Web Debate on Benefit-Cost Analysis

"Smith says that we have limited resources and that we may have to trade one environmental or educational program against another. But why is it only good things that have to be traded against each other? What if we want both education and environmental protection, what if we want both protection of coastal wetlands and spending on climate change mitigation? Personally, we’d like to have it all, and finance it by giving up some useless missiles or tax cuts for millionaires. Scarcity is artificially contrived, in the midst of American affluence, by declaring such choices off-limits. Why should we throw up our hands and say that the richest country in the world can’t afford to protect the environment and educate our kids? Cost-benefit analysis doesn’t reflect preferences like ours because it does not -- and cannot -- take a large look at what our society spends money on and help us get the things we want most. For that, we have democracy, not made-up markets."

I would be very interested to have people make comments on this on-line debate. Which side do you think gets the best of the discussion?

I know that most economists view the role and purpose of government as correcting market failure. Based upon the discussion by Ackerman & Heinzerling, I have no idea what they think the role of government should be. James Madison describes the role of government:

"Government is instituted to protect property of every sort; as well that which lies in the various rights of individuals, as that which the term particularly expresses. This being the end of government, that alone is a just government, which impartially secures to every man, whatever is his own."

Madison's "end of government" is pretty much the normative framework of individual liberty. I agree with Madison. While the normative framework of efficiency, which defines the economic role of government as correcting market failure, is not identical to the role of government defined with respect to individual liberty, it seems to me most economists are not hostile to liberty. I suspect that Ackerman and Heinzerling can be pretty hostile to individual liberty because of their assertion that we have democracy to help us get the things we want most. Would you agree?

Nomination Watch on Judicial Philosophy

Luckily, some Senators recognize that the Senate has an obligation to find out about a nominee’s philosophy. As the blog ThinkProgress noted, Senator Arlen Specter (R-PA), Chairman of the Senate Judiciary Committee, wrote in his autobiography that Senators should ask nominees about their judicial philosophies, and that nominees must answer or risk rejection by the Senate.

Well, I'm not sure about this idea. I think I agree, but I'm afraid my definition of judicial philosophy may be different from this author, and unfortunately the term is not explicitly defined. I suspect that for this author questioning about judicial philosophy means asking questions about what a nominee's opinion of a specific case is. It is my opinion that a nominee cannot answer such questions truthfully until the questions are actually presented and debated between the justices. Further, I don't think such questions are questions of judicial philosophy. In contrast, I think questions about judicial philosophy should attempt to discover whether the nominee believes the Constitution lives and breathes by the preferences of Supreme Court justices, or whether the nominee believes the Constitution is "living" because it includes a formal process by which it can be amended. I think such a question is about judicial philosophy, while questions of the first sort seem to me questions about judicial politics.

Party Politics

Speaking of parties, is one political party more honest than the other when it comes to disclosing the mess we are handing our kids? No. Each party has its constituents, all of whom share the convenient property of being alive and being able to vote. Future kids don't have that luxury, and current kids are kept far away from the polling booths. So the goal becomes to make the grown-ups happy. The Democratic grown-ups are happy when the government spends more money (on them). The Republican grown-ups are happy when the government raises less taxes (from them). The ideal solution, then, is to spend more and tax less.

Kotlikoff & Burns, The Coming Generational Storm .

What more do we need to know about politics?

By the way, I think this book by Kotlikoff and Burns is a must read.

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.

More Job Creation

Russell Roberts has a follow-up on jobs in our economy:

In my earlier post on job creation, I lazily opened with this line:

The US economy grows jobs steadily.

It's a standard way of thinking about the economy as an engine or machine that creates jobs the way a factory makes cars. The sentence conjures up an image of the economy as something over there, separate from the rest of us. When the economy is healthy, it creates jobs. When it's unhealthy, it struggles to create jobs or worse, destroys jobs.

