What is the Appropriate Social Discount Rate for a Charter City?
It's probably close to zero.
As the population and economy of a charter city grows, so too will the complexity of its policymaking. Benefit-cost analysis will play an increasingly important role as the administrative responsibilities of a charter city increase over time. The social and financial ramifications of infrastructure investment or regulatory decisions when the city is home to 10,000 people will be substantially different than those when the city is home to 1,000,000. An important component of benefit-cost analysis is the selection of the social discount rate, the rate at which future benefits are discounted in favor of present benefits.
Although there is substantial debate among economists about what the right social discount rate is for policymaking, and developing countries often set higher discount rates than more developed countries, the correct social discount for a charter city is probably close to zero.
At the Charter Cities Institute, we frequently stress the point that charter cities are long-term projects whose principle goal is to create sustained, intergenerational economic growth. We’ve highlighted Singapore’s strategic embedding of long-term thinking in its institutions and frequently cite Dubai’s long history of forward-thinking economic reinvention. Sheik Rashid’s famous quote with respect to Dubai’s limited oil reserves sums up this thinking well: “My grandfather rode a camel, my father rode a camel, I drive a Mercedes, my son drives a Land Rover, his son will drive a Land Rover, but his son will ride a camel.” In essence, the goal of a charter city is to ensure that no one’s grandson is still riding a camel.
Cowen and Parfit make the case against the use of a social discount rate at all in their famous 1992 paper, “Against the Social Discount Rate.” Tongue-in-cheek, they write: “Why should costs and benefits receive less weight, simply because they are further in the future? When the future comes, these benefits and costs will be no less real. Imagine finding out that you, having just reached your twenty-first birthday, must soon die of cancer because one evening Cleopatra wanted an extra helping of dessert.”
Cowen and Parfit’s treatment of the arguments in favor of a positive intergenerational discount rate raise interesting questions about moral, political, and economic judgements that we must make that impact both current and future generations. I encourage you to read the essay in its entirety and its follow-up essay in which Cowen defends the use of a zero discount rate on consequentialist grounds.
Readers may be familiar with Cowen’s 2018 treatise on economic growth, Stubborn Attachments, in which he makes the case for prioritizing long-run economic growth, essentially the layman’s application of his earlier writing with Parfit. Economic growth has been and continues to be the single most important factor in alleviating poverty, more so than any individual government policy change or randomized control trial-inspired intervention. Cowen’s thesis in Stubborn Attachments is our own thesis: growth is good and prioritizing growth over the long run is paramount. For this reason, the discount rate for a charter city should approach zero.
Some discounting in favor of current benefits is likely necessary. The main benefits of investments in public health or education initiatives that provide an improvement over what is available in the host country will largely accrue to the current generation and help attract new residents. But even in this case, the long-term outcomes for the charter city are improved. The four “proto-charter cities” we like to highlight, Shenzhen, Hong Kong, Singapore, and Dubai, were not built in a day. Instead, they were all built with careful thought afforded to the future and creating sustainable economic growth. Charter cities need to adopt this thinking too, lest their intergenerational economic performance regress to an unsatisfying mean.