favor and Against Discounting (Pure
Time Preference)

• Arguments Against

• Arguments in Favor

• Furthermore, the dominant underlying value
  judgment of Western economic philosophy is that
  peoples preference should count. Hence it is
  difficult to argue with the proposition that if
  people prefer the present over the future, then
  pure time preference indicates that discount
  rates are positive.

• The value judgment is improperly expressed. The
  argument is that it is tomorrows satisfaction
  that matters, not todays assessment of
  tomorrows satisfaction
• Future generations cannot represent their
  interests in todays markets and political
  debates

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Pure Time Preference

• But the question is any positive social discount
  rate used in a project that creates costs and
  benefits that are separated over a long period of
  time will discriminate the future generations and
  that is against the very spirit of
  sustainability the definition of which says
  meeting today's needs of development without
  compromising future generations' ability to
  develop.

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Arguments in Favor and Against Discounting
(Opportunity Cost of Capital)

• Arguments in Favor

• Arguments Against

• The opportunity cost of capital is the expected
  financial return foregone by investing in a
  project rather than in comparable financial
  securities. Theoretically, firms invest up to a
  point where the rate of return on marginal
  projects is equal to the interest rate.
  Consumers plans to save are brought to equality
  with producers plans to invest and the ruling
  interest rate reflects both the time preference
  of consumers and the rate of return on capital

• The opportunity costs of consumption are
  determined by the marginal return to capital,
  which, in turn, depends on investment levels,
  which depend upon how highly future benefits are
  weighted. If society as a whole valued all future
  periods equally, it would continue to invest
  until the rate of return on those investments
  (and, thus, the opportunity cost) was driven to
  zero. That opportunity costs are the result of
  valuing future outcomes less, not a reason for
  doing so.

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Arguments in Favor and Against Discounting
(Opportunity Cost of Capital)

• But there is an argument against using low or
  zero discount rate that it will encourage more
  investment overall, and this will increase the
  demand for resources and environmental services.
  In authors view this argument is not valid as we
  see that in the case of national economic
  development, the investment portfolio would
  consist of all projects to be carried out within
  the capital budget constraint as determined by
  the availability of the foreign exchange and
  local currency so the investment will only take
  place within the budget constraints and only
  those projects will be carried out that are
  economically justified and environmentally less
  harmful. As far as the private firms and
  businesses are concerned the government can
  impose resource taxes to discourage those
  projects which may harm the environment
  excessively.

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Arguments in Favor and Against Discounting
(Opportunity Cost of Capital)

• On the contrary we can observe that high discount
  rates used in developing countries under the
  prescription of World Bank and other lending
  agencies are a cause of much environmental
  degradation as the selection of such rates opt
  for short-term measures designed to satisfy
  immediate wants, and at the expense of
  sustainable practices. In turn, poor prospects
  arising from environmental degradation actually
  assist in generating the poverty that causes high
  discount rates (poverty-trap).

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Arguments in Favor and Against Discounting
(Risk)

• Arguments in Favor

• Arguments Against

• Public projects involve uncertainty and risk.
  When public projects are undertaken there is a
  chance that future benefits will not be fully
  realized or realized at a higher level than
  estimated .The further out into the future these
  benefits are expected to be realized, the greater
  the risk that some unexpected event or factor
  will occur and diminish the value of the future
  benefit. This uncertainty is handled by adding a
  risk premium to the discount rate.

• While adding risk premium to the discount rates
  it is being assumed that the scale of the risk
  increases exponentially with time. There is no
  reason to believe that the risk factor takes this
  particular form and so the allowance for it
  through a single discount rate adjustment is
  invalid. This argument is widely accepted by
  economists. Usually, the preferred method for
  dealing with uncertainty is directly to adjust
  benefits and costs and not to change the discount
  rate.

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Systems Thinking and Discounting

• McLaughlin and Davidson 14 describe systems
  thinking as
• "Seeing Whole Patterns. . . . Its time for us to
  make the next leap in consciousness to wholistic
  thinking to seeing whole patterns. In contrast
  with the prevailing linear paradigm, the New
  Paradigm sees everything as interconnected and
  interdependent . . . .Thus it is critical to keep
  the large picturethe whole systemin mind in
  order to create any kind of lasting solution and
  to avoid undue focus on effects, rather than
  dealing with causes that may be part of another
  system altogether.
• Wholistic thinking or ecological thinking
  seeing how everything affects everything else
  is finally beginning to influence other national
  policies, such as economics, where piecemeal
  solutions never work, since all sectors of a
  nations economy are interrelated and
  interdependent with the world economy. The
  systems view sees the world in terms of
  relationships and integrated wholes whose
  properties cannot be reduced to those of smaller
  units."