It's a very misleading metaphor. Job creation is the result of millions of decisions made by millions of people pursuing dreams and profits. When the environment for pursuing those dreams encourages risk-taking, jobs get created as long as people want to work. When the environment discourages risk-taking, people who want to work may not find it as easily.
. . .

The lesson here is to avoid metaphors taken from physics and engineering that are inevitably cause and effect metaphors and think instead of metaphors from biology where results emerge from the actions of multiple interactions in a complex system. Think rain forest not engine.

At least I said in that earlier post that the economy "grows" jobs. Sounds something like a rain forest. But the problem isn't the verb. It's the noun "economy" doing the growing like a farmer growing wheat. The economy can't do things. It is the result of individuals "doing."

This is excellent economics.

Global Warming and the US Economy

Alex Tabarrok:

Actually Laurie, and PGL of Angry Bear who links to David, the best study of the issue indicates that global warming is most likely a net benefit to the US economy. Carbon dioxide and greater temperature makes plants grow faster. The author, Yale economist Robert Mendelsohn writes:

Climate change is likely to result in small net benefits for the United States over the next century. The primary sector that will benefit is agriculture. The large gains in this sector will more than compensate for damages expected in the coastal, energy, and water sectors, unless warming is unexpectedly severe. Forestry is also expected to enjoy small gains. Added together, the United States will likely enjoy small benefits of between $14 and $23 billion a year and will only suffer damages in the neighborhood of $13 billion if warming reaches 5C over the next century. Recent predictions of warming by 2100 suggest temperature increases of between 1.5 and 4C, suggesting that impacts are likely to be beneficial in the US.

Speaking personally, I have undergone a greater shift in mean temperature by moving from Canada to the US than will occur in 100 years of global warming and I like it! My fellow Canadians, still stuck in the frozen north, will be glad to know that in the future they too can have warmer temperatures without giving up their prized health care system.

Jobs

Russell Roberts:

Not surprisingly, about half of the jobs are in above-average paying sectors. About half are in below-average paying sectors. Of course this tells you nothing of what has happened to the actual average. Some sectors with below average pay have created jobs that pay above the average and some high-wage sectors have created jobs with below average pay. But the point is that a growing economy creates all kinds of jobs. In truth, the wages attached to those jobs depend on our skills and the market for those skills. Those wages are enhanced by trade and by most of the things the doom and gloomers complain about.

Krugman's Policy Analysis Exposed

Professor Boudreaux is right on target.

In yesterday’s column, Krugman wrote:

How can medical experts who see obesity as a critical problem deal with an ideological landscape tilted in the direction of doing nothing?

One answer is to focus on the financial costs of obesity, and the fact that many of these costs fall on taxpayers and on the general insurance-buying public, rather than on the obese individuals themselves.

Krugman here reminds me of the 17-year-old kid who murders his parents and then pleads for the court’s mercy on grounds that he’s an orphan.

Krugman advocates government-provided, universal health care for all Americans. That is, Krugman advocates further turning issues that would otherwise be private in to ones that are, by policy design, public. (In econospeak, Krugman advocates creating an externality where one doesn’t naturally exist.) Championing existing levels of nationalized health-care in the U.S. (mainly Medicare and Medicaid), and calling for even more, Krugman then tosses his hands in the air rather cavalierly and cites these government policies as a justification for greater intrusion into people’s private lives (or, what should be people’s private lives – and would be people’s private lives exclusively – were it not for the very health-care policies that Krugman champions).

This sort of policy analysis happens often. A problem is asserted, which is then characterized as imposing costs on others. Reference (sometimes implicit, sometimes explicit) is then made to the economist's idea of a negative externality, and, of course, it is then asserted that the negative externality justifies government action to correct the asserted problem. But the problem is actually caused by other government action. An exteranlity is a market failure. When the problem results from government action (or inaction) we should not say we have an externality because we actually have a government failure with respect to achieving an efficient allocation of resources. The policy answer to government failure is not more government action that will add to inefficiency. The policy answer would seem to be to end the government action causing the asserted problem to begin with.

