Foresight as a survival characteristic: When (if ever) does the long view pay?

Abstract

Long-range R&D and capital investment projects are normally evaluated by means of a procedure (cost-benefit analysis) that involves a choice of time preference functions. Cost-benefit analysts and many economists typically assume that time preference is a behavioral fact of life and that the time preference function is essentially equivalent to a compound interest law. In practice, they tend to choose discount rates in the range of 3% to 8% per annum in real terms. Variability in projected cost-benefit ratios resulting from this uncertainty is commonly dealt with ad hoc, e.g., by simply presenting results for several different discount rates and letting the decisionmaker select among them. It is argued in this study that the basic discounting methodology is fundamentally flawed and can lead to significantly inferior social choices, i.e., choices that would be rejected by virtually any rational actor to whom the choice was fairly presented. A more general methodology is needed. Examples from several realms, including energy policy and environmental protection, are discussed to illustrate the thesis.