Bozo goes bozo

It’s remarkable how incredibly badly he understands things:

Discounting the future.

He should try reading the Stern Review, long discussion of it in there. Of course we discount the future. Because human beings do, righteously. A pound today is worth more than one tomorrow. Partly the time issue – interest – and partly uncertainty – the risk premium.

These things just do exist. Discounting the future – no, this does not mean the future is assigned no value, only that it is assigned a lower one than today – is thus just a part and parcel of being a being with a limited lifespan facing uncertainty.

As the Stern Review describes at length.

Now, it’s possible to have interesting conversations about the rate at which we should discount. But the base idea that we should is so obvious that it’s entirely remarkable to even think of opposing it.

We’re back in that world where Snippa just never does consider that other people have thought through the same problem occasionally.

15 thoughts on “Bozo goes bozo”

  1. Has he heard of the going concern principle? That idea of trying to evaluate whether the business has a future?, Mind you, some auditors are better at that than others… Carillion anybody? As soon as the CEO and CFO trousered their huge bonuses and left, surely someone should have noticed the warning lights flashing

  2. UK Treasury Green Book is also interesting if somewhat technical read on this.

    The introductory bit:

    Discounting and Social Time Preference

    5.32 Discounting is a technique used to compare costs and benefits occurring over different periods of time on a consistent basis. Discounting should be applied to all future costs and benefits. Discounting in appraisal of social value is based on the concept of time preference – that generally people prefer to receive goods and services now rather than later.

    5.33 For individuals, time preference can be measured by the real interest rate on money lent or borrowed. Amongst other investments, people invest at fixed, low risk rates, hoping to receive more in the future to compensate for the deferral of consumption now. These real rates of return
    give some indication of their individual pure time preference rate. Society as a whole, also prefers
    to receive goods and services sooner rather than later. This is known as ‘social time preference’.
    The discount rate used in the Green Book is known as the ‘social time preference rate’ (STPR). It is
    the rate at which society values the present compared to the future.

    5.34 The STPR has two components (Based on Ramsey F.P. (1928) “A Mathematical Theory of Saving” Economic Journal, Vol. 38, No 152, pp. 543 559):

    * ‘time preference’ – the rate at which consumption and public spending are discounted over time, assuming no change in per capita consumption. This captures the preference for value now rather than later.

    * ‘wealth effect’ – this reflects expected growth in per capita consumption over time, where future consumption will be higher relative to current consumption and is expected to have a lower utility.

    5.35 The STPR used in the Green Book is set at 3.5% in real terms, with exception for risk to life values which use a lower rate of 1.5%. The derivation of the discount rate can be found in Annex 6.

    Table 2 shows the present value of £1,000 declines in future years with a discount rate of 3.5%.

    Table 2. Present Values and Discount Rate

    Year Value
    0 £1,000
    1 £966
    2 £934
    3 £902
    4 £871
    5 £842
    6 £814
    7 £786
    8 £759
    9 £734
    10 £709

    5.36 The main role of discounting is to put interventions with different time spans and benefit cost profiles on to a common “present value” basis. In the longer term (over 30 years), the STPR declines in a series of steps to allow for future uncertainty in the value of its constituent parts, as explained in Annex 6. The approach to discounting where there are inter-generational wealth transfers is also described in Annex 6. The accompanying tables in Annex 6 and associated tables on the Green Book web pages show both the discount rate and discount factors that can be used to calculate a present value.

    5.37 Discounting is solely concerned with adjusting for social time preference and is separate from adjusting for inflation. The recommended Green Book discount rate applies to real values, with the effects of general inflation already removed. To promote transparency the best practice approach is to first convert costs or benefits to a real price basis, and then perform the discounting adjustment. The inflation rate and discount rate should not be added and applied to costs and benefits.

    5.38 In appraisal, discounting should never be applied retrospectively to costs and benefits that have already occurred. Values do not increase simply because activities took place in the past (although of course the value of some assets may tend to increase over time). Discounting and the
    calculation of NPSV are illustrated further in Box 10.

    5.39 Costs to government of raising funds (either through taxation or borrowing) are not a decision variable when considering whether to go ahead with a project or not. The STPR is therefore not linked to the costs of raising funds (either through taxes or borrowing).

    People often leave off the wealth effect angle and focus only on the time preference one but they both matter. In fact annex 6 shows exactly how much.

    Breakdown of the discount rate

    A6.6 The STPR is expressed as r = ρ + µg

    where:
    * r is the STPR,
    * ρ (rho) is time preference comprising pure time preference (δ, delta) and catastrophic risk (L),
    * µg is the wealth effect. The marginal utility of consumption (µ, mu), multiplied by expected growth rate of future real per capita consumption g.