Krugman ends his commentary with

Above all, we need to put aside our anti-government prejudices and realize that the history of government interventions on behalf of public health, from the construction of sewer systems to the campaign against smoking, is one of consistent, life-enhancing success. Obesity is America's fastest-growing health problem; let's do something about it.

I think we see here another sort of common problem in policy analysis. I believe the history of successful public health actions involves policies with respect to infectious disease. Infectious disease has attributes that probably fit well the economist's models of market failure. The policy issues asserted with respect to smoking and obesity do not (perhaps environmental tobacco smoke fits the market failure idea, but it seems to me that once we consider private property rights what is left of this issue as a market failure is small in magnitude), because they involve impacts on the individual that result from the individual's own choices. It is a mistake in analysis to put obesity in the same set of policy concerns as infectious disease. The public health bureaucracies have often successfully dealt with the market failures inherent in infectious disease. These days these bureaucracies seem to have branched out far beyond infectious disease, and far beyond the set of issues involving market failures. I don't think we want to suggest that any thing a public health agency attempts to do today will be beneficial simply because in the past public health agencies did often deal with market failures. The incentives and logic of bureaus lead in the direction of expansion, and even though a government agency may have once, historically, pursued policy goals consistent with the economist's idea of market failure, it is likely the agency will want to tackle any issue that might allow the agency to expand regardless of whether the logic of government action to correct market failure fits or not.

Kelo: Fight Socienics

Read Arnold Kling :

In its recent Kelo decision (see Professor Bainbridge's essay), the U.S. Supreme Court gave its approval to what might be called "Socienics," in that it put the social benefit before individual rights. When the government of the city of New London claimed that it had a higher social purpose for Mrs. Kelo's property, the majority believed that the opinion of the government officials was beyond question. In effect, the Court ruled that "there is no definition of right beyond that."

Now consider James Madison:

Government is instituted to protect property of every sort; as well that which lies in the various rights of individuals, as that which the term particularly expresses. This being the end of government, that alone is a just government, which impartially secures to every man, whatever is his own.

I agree with Madison. It seems to me that any government that acts as Kling describes, is a government that is just.

ACORN's Living Wages

Economists in college classrooms all across the country tell students about the economic implications of government laws that impose a minimum wage. Students learn that minimum wage laws lead to a decrease in employment, among other things. Bryan Caplan points out a political organization that seeks to get government to impose a minimum wage as well as to increase minimum wage levels already imposed. The organization calls itself ACORN and apparently it too has learned that minimum wage laws decrease employment. Check out this post :

For years, ACORN has tried like hell to avoid paying its own members the minimum wage required by law! This, as those same employees were working to raise minimum wages for everyone else.

In fact, ACORN actually went to court to fight for its right to pay wages below the legal minimum. What's more, ACORN made the exact same arguments its opponents make when arguing aginst higher minimum wages -- namely, that paying higher wages would mean the company would have to make do with fewer employees.

In a suit ACORN filed to exempt itself from California's minimum wage laws, the organization wrote in its brief:

"As acknowledged both by the trial court and California, the more that ACORN must pay each individual outreach worker--either because of minimum wage or overtime requirements--the fewer outreach workers it will be able to hire."

How About Liber8

This is right on. More money aid to Africa won't lead to economic prosperity.

The Volokh Conspiracy - The Only Supreme Court Editorial You Need to Read:

Excellent summary by Orin Kerr. Check it out.

Looming pension system crisis

Probably few Americans are familiar with the acronym "PBGC." This is the federal Pension Benefit Guaranty Corp., set up by Congress 30 years ago to provide insurance for defined benefit pension plans.

