In the last journal round up, we featured a paper that found that gains to life were valued higher than gains to consumption under standard assumptions about preferences. This sounds like one of those common sense things that are touted as a ‘finding’ but which most people would have said ‘I don’t need an economics degree to tell you that’. Fair enough. But these results do have consequences for economic methodology. One example of that is the social discount rate that we use for the evaluation of the benefits of medical technologies.
A positive social discount rate is often used so that gains in the future are worth less than gains today. But why? Based on the Ramsey growth model, the discount rate is equal to the sum of two components: a) the time preference rate as applied to cardinal utility, and b) differences in the marginal utility of consumption over time. The latter term is the product of the growth rate and the consumption elasticity of marginal utility, which is the rate at which consumption declines in consumption. Since we are valuing health benefit, we can express the consumption value of health, which is the amount of consumption at time t equivalent to one unit of health. Let’s examine these in more detail (see also Further Reading at the bottom for more in depth analysis).
1. Time preference
The extent to which an individual prefers present benefits to those in the future is known as an individual’s time preference. While an individual may have a positive time preference, whether rational or not, this does not necessarily imply a positive social discount rate. This is most clearly evident when we make inter-generational comparisons and evaluate policies that affect as yet unborn people. Often a positive social time preference for health is taken as given. Yet, while I may prefer to be in better health now rather than later, people who are as yet unborn have no such preference. They are not ‘waiting’ for these benefits to accrue. This is known as the No Waiting Argument, the strongest form of which states that we have zero time preference before birth. It makes little sense to argue that we should discount future benefits for as yet unborn people because they would prefer to receive those benefits now. At the very least, the No Waiting Argument shows that a positive discount rate within a life does not imply a positive discount rate across lives and hence a positive social discount rate.
2. Marginal Utility of Consumption
With regards to consumption goods a positive social discount rate is usually implied. A positive growth rate means future generations will have greater consumption and marginal utility is decreasing in consumption so equivalent goods should be valued more today. This is also a way of smoothing consumption across generations. A positive social discount rate for health effects is therefore implied if the consumption value of health is decreasing. However, the consumption value of health is likely to be increasing. One reason for this is that the marginal utility of consumption is likely to diminish faster than the marginal utility of health. The consumption today that is equivalent to a unit of health in terms of utility may be less than the equivalent. Some studies also suggest that the value of a statistical life increases with income and will therefore increase over time.
There are other reasons given in support of a positive social discount rate. Some authors have suggested that the future should be discounted because it is less certain. Uncertainty has been a key point regarding discounting in the debate about the economics of climate change. More uncertainty may be a reason to discount outcomes to reflect a reasonable risk premium, but while temporal distance may be correlated with higher uncertainty, it is not interchangeable with it. There are different levels of uncertainty attached to present day outcomes, which should attract the same discounting with respect to the uncertainty as any outcomes in the future.
Many of the arguments presented here have been aired in other debates, in particular in climate change economics, where the effects of environmental policies today have effects extending many hundreds of years in the future. A consensus is unlikely to be reached any time soon about the appropriate discount rate and this post is not a comprehensive treatment by any means. The choice of discount rate can have important consequences on our choices about which medical technologies to invest in. Indeed, different rates may have important equity implications. While many evaluations present results for a range of discount rates, these never include negative rates for benefits. Perhaps they should…
Claxton K, Paulden M, Gravelle H, Brouwer W, Culyer AJ. Discounting and decision making in the economic evaluation of health-care technologies. Health Econ 2011; 20: 2–15.
Gravelle H, Smith D. Discounting for health effects in cost-benefit and cost-effectiveness analysis. Health Econ 2001; 10: 587–99.