Environmental Economics & Cost-benefit Analysis

Dan Phaneuf on BCA:

Environmental economists tend to favor cost-benefit analysis in the policy arena because of the discipline and transparency it provides in evaluating policy options. It is easy to evaluate absolutes. Most would agree that reducing nitrogen contamination of groundwater wells, limiting the occurrence of code red ozone alerts, and preserving habitat for grizzly bears are worthy goals. Determining the relative merits of any one of these compared to the others, or compared to non-environmental goals such as improving public education, is much more daunting. Because policy making is ultimately about evaluating the relative merits of different actions some mechanism is needed to rank the alternatives. Without the discipline of cost-benefit analysis it is not clear how the interests, claims, and opinions of parties affected by a proposed regulation can be examined and compared. Criterion such as ‘moral’ or ‘fair’ do not lend themselves well to comparison and are subject to wide ranging interpretation. Who gets to decide what is moral or fair? Cost-benefit analysis is far from perfect, but it demands a level of objectivity and specificity that are necessary components of good decision making.

Certainly economists may favor the use of benefit-cost analysis because doing so involves transparency and discipline, and perhaps because both these things encourage objectivity by the analyst. But, there must be more than this that is involved.

As is noted in this quote, choosing among policy alternatives involves, either implicitly or explicitly, the ranking of alternatives, and in order to rank alternatives, it is necessary to make value judgments. In a sense, "benefit-cost analysis" (BCA) can have a generic meaning which relates to any choice. That is, to make a choice a person considers the benefits against the costs of each available choice, and then presumably, the person chooses the alternative with the greatest excess of benefits over costs. Different people can, and do, make different choices even though they face the same alternatives. Different people make different value judgments about what the relevant "goal" is, and therefore, for different people each of the available choices is valued or evaluated in different ways. In thinking of BCA this generic way, benefits are associated with advancing toward the goal and costs are associated with detracting from the goal. As such, different value judgments would imply that the benefits and costs have to be computed in different ways. For the same set of policy alternatives, different value judgments must lead to computed benefit-cost analyses that are different.

When environmental economists do benefit-cost analysis what value judgments do they use? Note, first, that the value judgments I am writing about provide economists with an answer to this question: What is the appropriate role or purpose of government in our system of political economy? Or to borrow, and paraphrase, from Weimer and Vining : What do we consider legitimate uses of government's coercive power? For most environmental economists the value judgment that answers these questions is that the economy should achieve an efficient allocation of resources, and therefore, the role and purpose of government is to aid the economy in achieving efficiency. Much economic analysis of efficiency is theoretical. For environmental economists, benefit-cost analysis represents the applied version of theoretical efficiency analysis.

Saying that economic benefit-cost analysis is the economist's applied tool for assessing the efficiency of alternative public choices and policies doesn't really tell us very much which is specific. We still need to know what the economist means by "efficiency." A very general idea is that an efficient choice for government is one that means people in the community in general will be better off as a result. This means, then when an environmental economist makes a benefit calculation, the idea is to make an estimate in dollar terms of how much better off people in the community will be. Similarly, the cost calculation is supposed to be an estimate of how much worse off people in the community will be. In general, the people who are better off, given a choice by government, will not be the same people who are worse off because of government's choice. Economists want to recommend only government actions which are expected to have benefits greater than costs (both terms as specifically defined by us) because when this condition obtains they know it is possible to use resources differently in our system of political economy, and in such a way that people in the community in general can be better off.

Economists certainly like benefit-cost analysis for the reasons cited in the above quote. But, there is more to it. We also like benefit-cost analysis because we conceptually construct, and then estimate, our notions of benefits and costs so that we can make empirical statements about which government choices will aid in achieving the normative purpose of government, which, in the case of most environmental economists, is an economically efficient allocation of resources.

So, if you agree with the role of government utilized by economists, then you probably should like to know the results of their benefit-cost analyses. On the other hand, if the value judgments you favor to define the role and purpose of government (and its use of coercion) differ from that of economists, then the benefit and cost numbers estimated by economists are not likely to tell you much about whether a given choice by government advances toward the role of government you favor. In that case, I assume you would want to develop your own definitions of benefits and costs based upon the value judgments you use to define the role of government.