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Discounting the Discount Rate: How Can We Value a Sustainable Future?
“We are made wise not by the recollection of our past, but by the responsibility for our future.” — George Bernard Shaw
A bird in the hand…
We know that a bird in the hand is worth two in the bush. The adage works well, and it makes sense for a hunter-gatherer, but does it also holds true for a globalised species seeking a sustainable future? Under some circumstances might the bird in the hand actually be worth less than a larger number of birds, which are potentially available but currently out of reach?
Does the value proposition change at four birds in the bush, at six, or at ten?
How do we value something we could have against what we have already?
Such questions abound as we focus upon one of the most fundamental challenges to the achievement of a sustainable and prosperous future: the lack of a functional economic mechanism to help us positively value the future.
Our financial measures predominantly focus upon the value of the immediate. There is of course a certain logic to valuing today more highly than we value next week or beyond — the present actually exists (for the sake of argument) whilst next week is only a logical probability. In any case, even if we could be sure that next week will exist, we have no idea what might happen between now and then, what new technologies would transform the opportunities we might have to catch birds/make bird substitutes/change our dependency upon birds, etc.
Discounting our chances for a sustainable future
A consideration of future value is a key part of any investment decision, financial planning or accounting process. An amount of money in your hand can be considered as definitely real (in as much as money is ever real) whereas money in the future is always considered to be less valuable as it is far more notional and conditional upon circumstances. This is referred to in terms of the discount that future value would have when set against its value now (net present value).
The mechanism for calculating this reduction of value over time is the discount rate. A seemingly innocent and rational accounting technique, the discount rate is perhaps the most significant reason why we find it so hard to invest in a sustainable future.
Some approaches exist that allow us to value future outcomes, yet each is substantially constrained by the deadening effect of the discount rate. Cost-benefit analysis, for instance, is the main vehicle for assessing the likely financial outcomes of different courses of action. It was used by Lord Stern to calculate that the costs of a transition to a lower-carbon economy were a fraction of those of dealing with the implications of unconstrained climate change.
Logical? Sort of …
Discounting future value makes a great deal of sense for many things but it also projects a restraint on forward planning that restricts adequate investment in sustainable change.
Like so many aspects of economics and accounting, it is intensely logical (and useful) within a very specific frame of reference. If that frame of reference shifts, then logic would dictate a re-consideration of its utility.
The frame of reference for the discount rate has definitively shifted.
From discounting to compounding — our route to a sustainable future
Economics, finance and accounting may not have developed mechanisms to compound value over time (as noted, because the future doesn’t exist yet). However, it’s conceivable to imagine a social and economic architecture that would innately involve an ability to compound the future.
There a couple of possible ways to increase future value and therefore encourage behaviour that pays off over the long term:
For there to be a purpose to capitalism… This solution is exquisitely easy to express, though perhaps rather harder to achieve. We need to introduce a long-term purpose for economic activity. In addition to being financially and personally worthwhile for individuals to participate, economic activity should make a manifest contribution to the achievement of:
With these goals in place, it would be relatively easy to compound value, to judge behaviour by its contribution to these goals, asking the question ‘are these activities likely to achieve or to undermine our sustainable destination?’
Just as investors currently (in theory) assess the likelihood of a company achieving its stated aims and value them accordingly, so this could done in the context of a shared long-term goal. Long money and short money — changing the rules of money. This refers to ideas which either change the conception of money itself (I have previously suggestedthat thermodynamic performance, abundance, contribution to natural capital and balanced social interdependence are good suggestions to add to the current basic elements of scarcity, supply and demand) or which alter the rules that are applied to money.
One such approach to the rules of money would be to create “Long money” and “Short money.” Short money would have a use by date and be spent on day-to-day things, Long money would be more suited to infrastructure investment and projects with a long term or common-good payoff.
The mechanism for creating such distinctions exists, it is called demurrage — it is a reverse interest rate and refers to a cost levied for holding or owning money for a given period. Applying demurrage universally would naturally discourage people and organisations from sitting on money, and encourage its circulation or investment as Long money, which would be inherently more useful for the common good.
A practical example of this type of thinking is in the area of alternative currencies, which have been used in reality across the world in order to achieve a range of rather amazing things. A pioneer of alternative currencies is Bernard Lietaer — his books and websites give a number of incredibly inspiring and creative examples as to how alternative money can change the world and in many cases already has.
We meant to save our civilisation but didn’t have a budget code for the work …
The discount rate dominates and dictates an unsustainable future because, surprisingly or not, humanity doesn’t have a plan. As a species we are old enough, and dangerous enough, not to be blundering around without a destination and a plan by which to get there.
A common direction is not dictatorship, communism or even collectivism, it is simply an intention to survive, and perhaps even to thrive over the coming decades.
Our current mode of capitalism is no less collectivist than what I propose — it defines shared modes of behaviour, measurement, legality and value — however current capitalism lacks a definable and constructive plan for the prosperity of our species or planet over the long term. This is an issue that is manifestly worth addressing as it is clear that the demand is there: Most of humanity is keen to ensure a viable and successful future for themselves and their loved ones.
LIkewise, our conceptions of the meaning and purpose of money are no more fixed in stone or incapable of change than any other systems (though they may have more inertia). Money is a tool, a means by which we signify value and facilitate exchange. Valuing the long-term success of our species should certainly be worth something and perhaps it is time we considered the role that our means of exchange could have in achieving that success.
The forthcoming challenges of sustainability should spur our action, so that we might design ways to overcome the barrier of the discount rate and work towards building a greater future value than our limited financial mechanisms currently allow us to conceive.
“This is the first age that’s ever paid much attention to the future, which is a little ironic since we may not have one.” — Arthur C. Clarke
This post first appeared on the Terrafiniti blog on September 29, 2014.
Joss Tantram is an experienced expert in sustainable innovation and thought leadership.
He mixes 15 years of private sector experience with 5 years in WWF, the worlds largest environmental NGO.
Joss leads Terrafiniti's strategic services and their R&D and innovation initiative,… [Read more about Joss Tantram]
by Joss Tantram
October 13, 2014
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