2.5.1.2. Specifying the Baseline
Each of the foregoing assumptions represents a qualitative dimension along
which the baseline of an impact assessment must be defined. A researcher who
wants to estimate the costs or benefits of changing conditions must define as
fully as possible the socioeconomic, political, institutional, and cultural
environments within which the change will be felt. A "first-best"
analysis assumes that everything works efficiently in response to changing conditions
in the context of all of the right information; results of first-best analyses
reflect benchmarks of "best-news" scenarios. Second-best analyses
assume that distortions caused by the failure of some or all of these assumptions
to hold will diminish the efficiency of the first-best world; they can produce
dramatically different answers to cost and valuation questions. Indeed, baselines
that are constructed to reflect the global externalities of climate change by
definition reflect second-best circumstances.
It may be reasonable to assume that distortions will persist as change occurs
over the short run. Making the same assumption over the long run could be a
mistake, however. Will information not improve over time? If distortions are
costly, they may persist over the long term if the beneficiaries have sufficient
power to preserve their advantage. There is no right way to do second-best analysis;
it is simply incumbent on the researcher to report precisely what assumptions
define the baseline.
2.5.1.3. Discounting the Future
The discount rate allows costs and values occurring at different times to be
compared by converting future economic values into their equivalent present
values. Formally, the present value of some cost Ct that will come due in t
years is
Ct / (1+d)t ,
where d is the appropriate discount rate. The discount rate is non-negative
because resources invested today in physical and human capital usually can be
transformed into more resources later on. The IPCC and others have focused an
enormous amount of attention on the discount rate (for detailed discussions
see Arrow et al., 1996; Portnoy and Weyant, 1999; Chapter
1 of this volume). Toth (2000b) provides a review of this and other more
recent literature, with particular emphasis on the implications of discounting
to issues of intergenerational equity.
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