Today, the PBGC's insurance program is overwhelmed, underpriced and proves a false sense of security to tens of millions of American workers and retirees. Companies are too often offloading their pension commitments to the agency, leaving PBGC with a $23 billion deficit at the end of 2004 after posting an accounting surplus of more than $7 billion in 2001. According to the Congressional Budget Office (CBO), that deficit is likely to grow dramatically over the next 10 years -- by as much as $48 billion -- and the PBGC's single-employer program is slated to run out of cash sometime between 2020 and 2025. That is more than 20 years earlier than the expected Social Security shortfall.

As chairman of the Senate Budget Committee, I believe this serious long-term fiscal problem must be addressed now. While the root of the problem concerns widespread underfunding among defined benefit pension programs and an outdated law permitting it -- an issue the administration and Congress are tackling -- we also must take steps to maintain the PBGC's solvency and protect participants, beneficiaries and investors.

Sounds like an example of "moral hazard." Government promises to "back up" pension plans, employers then underfund, and the risk of pension fund failures increases.

Perhaps the problems here are even worse than those associated with moral hazard:

The PBGC receives no appropriated funds. Claims are paid primarily from the revenue of the premiums from sponsors of covered pension plans. Current annual fixed-rate premiums are set at $19 per participant, well below the value of the PBGC insurance. Rules surrounding fixed and variable premium levels must be updated, taking into account the amount of existing underfunded liabilities.

Government is supplying the insurance. Are you surprised, therefore, to discover the premiums are too low?

Judicial Activism

Ever wonder what the term judicial activism means? This is a post worth reading. Do I stretch the term too far to suggest that commitment to the idea of a "living constitution" is a commitment to judicial activism

Three Lessons for the Great Debate Over The New Justice

I like Randy Barnett :

LESSON ONE: Watch the switch from a list of ignored textual provision to good and bad results.
LESSON TWO: Watch the switch from meaningful scrutiny to extremely deferential "rational basis" scrutiny, as a means of continuing to ignore portions of the text.
LESSON THREE: Watch for an appeal to "precedent" to attack a nominee who may favor reviving the original meaning of portions of the text--e.g. the "public use" portion of the Takings Clause--that have been ignored for far too long.

I think Barnett offers very good advice to any one interested in the Supreme Court and a written Constitution, in contrast to a "living constitition" that lives according to the preferences of 5 justices of the Supreme Court.

Eliminate the Supreme Court?

Hanno Kaiser suggests eliminating the Supreme Court. I don't really like his specific proposal, but I am curious about whether there might be a reason to say the Supreme Court cannot interpret the Constitution. Earlier I noted that I thought the Constitutional role of the Supreme Court in our system of political economy was to protect individual liberty. In contrast, both the Legislative and Executive branches of government respond to incentives that reflect the "will of the majority" (and sometimes the will of many minorities due to logrolling). It seems that if we are to minimize tyranny of the majority, we need a branch of government that can, and will, protect individual liberty as the priority of that branch of government. In our system of political economy, the only branch of government that could possibly want to protect individual liberty would seem to be the Judiciary.

If the Supreme Court decides it will defer to "the will of the majority," and if it will not protect individual liberty from tyranny of the majority, then why not just say it cannot interpret the Constitution? Let the Constitution be interpreted by the other two branches of government.

What do you think?

The Hot Major For Undergrads Is Economics

The reason for posting this one should be obvious, eh?

Economic Liberty

Mancur Olson suggested there are 2 necessary conditions for economic prosperity in his book Power and Prosperity:

. . .it was natural to ask how a society can obtain the types of markets that generate the rapid and sustained growth that brings a cornucopia of wealth. If we bring all of the theory and evidence together at once, we see that. . . .only two general conditions are required for a market economy that generates economic success.

