In discussions I have been having since last week on the subject of discount rates, I have run into a troubling attitude among some in the clean tech industry: we should do away with discounting altogether. The argument goes like this. Discount rates are based on factors that are uncertain and often highly variable. If we eliminate discounting from cost-benefit models, those models will have a less error and therefore will be improved.
To eliminate discounting would be a gigantic mistake. I will not go into the technical reasons why eliminating error does not necessarily improve a model. I will explain two other reasons that discounting is critical. First, discounting is a near sacrosanct tool in the world of finance. Arguing for more investments in renewable energy or efficiency using cost-benefit models that do not involve discounting will convince very few (if any) investors.
Second, discounting makes the models much more useful. The test of a good model is not whether it is accurate--it isn't: inaccuracy is an inherent characteristic of all models. The test of a good model is whether it gives us useful insight. Discounting reflects a key economic reality: the time value of money. We get much more insight from a long-term cost-benefit analysis if it accounts for this reality.
There are problems with discounting, absolutely. The assumptions behind standard financial discounting models are flawed, and they are particularly problematic when it comes to clean energy. But eliminating the discount rate would be like cutting off your leg because you twisted an ankle. It eliminates a problem, but it creates far greater problems.
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