Is environmental quality worth the cost?

• Author: Smith, V. Kerry
• Position: Research Summaries

In outlining the principles for project evaluation over fifty years ago, Otto Eckstein--one of the fathers of benefit-cost analysis and a former member of the NBER Board of Directors--was skeptical about the prospects for reliably measuring the economic tradeoffs that people would make in order to increase the amounts of public goods provided to them through new federal projects. (1) Much has changed in the ensuing five decades: benefit cost analyses are now a standard part of the information used in evaluating new major rules, with President Obama's revision to Executive Order 12866 continuing the practice started in 1981, and efforts to measure the tradeoffs that people would make to enjoy increases in the public goods (or reductions in the "bads") that are intended to come from those rules are more common. The Environmental Protection Agency (EPA) has led the way among regulatory agencies in developing guidelines for how these analyses should be conducted. Nonetheless, these analyses are not without controversy.

Many popular accounts today describe environmental regulations as "job-killers" and neglect their potential benefits. Indeed, the EPA's release of their report on the benefits and costs of the Clean Air Act Amendments in March of this year barely made the headlines. (2) This research summary describes some of the studies that have tried to document the benefits from environmental policies, so that there can be an appropriate weighing of benefits and costs. It also outlines the opportunities for future work.

Research Strategies for Measuring Valuation

The Hedonic Model

The hedonic property value model has been a workhorse in demonstrating that spatially delineated amenities (and disamenities) influence housing prices. A decade and a half ago, Ju Chin Huang and I took stock of the record and found that consistent and plausible measures of the tradeoffs for air pollution had been derived using hedonic property value studies. (3) Today we have a more nuanced view. The ability to estimate the role of location-specific public goods, such as air quality, relies on spatial variation. Often there are unobservable attributes important to the price of a house that co-vary with the local public good of interest. Equally important, self selection of households based on preferences is another potential source of bias in hedonic estimates. In the absence of a careful identification strategy with credible instruments, we now realize that significant bias is possible. (4) However, controlled simulation analyses evaluating strategies using spatial fixed effects to absorb the confounding effects of omitted variables, and quasi-experimental methods to purge time varying omitted variables, suggest that both strategies can be effective. (5)

Of course, there are important caveats. When the nature of the...