On Discount Rates for Cost-Benefit Analysis

Abstract

This paper is concerned with the choice of the appropriate rate of discount for use in cost-benefit analysis and project appraisal. In particular, attention is focused on the manner in which the appropriate discount rate depends upon the conditions prevailing in the labor market of the economy in question. Where labor is genuinely in excess supply, to the point where all workers to be employed in the operation of a project can be assumed to be drawn from a large pool of unemployed, the wages to be paid to labor should not be counted as an economic cost, and should therefore not be deducted from the gross benefit stemming from the investment in the project. The consequence of this procedure is to produce high estimated returns to investment, and consequently a high discount rate for cost-benefit work. For India in particular, the assumption of a superabundant labor supply, in the sense just mentioned, would appear to require that a discount rate of over 30 percent be used in cost-benefit analysis.