An Aggregate Measure for Benefit–Cost Analysis

Published date16 October 2007
Date16 October 2007
Pages223-245
DOIhttps://doi.org/10.1016/S0193-5895(07)23010-6
AuthorRichard O. Zerbe,Yoram Bauman,Aaron Finkle
AN AGGREGATE MEASURE FOR
BENEFIT–COST ANALYSIS
$
Richard O. Zerbe Jr., Yoram Bauman and
Aaron Finkle
ABSTRACT
The Kaldor–Hicks (KH) criterion has long been the standard for benefit–
cost analyses, but it has also been widely criticized as ignoring equity and,
arguably, moral sentiments in general. We suggest the use of an aggregate
measure (KHM) instead of KH, where M stands for moral sentiments.
KHM simply adds to the traditional KH criterion the requirement that all
goods for which there is a willingness to pay or accept count as economic
goods. This addition, however, runs up against objections to counting
moral sentiments in general and non-paternalistic altruism in particular.
We show these concerns are unwarranted and suggest that the KHM
criterion is superior to KH because it provides better information.
$
Reprinted from Ecological Economics, Vol. 58, issue 3, Richard O. Zerbe Jr., Yoram
Bauman, and Aaron Finkle, An Aggreagte Measure for Benefit–Cost Analysis,449–461, (2006),
with permission from Elsevier. This work was supported by the Center for the Study and
Improvement of Regulation at Carnegie Mellon University and the University of Washington
and by the Earthquake Engineering Research Centers Program of the National Science
Foundation under Award Number EEC-9701568. This article builds on Zerbe (2001).
Research in Law and Economics, Volume 23, 223–245
r2005 Elsevier B.V.
ISSN: 0193-5895/doi:10.1016/S0193-5895(07)23010-6
223
BACKGROUND
The Kaldor–Hicks (KH) criterion arose out of discussions among
prominent British economists during the late 1930s.
1
Before that time it
was generally assumed that each individual had an ‘‘equal capacity for
enjoyment’’ and that gains and losses among different individuals could
be directly compared (Mishan, 1981, pp. 120–121;Hammond 1985, p. 406).
Robbins (1932, 1938) disturbed this view by arguing that interpersonal
comparisons of utility were unscientific. Kaldor (1939, pp. 549–550)
acknowledged Robbins’ (1938, p. 640) point about the inability to make
interpersonal utility comparisons on any scientific basis, but suggested it
could be made irrelevant. He suggested that, where a policy led to an
increase in aggregate real income,
ythe economist’s case for the policy is quite unaffected by the question of the
comparability of individual satisfaction, since in all such cases it is possible to make
everybody better off than before, or at any rate to make some people better off without
making anybody worse off.
Kaldor (1939, p. 550) goes on to note that whether such compensation
should take place ‘‘is a political question on which the economist, qua
economist, could hardly pronounce an opinion.’’
2
Hicks (1939) accepted this
approach which came to be called KH.
Thus, it came to be thought that including considerations of the income
distribution or of compensation would involve interpersonal comparisons,
and that such comparisons should be avoided by excluding considerations
of actual compensation or of the income distribution.
3
It was thought that
this exclusion would lead to a measure of efficiency that was more scientific.
4
KH separates efficiency and equity and proposes to leave the latter to
the politicians. Undoubtedly, there is some merit in separate accounting
but it does not follow that economists should refrain from providing
information on equity and moral sentiments. Increasingly, economists have
not refrained (e.g. Andreoni, 1995;Palfrey & Prisbey, 1997;OMB, 2003
Report).
The modern version of KH may be reasonably characterized by the
following assumptions: (1) treat every dollar the same regardless of who
receives it (equal marginal utility of income)
5
; (2) a project is efficient if it
passes the potential compensation test (PCT), i.e., if the winners could
hypothetically compensate the losers from the project (Kaldor, 1939,
pp. 549–550);
6
(3) gains are to be measured by the willingness to pay (WTP)
and losses by the willingness to accept (WTA); and (4) equity effects are to
RICHARD O. ZERBE JR. ET AL.224

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