The effects of applying alternative discounting methods on the economic feasibility test of Free Trade Zone development project

Abstract

Purpose The purpose of this paper is to examine the applicability of the alternative way of discounting, such as the hyperbolic discount method, for the economic feasibility test on Free Trade Zone development project that needs intergenerational analysis. Design/methodology/approach To analyze the effects of applying alternative discounting method in the cost-benefit analysis, this paper uses the hyperbolic discount method and HM-Treasury’s method (Britain), as well as the traditional exponential discount method. Also, this study uses benefit and cost data from the actual feasibility test of the Free Trade Zone development project in Korea, to obtain better policy implication. Findings For the case of long-term analysis, using the exponential discounting method in the benefit-cost analysis could not give us balanced analytic results, because it discounts too much on future generation’s benefits. In contrast, if we use the hyperbolic discounting method, we could obtain better balanced results since it can control the generational effects. This paper also finds that for the results to be valid, the analysis period must be expanded long enough (a minimum of 100 years). Originality/value The major findings of this paper confirm the results of previous studies regarding long-term benefit-cost analysis. Also, the result of this paper is properly compatible with the findings of behavioral economics, such as the time inconsistency of preferences. However, no research has been done with the proper length of analytic periods for using hyperbolic discounting yet. To examine this matter, this paper performs benefit-cost analysis with actual data from the feasibility studies in Korea. To the best of the author’s knowledge, this is the first study to find the proper length of analytic periods that can be compatible with the hyperbolic discount method.