. . . .the first of these conditions is the paradoxical condition of secure and well-defined individual rights. Rather than being a luxury that only rich countries can afford, individual rights are essential to obtaining the vast gains . . .and to obtaining the bounteous harvests that property-intensive and contract-intensive production can yield. In particular, a market economy can reach its full potential only if all of the participants in that economy, whether individuals or corporations, native or foreign, have the right to the impartial enforcement of the contracts they choose to make. It may also reach its full potential only if all participants have secure and precisely delineated rights to private property. . . .

There is no private property without government -- individuals may have possessions, the way a dog possesses a bone, but there is private property only if the society protects and defends a private right to that possession against other private parties and against the government as well. . . . [pages 195-196]

The second condition required for a thriving market economy is simply the absence of predation of any kind. . . .one other kind of predation can and often does occur even in societies with the best individual rights. This is predation through lobbying that obtains special-interest legislation or regulation and through cartelization or collusion to fix prices or wages. . . .The distortions of prices and the obstacles to innovation arising from distributional coalitions make an economy sclerotic. . . . [pages 196-197]

I believe that since the "economic due process" era, the Supreme Court has given greater protection to political liberties than to economic liberties. In the realm of liberties such as free speech the Court seldom defers to legislatures, but it has often been very deferential with respect to economic liberties. I suggest this contrast is evident in its Kelo opinion because it allowed government to take private property for transfer to another private use (even though a "public purpose" or "public benefit" was asserted). If the Court had not deferred to a legislative determination, it could have seen the transfer from one private use to another.

In deferring to legislative determination in cases where economic liberties are at risk or are actually infringed, the Court moves our system of political economy farther away from the conditions necessary for continued economic prosperity. Is there any action of government that is more predatory than taking property from one private use to transfer it to a different private use, and from one private owner to another private owner? I think not.

It seems to me the Kelo opinion does precisely what Olson explains should not be done if we want continued economic prosperity because "there is private property only if the society protects and defends a private right to that possession against other private parties and against the government as well." In Kelo the Supreme Court chose not to defend the private right of property against either other private parties or against government.

Epstein, Kelo, & The Role of the Judiciary

Richard Epstein on the Court's recent takings opinion:

The court could arrive at its shameful Kelo ruling only by refusing to look closely at past precedent and constitutional logic. Courts that refuse to see no evil and hear no evil are blind to the endemic risk of factional politics at all levels of government. And being blind, this bare Supreme Court majority has sustained a scandalous and cruel act for no public purpose at all.

I think the Kelo opinion illustrates in an important way that the Supreme Court in particular, and the Judiciary more generally, has often failed to carry out it's proper Constitutional role in our system of political economy. Both the Legislative and Executive Branches of government respond to the "will of the majority." This is their natural tendency. Neither the Legislature, nor the Executive, branch of government really sees incentives to protect the liberty of the individual. The Judicial branch of government is the one branch of government that has any reason to protect the liberty of the individual, and this is largely because our Constitution was written with the protection of individual liberty in mind. But, when the Supreme Court turns from it's role as protector of individual liberty in order to defer to the "will of the majority," the Supreme Court allows our system of political economy to be characterized by tyranny of the majority.

I suggest that it should matter not one little bit what government says the "public purpose" of its action is. The legislative branch, as well the exective branch, will always say that it acts in the public interest, and for legitimate public purpose, and to great public benefit. It will say so, both when this is true, and when the point of government's action is quite clearly to take from Mutt to give to Jeff. The government should never be allowed to take property from Mutt to transfer it to Jeff, no matter the excuse offered by government, simply because that property belongs to Mutt, not to Jeff and not to government. It should matter not, whether it is the will of the majority. It is Mutt's property. It is not the majority's. It is the role of the Judicial branch of government to protect individual liberty from the will of the majority. In Kelo the Supreme Court failed in its Constitutional role in our system of political economy.

Energy Doesn't Come From Pork

Arnold Kling offers analysis of a portion of the Energy Bill:

Here is everything you need to know about energy policy:

Energy doesn't come from pork.

The Energy Bill seems to provide a classic example of rent seeking and Congress.