    A6.7 As recognised in the 2003 Green Book there are a range of estimates of the individual components of the discount rate (See discussion paper: Spackman, M. (2016) “Appropriate time discounting in the public sector” GRI Working Paper No. 182. Grantham Research Institute on Climate Change and Environment. London School of Economics). Research continues to illustrate a range of plausible estimates but concludes that the overall discount rate of 3.5% remains within that range and is justifiable (See Freeman, Groom and Spackman (2018) “Social Discount Rates for Cost-Benefit Analysis: A Report for HM Treasury” published on the HMT Green Book web page).

    A6.8 The way in which the STPR is applied in the Green Book requires each component to be specified. This facilitates sensitivity analysis and clarifies treatment where individual components of the discount rate should be adjusted (e.g. for health discounting). The overall values ascribed to specific components of the STPR are retained from the 2003 edition as set out below. The calculation of the STPR is shown in Box 29.

    Estimates of ρ

    A6.9 The estimate of ρ (rho) is the sum of an allowance for time preference (δ) and an allowance for unpredictable risks not normally included in appraisal, known as
    ‘catastrophic’ and ‘systemic’ risk (L).

    A6.10 The risks contained in L could, for example, be disruptions due to unforeseeable and rapid technological advances that lead to obsolescence, or natural disasters that are not directly connected to the appraisal. L also includes a small premium for ‘systemic risk’ because costs and benefits are usually positively correlated to real income per capita. With regard to time preference, δ, Freeman, Groom and Spackman (2018) survey the evidence and show that plausible values range from 0% to 1%. Coupled with an estimate of 1% for the risk component, L, this is compatible with a value of 1.5% for the overall value of ρ.

    A6.11 For the purposes of the STPR the estimate of δ is retained at 0.5% and the estimate of L is retained at 1%. The estimate of ρ is therefore 1.5%.

    Estimates of µ and g

    A6.12 Available evidence suggests a range of plausible values of µ (mu). The 2003 edition of the Green Book set a value of 1. As set out in Annex 3, the estimate used by DWP for distributional weighting is 1.3 (based on Layard et al. (2008) “The marginal utility of income” Journal of Public Economics, Vol. 92, pp. 1846-1857), while Groom and Maddison (2018, “New Estimates of the Elasticity of Marginal Utility for the UK” forthcoming in Environmental and Resource Economics. Working paper version (2013) Centre for Climate Change Economics and Policy Working Paper No. 141) use a number of techniques to estimate a pooled value of 1.5.

    A6.13 Historic growth rates in consumption per capita depend on the time period considered and the extent to which more recent growth rates or projections are considered to be representative of long term trends. The 2003 Green Book set g at 2%. Freeman, Groom and Spackman (2018) reference average real annual per capita consumption growth for the UK for the period 1949 – 2016 of 2.2% per year. Estimates based on ONS data from the recent past, for example 1996 to 2016, are lower at 1.7% per year (The ONS quarterly national accounts publication provides historic consumption data. Based on analysis in December 2017 the approximate compound annual growth rate in consumptions per capita between 1996 and 2016 was 1.7%. Freeman, Groom and Spackman (2018) provide a range of estimates for different historical horizons).

    A6.14 Future projected growth rates are also relevant. Long-run forecasts of GDP growth (rather than consumption) from the Office of Budget Responsibility are for growth of 2.2% per year in real terms. This implies an annual projected growth rate of GDP per capita of 1.9% (Long-run forecast of GDP growth from the Office for Budget Responsibility – Long-term economic determinants – November 2017 Economic and fiscal outlook – supplementary documents published on 24th of January 2018. Estimate of average long-term GDP per capita growth consistent with OBR’s long term economic determinants).

    A6.15 Taken together, the range of estimates of µ and g suggest 2% remains plausible as an estimate of the overall wealth effect. For the purposes of the STPR the estimate of µ is retained at 1 and g at 2%.

    Box 29. Calcuation Of STPR

    r = ρ + µg
    Where ρ = 1.5%; µ = 1.0; and g = 2%
    0.015 + 1*0.02 = 3.5%

    Exceptions to the standard STPR
    A6.16 The recommended discount rate for risk to health and life values is 1.5%. This is because the
    ‘wealth effect’, or real per capita consumption growth element of the discount rate, is excluded. As set out in Annex 2, health and life effects are expressed using welfare or utility values, such as Quality Adjusted Life Years (QALYs), as opposed to monetary values. The diminishing marginal utility associated with higher incomes does not apply as the welfare or utility associated with additional years of life will not decline as real incomes rise.

    A6.17 The standard UK discount rate may not be appropriate for appraisal of Official Development Assistance (ODA) expenditure. For example, long term growth rates, the probability of catastrophic risk and the macro-economic effects associated with expenditure may differ. An appropriate estimate of the STPR for the recipient country should be used. Government departments should
    contact Department for International Development if they require further information.

    Long term discounting

    A6.18 Policies or projects which involve long term effects may require a different approach. This can be particularly important for policies expected to have significant environmental effects. Where long term effects are expected to occur, the appraisal of proposals may involve longer timescales. Generally, the maximum life span of an intervention is assumed to be up to 60 years. This may be extended where there is evidence a longer time period is required for the full effects of an intervention to materialise.

