Declining Discount Rates for Energy Policy Investments in CEE EU Member Countries

Abstract

Energy policy investments are usually evaluated using a cost-benefit analysis (CBA), which requires an estimation of the social discount rate (SDR). The choice of SDR can be crucial for the outcome of the appraisal, as energy-related investments generate long-term impacts affecting climate change. Once discounted, these impacts are highly sensitive to slight changes in the value of the SDR. Some countries (the UK and France) switched from a constant SDR to the declining rate scheme—a solution that limits the impact sensitivity. To our knowledge, none of the CEE countries apply DDR in CBA. While a constant SDR is a relatively well-established approach, declining SDRs are estimated to be used much less frequently, particularly for CEE EU member countries and energy policies. The rationale for the decline can rest on uncertainty over future discount rates, as shown by the approach developed by Weitzman and Gollier, which extends the classical Ramsey model. We applied this approach in our paper, as the Ramsey formula is the prevailing formula for EU countries’ SDR estimates. We estimated a flat SDR via the Ramsey formula with Gollier’s “precautionary term”, and next, we calculated Weitzman’s certainty equivalent rates for the 500-year horizon. Ramsey’s SDRs, obtained using consumption growth rates dating back to 1996, varied between 6.77% for Lithuania and 2.95% for Czechia and declined by 0.15% on average (Gollier’s term). Declining SDRs for the longest horizon dropped to approx. 0.5% (from 0.35% for Bulgaria to 0.67% for Poland), and the descent is deeper and faster when forward SDRs (following the UK Green Book approach) were considered (0.01% to 0.04%). The results are important for long-term policies regarding energy and climate change in CEE EU member countries, but they are still dependent on fossil fuels and experience an investment gap to fulfil EU climate goals.