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Systems Thinking and Discounting (contd)

• Perhaps, we would have to go a long way to find a
  clearer or more complete exposition of pure
  Systems Thinking than that contained in the
  above slide. The depletion of ozone layer or
  increase in greenhouse gas emissions or the
  pollution of oceans is no more a concern of a
  single society presently living in any country.
  Similarly, society is no more a collection of
  living individuals whose preferences should
  count. Let us investigate the pure time
  preference and opportunity cost of capital
  concepts from the holistic viewpoint.

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Systems Thinking and Discounting (contd)Pure
time Preference

• When the pure time preference argument is looked
  from the holistic viewpoint a question can be
  asked whose time preference are we talking about
  whose capital and wealth are linking whose time?
  Is it the present society living in USA or Canada
  or is it in some African country? And what about
  the generations to come who will take care of
  their time preferences? Therefore, from holistic
  point of view pure time preference argument is
  ethically and morally indefensible in the
  selection of discount rate.

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Systems Thinking and Discounting
(contd)Opportunity Cost of Capital

• Before analyzing the opportunity cost of capital
  concept with holistic viewpoint let us first
  examine the practical implication of this concept
  for selecting discount rates in different
  countries. Since the opportunity cost is linked
  to the prevailing conditions within a given
  country, the discount rate tends to vary, often
  significantly, from country to country. For
  developing countries the discount rate used is
  much higher than the industrialized countries to
  reflect the scarcity of capital and the much
  larger profitability of new investment projects
  that compete for limited financial resources.

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Systems Thinking and Discounting
(contd)Opportunity Cost of Capital

• Now as we see we have different discount rates
  for different countries so a project considered
  good in USA may not be economically justified
  in India. For example, a large coal-fired power
  plant which generates millions of tons of
  greenhouse gases annually may be economically
  justified in one country but may not be a good
  project in another country because of the use of
  different discount rates for selection of the
  project. Consider the holistic approach and we
  see that the harm to environment is the same
  whether such kind of project is carried out in
  USA or in India. So in this regard the discount
  rate should not be linked to opportunity cost of
  capital in a country but in sustainability
  context to environment.

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Conclusions

• The paper has argued against using the practice
  of discounting. It has been shown intuitively
  that both the time preference and the opportunity
  cost of capital arguments are in conflict when we
  take the holistic approach to the environment.
• When the pure time preference argument is looked
  from the holistic viewpoint the question is whose
  time preference we are talking about a society
  living in a developed world or a society living
  in less developed world or a society yet to come.
• When the opportunity cost concept is seen from
  holistic approach we find that there are
  different opportunity costs for the same project,
  having same global environmental impacts, done in
  developed world or in some underdeveloped world
  and hence there is no agreement on the same
  discount rate.

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Conclusions (Contd)

• What is clear from this is that we need a
  paradigm shift a complete change in
  perspective. There is a need to engage
  meaningfully with a complex systems approach to
  social and natural systems. While the full
  implications of the quantum change in perspective
  have yet to filter down to the level of general
  consciousness the forest has been cleared and the
  path is open
• No doubt there may be reluctance due to powerful
  vested interests related to both cognitive belief
  systems and to the institutional position. But
  with courage and commitment the harmful effects
  of untrue economic theory can be challenged. Both
  the time preference and the opportunity cost
  concept are the tools to support the institution
  of interest. But as we see both cannot stand in
  the way of systems thinking.

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Conclusions (Contd)

• Interest and usury cause injustice and major
  financial inequality in the society.
• The practice of usury lending money and
  accumulating interest on the loan can be traced
  back 4,000 years. But it has always been
  despised, condemned, restricted or banned by
  moral, ethical, legal or religious entities.
• Let us see what great religious scriptures say
  about usury.

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Quran on Usury

• Those who take usury will rise up before God (on
  the Day of Resurrection) like one whom Satan (the
  Evil One) by his touch has driven to madness.
  That is because they claim "Trade is the same as
  usury." But God has permitted trade and forbidden
  usury. Those who after receiving admonition from
  their Lord, desist, will be forgiven for the
  past their Judge is God. But those who go back
  to usury are companions of the Fire they will
  abide therein for ever.  
• Qur'an 2 275

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Quran on Usury

• God will deprive usury of all growth, but will
  bless deeds of charity with increase. For God
  does not like the ungrateful sinners. Qur'an 2
  276
• O ye who believe! fear God and give up what
  remains of your demand for usury if ye are indeed
  believers. Qur'an 2 278
• O ye who believe! devour not usury doubled and
  multiplied but fear God that ye may
  prosper. Qur'an 3 130

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Prophet Muhammads Last Sermon

• ..Remember that you will indeed meet your
  LORD, and that HE will indeed reckon your deeds.
  God has forbidden you to take usury (riba),
  therefore all riba obligation shall henceforth be
  waived. Your capital, however, is yours to keep.
  You will neither inflict nor suffer inequity. God
  has judged that there shall be no riba and that
  all the riba due to Abbas ibn Abd al Muttalib
  shall henceforth be waived..