    A6.19 The standard STPR of 3.5% applied in appraisal should decline over the long term due to uncertainty about future values of its components. The declining rates are shown in Table 8. To support practical application in appraisal, discount factors by year can be found in Table 9 and Table 10 below in addition to the Green Book web-pages. The basis for the approach to long-term discounting set out here can be found in supplementary guidance on intergenerational wealth transfers and social discounting.

    The intergenerational transfer stuff is quite interesting too but somewhat besides the point.

  3. In short… You can disagree with some of this stuff if you like. I mean personally I’ve rarely been impressed by OBR estimates and I think there’s potentially a lot of over-optimism in their long-term per capita GDP growth figure, certainly some downside risk to it. We have seen some other developed economies stagnate almost completely for decades, we still haven’t worked out our escape route from near-zero interest rates and massive debt, and even if you don’t allow for some chance of stagnation I think 2% growth per capita looks a bit rosy. There’s a huge section in the Green Book on optimism bias in project evaluation, incidentally. But I’m not a macroeconomist so what do I know?

    What you can’t ignore is the intellectual and technical work that has gone into designing rational, evidence-based processes for discounting long-term projects. Similarly in the corporate case with the extensive research into cost of capital. I can’t even get my head around how someone could supposedly have worked in a commercial setting at a half-senior level and not grasped the basic ideas around cost of capital and the need for a project to do more than bring back (only in the future) the same inflation-adjusted cash sum you put into it in the first place.

    It’s not just something someone made up on the spot, and the discount rates haven’t been plucked from thin air. If you chuck out this edifice for evaluation, you bring in all kinds of distortions. I can’t understand how he can be so flippant about this so regularly and yet several people who have worked at a high level in business, government, management or economics academia still take him seriously.

    The Green Book: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/685903/The_Green_Book.pdf

    Social Discount Rates for Cost-Benefit Analysis: A Report for HM Treasury by Mark Freeman, Ben Groom and Michael Spackman: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/685904/Social_Discount_Rates_for_Cost-Benefit_Analysis_A_Report_for_HM_Treasury.pdf (an interesting read with extra detail about catastrophic risk etc)

  4. It looks as if Murphy has forgotten what a discount rate means and then looked up the alternative non-financial meaning of “discount” in a cheap dictionary.

  5. MyBurningEars

    “In short…:

    If only.

    You need to get your own blog; your comments are ten times longer than Tim’s posts.

  6. Economics and accounting do care about the future. The simple fact that we have investment says this must be true. The very act of investing valuable currency today and then assuming that the returns on a dollar for dollar or pound for pound basis will each be less valuable than the ones invested today, but that we’ll get enough more of these less valuable dollars or pounds back to make it worthwhile, is surely an act of optimism and a statement of confidence in the future.

  7. He knows exactly what it means, he is just being extraordinarily slippery in using one form of the word, the one more known in public use (to disregard completely) in place of another more technical meaning (to reduce future value according to an accounting standard).

  8. ‘It’s remarkable how incredibly badly he understands things’

    Not really Tim – I think you’ve proven over nearly a decade that the man is incapable of stringing together thoughts across consecutive days let alone constructing a coherent ideological view of anything. Combine this with an over-estimation of his capabilities that I have seldom seen outside woorks of satire and the sole thing that is remarkable is that anyone gives him even the slightest oxygen of publicity.

    In the BLM era (especially given his Irish roots and concomitant experience of racism) he is clearly ‘the man for the season’. In the land of the utterly ignorant he is not so much a king as Emperor of all he surveys..

  9. Dennis, A Very White Cultural Appropriator

    News that is somewhat disturbing, but holds out the possibility of being unintentionally hilarious…

    Richard Murphy is going to produce a series of Youtube videos “explaining economics”.

  10. Worrying that accounting is not sufficiently concerned about the future always strikes me as similar to complaining that Historians focus too much on the past.

    You can’t do detailed accounts for the future, and you shouldn’t try to.

    Complaining that economics isn’t focused enough on the future is just mental. Predicting future outcomes is pretty much why anyone cares to learn about it.

  11. “Bozo goes bozo”

    Thought it would be about Bozo Bojo’s green crap and bunging $2billion to “The Arts” so they can make more Marxist & green crap

  12. So. Give me a £10,000 today and I’ll give you £1,000,000 pounds in 50 years.

    How’s about that for a deal Spud?

    What do you mean “You’ll be dead”? I thought you cared about the future?

  13. Can you imagine Ritchie shopping for a new pair of trousers in the January sales.

    “So they’re free.”

    “No sir, they’re discounted.”

    “So they’re free.”

    “No sir, they’re discounted.

    And so on and so forth.

  14. John77

    Yes that’s what he’s done, but it seems to be the deliberate mangling of word definitions common on the Left.

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