Scenario-dependent discounting for climate change adaptation decisions for infrastructure

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ABSTRACT Substantial investments are often required to adapt our infrastructure to a changing climate. To decide whether these investments are worthwhile (i.e. cost-effective) or not, cost–benefit analyses have been proposed and applied. The results of these analyses have been found to be strongly influenced (or even completely governed) by the adopted discount rates. Nonetheless, the discount rates used in these cost–benefit analyses are often arbitrarily assumed and are inconsistent with the divergent socio-economic assumptions embedded in the different climate change scenarios. This study addresses this gap and proposes a method for deriving scenario-dependent optimal discount rates that account for the contrasting socio-economic characteristics portrayed by the different climate change scenarios. The proposed method is based on the classical Ramsey discounting model, which is widely recognized as a sound basis for social discounting. The proposed method is applied, considering three different climate change scenarios (i.e. SSP1-SSP3), on ten selected countries that represent the different stages of economic development (four developed countries including Australia, the United States, France, and Sweden; four developing countries including China, Kuwait, Egypt, and South Africa; and two countries representing economies in transition, namely Russia and Albania). For all the considered countries, the optimal discount rate in SSP3 is lower than that in SSP2 and SSP1, respectively. These different discount rates reflect the different socio-economic characteristics defining each SSP scenario. Furthermore, an illustrative example is presented to highlight the effect of using the derived scenario-dependent discount rates on the results of cost–benefit analyses in comparison to using discount rates that are commonly adopted in literature. It can be concluded that adopting commonly recommended discount rates can lead to suboptimal climate change adaptation decisions.

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