A ‘component-based’ approach to discounting for natural resource damage assessment

Abstract

The paper proposes a ‘component-based’ approach to guide the choice of the social discount rate in natural resources damage assessment, where time and discounting are key features. It is a multi-rate discounting scheme, which draws on concepts from dual-rate and time-declining approaches. Each damage component is discounted at a component-specific constant rate, related to its time-trajectory. Assuming a normatively defined declining schedule of rates as a starting reference, components with longer time profiles – generally represented by welfare losses – are discounted at lower rates than short-term damage components — mainly remedial costs. The rationale behind this choice is that the longer the duration of the damage component, the higher the related nonincident specific uncertainty on the resource values and the more relevant the equity issues. When estimating the total damage, the resulting implicit average discount rate depends on the duration of each component and its relative relevance in the total damage in each moment. From an operational point of view, anchoring the rates to government prescriptions would support the robustness of the damage estimates in a court of law, whereas the dual-based environmental discount rate is based on ad-hoc assumptions that are more difficult to justify.