Rethinking cost-benefit analysis.

• Author: Adler, Matthew D.

1. INTRODUCTION

   The reputation of cost-benefit analysis (CBA) among American academics has never been as poor as it is today, while its popularity among agencies in the United States government has never been greater. Many law professors, economists, and philosophers believe that CBA does not produce morally relevant information and should not be used in project evaluation. A few commentators argue that the information produced by CBA has some, but limited, relevance. Defenders of CBA form an increasingly beleaguered minority, consisting mostly of applied economists who feel compelled to respond to attacks on the methodological underpinnings of their work. Modern textbooks on CBA are plentiful, and some of them are optimistic about the usefulness of the procedure, but most of them frankly acknowledge its serious flaws and the inadequacy of the standard methods for correcting these flaws.(1)

   Government agencies now routinely use CBA. This was not always the case. Before the 1980s, agencies did not systematically rely on CBA when evaluating regulations and other projects. But executive orders issued by the Reagan and Clinton administrations have since made the use of CBA by agencies common,(2) and Congress has enacted numerous statutes requiring agencies to perform cost-benefit analyses.(3) The Environmental Protection Agency (EPA) alone has spent tens of millions of dollars on CBA over the last fifteen years.(4) Other agencies are as committed as EPA to using and improving the techniques of CBA. The academics' skepticism appears to have had no influence on them. What accounts for this divergence between academic opinion and government practice? Are the academic criticisms of CBA valid?

   This Article provides a qualified defense of the use of CBA by administrative agencies. It makes the following claims. First, a common criticism of CBA--that it sometimes produces morally unjustified outcomes--overlooks the fact that CBA is a decision procedure, not a moral standard. A decision procedure is a method for achieving desirable results, and some decision procedures are more accurate or less costly than others. CBA is justified, even if it sometimes produces undesirable outcomes, as long as the total costs associated with CBA (the costs of undesirable outcomes, plus procedural costs) are lower than the total costs associated with alternative decision procedures. We argue that alternatives that are proposed in the literature--risk-risk analysis, feasibility-based assessment, direct interpersonal comparisons, and so on--will typically be costlier than CBA, as long as CBA is used in the right way.

   Second, CBA will produce reasonably accurate results only as long as it is used in the right way, and this means that under certain conditions agencies may need to modify the traditional understanding of CBA, or even depart from CBA entirely. When a proposed project would affect people who have highly unequal levels of wealth, or who are poorly informed about the consequences of the project, or whose preferences fail for other reasons to register projects that would enhance their well-being, agencies should modify or depart from CBA. One possible modification to CBA is the weighting of costs and benefits by a factor that reflects the marginal utility of money for the persons affected. Another is a revision of the standard methodology for computing costs and benefits, the "willingness to pay" and "willingness to accept" methodology, so as to take account of the disjunction between the mere satisfaction of a person's preferences and the enhancement of his well-being. The proper adjustments to standard CBA cannot be described at a high level of abstraction, but depend on such things as the competence of agencies, the degree to which they can be monitored by politically responsive actors, and the extent to which people's stated preferences and market choices track their own welfare.

   Third, CBA suitably revised to reflect these concerns is consistent with a broad array of popular theories of the proper role of government. It is commonly and mistakenly believed that CBA presupposes a particular form of utilitarianism that assumes that the government should maximize the satisfaction of people's preferences, even when these preferences are uninformed or distorted. By contrast, we argue that CBA, properly understood, is consistent with every political theory that holds that the government should care about the overall well-being of its citizens--including non-utilitarian theories that supplement "overall well-being" with additional moral considerations, and non-preference-based theories that incorporate a different view about the nature of well-being. The use of CBA by agencies in suitable circumstances is consistent with commitments to distributive justice, deontological rights, and other moral values, and it is consistent with the view that objective values, hedonic pleasures, and other factors beyond preference-satisfaction figure in human welfare. We also claim that the traditional economic defenses of CBA, based on the Pareto principle and the Kaldor-Hicks principle, are wrong.

   We develop this argument as follows. Part II provides some background on CBA, including a brief history of the procedure and some case studies that show how CBA is typically used by agencies today. Part III describes the mechanics of CBA and explains why the traditional economic defenses of CBA fail. Part IV lays the philosophical groundwork for our own defense of CBA: It categorizes theories of well-being, argues for the possibility of interpersonal welfare comparisons and the moral relevance of overall well-being, and distinguishes between moral criteria (such as overall well-being) and morally justified decision procedures (such as CBA). Part V compares CBA with other possible decision procedures in light of overall well-being, and concludes with a tentative recommendation about the justified scope of CBA. Part VI discusses nonwelfarist considerations, such as deontological rights and distribution.

2. BACKGROUND

   Modern CBA is the outgrowth of three historical developments. The first is the growth of the central government in the United States and other countries over the course of the twentieth century. In the United States, the New Deal government initiated the use of CBA in 1936, when Congress ordered agencies to weigh the costs and benefits of projects designed for flood control.(5) The popularity of CBA among administrative agencies increased rapidly thereafter with the growth of the federal government.(6) The second development was the rise of Progressivism at the end of the nineteenth century and the beginning of the twentieth century. Progressives believed that government could be separated into a realm of value-laden politics and a realm of administrative expertise based on scientific principles.(7) The third development was the invention of modern welfare economics, which would supply these scientific principles. Early welfare economists believed that economic concepts could be used to rationalize the implementation of government policies.(8) Their efforts were encouraged in the 1950s and 1960s when the U.S. government and the governments of other countries sought technical assistance in the development of formal procedures of CBA.(9)

   Modern welfare economics can be traced back to Vilfredo Pareto. Pareto proposed as a principle of evaluation that a project is desirable if it makes at least one person better off without making anyone else worse off.(10) The difficulty posed by the Pareto criterion is that it is too strong. Few projects satisfy the criterion, because just about every worthwhile government project will hurt people, and compensating those people is usually infeasible. This difficulty led to the proposal of hypothetical compensation tests by J.R. Kaldor, Nicholas Hicks, and others.(11) Compensation tests hold that a project is desirable if its beneficiaries are enriched enough that they could overcompensate those who are hurt by the project. These tests vastly increase the range of projects that can be evaluated, compared to the Pareto test. The compensation tests would become the basis of modern CBA.

   The compensation tests, however, were received unenthusiastically by theoretical welfare economists.(12) When the storm of criticism subsided, some economists declared that not only compensation tests, but all of welfare economics, was dead, a declaration that has been repeated many times since.(13) Despite these views, CBA obtained a foothold among applied economists and government agencies. Applied economists and agency officials believed that, whatever its problems, CBA was superior to the alternatives. When the government proposed a project, taxpayers and critics demanded a justification, and the most obvious justification was that the project would produce gains that exceeded its costs.

   Thus, CBA enjoyed a brief period of popularity in the 1960s, despite the absence of a consensus regarding its theoretical foundation. By the 1970s, however, even applied economists and government agencies had begun to doubt its utility. The emerging problems with CBA were not theoretical, but practical and ideological. As a practical matter, researchers had a great deal of trouble obtaining relevant data, especially for the purpose of valuing environmental resources, human life, and other hard-to-measure goods. The claim that the benefits of a project exceed its costs is not persuasive when the benefits and the costs appear to rely on arbitrary valuations. As an ideological matter, the technical and utilitarian flavor of CBA was unappealing to the political culture that prevailed during the 1970s.(14) It may be that progress in valuation techniques and changes in ideology, or perhaps a sense that regulation had gone too far, account for the reemergence of CBA in the 1980s and 1990s--it is too early to tell. Whatever the case, the modern...