PLCY 240 – March 19, 2009Introduction to Cost-Benefit AnalysisBasic Steps of CBA:

1) specify the set of alternative projects

2) decide whose benefits and costs count (who has standing)

3) list the impacts and determine how to measure them

4) predict the impacts quantitatively over the life of the project

5) monetize impacts

6) discount benefits and costs to obtain present values

7) compute NPV of each alternative

8) perform sensitivity analysis

9) make a recommendation

Ethics and Efficiency: Cost-Benefit Analysis

Steven Kelman:

a professor of public management at Harvard

Steven Rhoads:

a professor of public policy at the University of Virginia

Steven Rhoads, “Benefit-Cost Analysis”

• CBA is now required by many government agencies to assess the impact of proposed regulations or programs

• Costs may be fairly easy to calculate

• Calculating benefits is more difficult– estimate impact of programs– estimate value of impact– note that finding control groups can be difficult

Rhoads, cont.

• Difficulties can arise when attempting to estimate costs such as:– value of time– value of reduced illness– value of improved environmental conditions– value of a human life

Steven Kelman, “Cost-Benefit Analysis: An Ethical Critique”

• The conceptual framework for cost-benefit analysis is utilitarianism– implement the policy if the benefits are greater than

the costs

• Kelman argues that some actions whose costs are greater than their benefits may still be morally correct (and vice versa)

• Depending on the duties and rights at stake and the importance attached to them, CBA may be irrelevant

Kelman, cont.

• Much of CBA is based on estimates of “willingness to pay” (WTP)

• Criticisms of WTP estimates:– WTP for an increase in well-being versus

willingness to accept (WTA) compensation for a decrease in well-being

– WTP to avert a decrease in well-being versus WTA to forego an increase in well-being

• in each case, the welfare loss is inflated because losses weigh more heavily than gains

• losers value losses more than winners value gains

Kelman, cont.

• More criticisms of WTP estimates:– invariably based on private transactions; do

not account for values based on collective public decisions

– the very act of trying to assess a value on a non-market good may reduce the good’s intrinsic value

Kelman, cont.

• Robert Solow’s replies to Kelman’s criticisms:– WTP and WTA estimates are only used in the

context of making decisions regarding public goods

– CBA doesn’t purport to eliminate ethical principals

– CBA does account for the inflated values of welfare losses

– even Kelman acknowledges that some CBA is beneficial in policymaking

Rhoads, cont.

• Critiques of CBA criticisms:– CBA works both in favor of and against

regulation– uncertainty is part of economic analyses;

doing away with CBA will not eliminate it• sensitivity analysis can help policymakers

understand the effects of uncertainty• the range of plausible values is still not unbounded

– even with non-quantified values, CBA can provide clear recommendations

Rhoads, cont.

• More critiques of CBA criticisms:– it’s true that government officials are unwilling

to acknowledge that lives are being lost because the costs of saving them are too high

• so do the analysis but do not expect public debate

– analysts who do CBA do take equity seriously

• Overall, CBA does more good than harm