Part 4
Net Present Value An ecosystem produces a flow of valuable services across time. In this sense it can be thought of as a capital asset. This analogy can be extended by calculating the net present value of the future flows of ecosystem services, just as the asset value of a traditional capital asset (or large project) can be approximately calculated as the net present value of its future benefits. This calculation is an exercise however, because ecosystems are not bought and sold in this manner. Calculating the net present value of an asset in traditional economics requires the use of a discount rate. The Army Corps of Engineers use a 4.125% discount rate for large projects, which lowers the value of the benefits by 4.125% every year into the future. Seattle Public Utilities and some other institutions use a 5% discount rate for capital construction projects. The net present value of the Puyallup Watershed was valued using two discount rates: zero and 4.125%.
Discounting has limitations. Using a discount rate assumes that the benefits humans reap in the present are more valuable than the benefits provided to future generations. Renewable resources should be treated with lower discount rates than built capital assets because they provide a rate of return over a far longer period of time. Most of the benefits that a natural asset such as the Puyallup Watershed provides reside in the distant future, whereas most of the benefits of built capital reside in the near-term, with few or no benefits provided into the distant future. Both types of assets are important to maintain a high quality of life, but each also operates on a different time scale. It would be unwise to treat human time preference for a forest like it was a building, or a building like it was a disposable coffee cup.
A discount rate is designed to control for the following: 1. Pure time preference of money. This is the rate at which people value what they can have now, compared with putting off consumption or income until later. 2. Opportunity cost of investment. A dollar in one year’s time has a present value of less than a dollar today, because a dollar today can be invested for a return in one year. 3. Depreciation. Built assets such as cars and levees tend to deteriorate and lose value due to wear and tear, while natural assets tend to appreciate in value. Discounting can be adjusted for different types of assets.
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The Puyallup River Watershed: An Ecological Economic Characterization