Abstract
Using the extended Ramsey rule, the socially efficient rate is the difference between a wealth effect and a precautionary effect of economic growth. This second effect is increasing in the degree of uncertainty affecting the future. In the literature, it is usually calibrated by estimating the historical volatility of the growth of GDP in a specific country. In this paper, I show that using cross-section data tends to magnify uncertainty, and to reduce the discount rate. Using a data set covering 190 countries over the period 1969-2010, I justify using a much smaller discount rate around 0.7% per year for time horizons exceeding 40 years.
Highlights
For many thousands of years, since homo-sapiens emerged as the dominant species on earth, almost all of their consumption was determined by what they collected or produced over the seasonal cycle
If one believes in the permanency of economic growth, an intuitive wealth effect prevails in discounting: One should invest in favour of the future only if the return of the project is large enough to compensate for the increasing intertemporal inequality that this project generates
Many of them have experienced a huge volatility of their growth rate during the same period. This suggests that the discount rate that should be used in these countries should be smaller than in the western world, even in the case of similar expectations on the trend of economic growth
Summary
For many thousands of years, since homo-sapiens emerged as the dominant species on earth, almost all of their consumption was determined by what they collected or produced over the seasonal cycle. If one believes in the permanency of economic growth, an intuitive wealth effect prevails in discounting: One should invest in favour of the future only if the return of the project is large enough to compensate for the increasing intertemporal inequality that this project generates. It is intuitive that the uncertainty about the growth rate of the economy should play an important role in the determination of the intensity of our sacrifice in favour of the future, i.e., on the level of the discount rate. The theory states that the uncertain growth generates a precautionary effect that tends to reduce the discount rate. I show that the mean precautionary effect estimated from the mean volatility of the annual growth rate in 190 countries from 1969 to 2010 is around 1%, which is 10 times larger than in the western world.
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