Cost-Benefit Analysis and the environment: The time horizon is of the essence

Abstract

Cost-Benefit Analysis is a key tool for evaluating welfare gains or losses from an investment. It is now well established that environmental impacts are crucial to consider the full welfare implications of a project. Debate has focussed on approaches to improve the valuation of environmental impacts, and controversy in the discounting of future impacts to present values. The issue of the time horizon of analysis is frequently overlooked. The framing of the time horizon has major implications, as environmental costs and benefits often accrue in the long-term. The technical aspects of setting the time horizon are reviewed, along with updates to practice guidance, noting the longer time horizons now becoming typical. It is demonstrated that the time horizon can have a considerable impact on results, even more substantial than the discount rate. While uncertainty is noted as a technical challenge to longer-term analysis, the use of scenarios and sensitivity testing are noted as an appropriate response. For projects with long-term environmental effects, such as those related to air pollution, climate change and ecosystem damages, it is recommended to use timescales of 100+ years for economic evaluation of the impact. Failing to fully capture these long-term welfare gains and losses will distort analysis with a bias towards those projects that are more carbon-intensive, or environmentally damaging. Such a bias would undermine not only the evaluation, but welfare and sustainable development in general.