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Usury in Western Philosophy

• Many of the early Western philosophers including
  Plato, Aristotle, Cato, Cicero, Seneca and
  Plutarch were critics of usury. In the legal
  reforms (Lex Genucia) of the Roman Republic (340
  BC), usury and interest were banned. However, in
  the final period of the Republic, the practice
  was common. Under Julius Caesar, a limit of 12
  per cent was imposed due to the great number of
  debtor, and under Justinian it was set at a mean
  between 4 per cent and 8 per cent
• Reference http//www.henciclopedia.org.uy/autores
  /Laguiadelmundo/Usury.htm

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Old Testament on Usury

• Nehemiah 57I pondered them in my mind and then
  accused the nobles and officials. I told them,
  "You are exacting usury from your own
  countrymen!" So I called together a large meeting
  to deal with them
• Nehemiah 510I and my brothers and my men are
  also lending the people money and grain. But let
  the exacting of usury stop!
• Nehemiah 511Give back to them immediately their
  fields, vineyards, olive groves and houses, and
  also the usury you are charging themthe
  hundredth part of the money, grain, new wine and
  oil."

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Old Testament on Usury (Contd)

• Psalm 155who lends his money without usury and
  does not accept a bribe against the innocent. He
  who does these things will never be shaken.
• Ezekiel 188He does not lend at usury or take
  excessive interest. He withholds his hand from
  doing wrong and judges fairly between man and
  man.
• Ezekiel 1813He lends at usury and takes
  excessive interest. Will such a man live? He will
  not! Because he has done all these detestable
  things, he will surely be put to death and his
  blood will be on his own head.

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Old Testament on Usury (Contd)

• Ezekiel 1817He withholds his hand from sin and
  takes no usury or excessive interest. He keeps my
  laws and follows my decrees. He will not die for
  his father's sin he will surely live.
• Ezekiel 2212In you men accept bribes to shed
  blood you take usury and excessive interest and
  make unjust gain from your neighbors by
  extortion. And you have forgotten me, declares
  the Sovereign LORD.

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Usury on the Cross

• Holy Prophet Jesus (peace be upon him) was sent
  to the people to confirm God's commandments and
  remind them the Message of God. According to
  Matthew's Gospel, Jesus said "Do not think I
  have come to destroy the Law or the Prophets. I
  have come, not to destroy, but to fulfill. The
  Bible, Matthew 517

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Usury on the Cross (Contd)

• The prohibition of usury was adopted as a major
  campaign by the earliest Christian Church,
  following on from Jesus' expulsion of the
  money-lenders from the temple.
• The decrees of the Hebrew Bible were revived and
  a new reference to usury in the New Testament was
  added. Based on the authority of those texts, the
  Catholic Church of the 4th century AD banned the
  clergy from charging interest, a rule that was
  later extended in the 5th century to the laity.
• In the 8th century, under Charlemagne, usury was
  declared a criminal offense. The anti-usury
  movement gathered force in the late Middle Ages
  and reached its peak in 1311 when Pope Clement V
  totally banned the practice and declared null and
  void all secular law defending it.

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Oldest References to Usury

• The oldest references to usury are found in
  religious manuscripts of India, dating back to
  2000-1400 BC where the 'usurer' is associated
  with any interest lender. In the Hindu Sutra
  (700-100 BC) as well as in the Buddhist Jatakas
  (600-400 BC) there are many references to the
  payment of interest, along with expressions of
  disdain for the practice.
• Reference http//www.henciclopedia.org.uy/autores
  /Laguiadelmundo/Usury.htm

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Demon on the Move

• This 'demon' governs current global relations,
  condemning most of the world population to living
  under the sign of debt i.e., each person born in
  Latin America owes already 1,600 in foreign
  debt each individual being conceived in
  Sub-Saharan Africa carries the burden of a 336
  debt, for something that its ancestors have long
  ago paid-off. In 1980 the Southern countries'
  debt amounted to 567 billion since then, they
  have paid 3,450 billion in interests and
  write-offs, six times the original amount. In
  spite of this, that debt had quadrupled by the
  year 2000, reaching 2,070 billion.
• Reference http//www.henciclopedia.org.uy/autores
  /Laguiadelmundo/Usury.htm

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Conclusions (Contd)

• God does not want to see such circumstances
  between humankind, created by human greed. It is
  very clear from the Jewish, Christian and Muslim
  religious scriptures that social values built on
  the structure of usury certainly cause God's
  anger.
• Eliminate the interest and we see that there is
  no need of discounting. By eliminating the
  interest we are
• Reducing the environmental risk
• Reducing the poverty in developing world
• Reducing the gap between rich and poor
• Reducing the unemployment problem
• Reducing the problem of inflation
• Increasing the economic efficiency
• Safeguarding the interest of future generations
  etc.