[Over an extended period ZNet has been publishing excerpts of chapters from Robin Hahnel’s latest book, Green Economics: Confronting the Ecological Crisis, available from M.E. Sharpe. Excerpts published here are not the full chapters which are made available inside the book. More information about the book and links to purchase it are below. Or, if you want, first, go to previous excerpts: Introduction / Chapter 1 / 2 / 3 / 4 / 5 / 6 / 7 / 8 / 9]
Mainstream economists often give the impression that cost-benefit analysis (CBA) does not involve value judgments, when, in fact, CBA rests on a number of questionable value judgments, and pretending otherwise only serves to disguise important choices incorporated into the analysis. Mainstream economists also present CBA as the only rational and objective method for making social choices about the environment, when in fact there are many situations where CBA is not the appropriate methodology at all. In particular, CBA is inappropriate when compensation is unlikely to rectify inequities, when people have rights, when power differentials bias estimates of costs and benefits, when time frames are long and the choice of a rate of time discount is overwhelmingly determinant, when continuity is unlikely, when benefits are hard to quantify, and when the consequences of improbable outcomes are very large relative to those of more probable outcomes….
The Lure of CBA
“If the benefits of doing something outweigh the costs, it should be done. But if the costs outweigh the benefits, then it would be a mistake to do it.” What could be more sensible? What could be more obvious? This has the markings of a “truth” that requires no explanation. One might even offer this as a simple definition of rational behavior. It is hard to imagine a more straightforward approach to social choice, and indeed, this is precisely the attraction of CBA and one reason that challenging it is so difficult….
CBA and Value Judgments
Despite the appearance of objectivity, a host of value judgments lies behind CBA….Whereas the efficiency criterion and CBA may often be the “rational” way for an individual to approach decision-making, society, of course, is comprised of many different people and many different interest groups….There will be losers as well as winners if the environment is better protected, just as there are always winners as well as losers when it is degraded. In other words, there are always distributive issues as well as efficiency issues involved in environmental policy choices….
Even if it is possible to accurately estimate benefits and costs quantitatively—which is by no means a trivial task—we must make a value judgment that benefits and costs for different individuals and groups of people are quantifiable and comparable. We must make a value judgment about how much to weigh the welfare of different individuals and groups. Finally, we must make a value judgment that no individual or group rights are at stake, so that maximizing our measure of social welfare is all that matters….
It is a truism that if aggregate benefits exceed aggregate costs, then it is possible for those who benefit from a policy to fully compensate those whom the policy disadvantages for their losses and still enjoy positive benefits for themselves….
The first problem with talk about compensation is that it is all too often just that—only talk. Knowing that in theory any policy that passes their CBA test need not harm anyone may ease economists’ consciences, but theoretical compensation that is not actually paid does nothing to ease the pain of those the policy harmed….
But there is a second problem when economists talk about compensation that progressives are often oblivious to. When economists do talk about actual rather than theoretical compensation, they are only talking about compensation for the redistributive effects of a policy. Discussion is invariably about whether or not some of the benefits of winners will be transferred to losers. The standard operating assumption is that fully compensating the losers for their losses would be the most that anyone could hope for, and since reasonable people understand the world is never perfect, losers should be happy to settle for something less than full compensation. But notice that this mind-set implicitly assumes that those who benefit from a policy deserve to capture the entire efficiency gain from the policy! This mind-set not only implicitly assumes that the pre-policy distribution of welfare was fair in the first place, it also assumes that those whom a policy benefits deserve to capture the entire efficiency gain while others deserve not to benefit at all….
When the Rate of Time Discount Is Determinant
The benefits of environmental degradation typically occur sooner than the costs, while the benefits of environmental protection invariably come later than the costs. This means that environmental cost-benefit studies will be sensitive to the rate of time discount chosen by the analyst. If a benefit or cost is treated in the same way no matter when it occurs, then there is no “discounting” and the rate of time discount is zero. However, if net benefits farther in the future are deemed less important than net benefits in the present, a positive rate of time discount is used, and the higher the rate of discount the more strongly future consequences will be discounted compared to more immediate consequences….
Suppose we use CBA to decide whether or not to protect our grandchildren from a climate-related loss of $100 they will suffer sixty years from now. According to CBA, how much should we be willing to pay today to prevent their loss sixty years from now? If we use a zero discount rate, we should be willing to pay up to $100 today for this $100 benefit for our grandchildren sixty years from now. However, if we use a discount rate of even 1 percent, CBA indicates that we should not pay more than $55. If we use a 3 percent discount rate, CBA will tell us not to pay anything over $17. If we use a 5 percent discount, CBA will instruct us not to pay much more than $5. Clearly, the amount that CBA shows is “rational” to spend now to avoid environmental damages later is highly sensitive to choice of a discount rate….
When Continuity Is Unlikely
In theory, CBA is still applicable even if there is a tipping point…. but we had better be very sure exactly where the tipping point is or we risk making a very big mistake. Take the case of carbon emissions. Initially, as we increase emissions, the benefits of doing so will be significantly higher than the costs—sending a strong signal that we should keep increasing emissions. But when there is a tipping point this strong signal to keep emitting will continue right up to the tipping point…. Comparing costs and benefits of increasing carbon emissions to decide if further emissions are “efficient” can be a disastrous way to make this social decision.
When Benefits Are Hard to Quantify
To apply CBA we need to know something quantitative about the benefits of reducing emissions, and there lies the rub. While quantitative estimates of the costs of emission reductions are readily available, translating a long list of different ways that reducing emissions will provide benefits into a single number is very difficult. It is so difficult that many people quickly despair, concluding that only a fool would tackle the task of trying to quantify the benefits of environmental protection….
The strongest argument for quantifying environmental benefits even when this is difficult is that unless environmental benefits are quantified, it is very difficult to present a case for how and to what extent they should be weighed against costs that are quantified. Environmental economists use three main methods to tackle what they understand is a difficult practical problem. There are situations in which the results from these methods of quantifying environmental benefits inspire confidence and thereby provide a strong prima facie case for using CBA, provided there are no other reasons to believe that CBA is inappropriate. But as we will see, often “solutions” to the quantification problem are not robust and inspire little confidence. In these cases, insisting on plowing ahead regardless, making important social choices on the basis of highly questionable CBA analyses, is problematic, to say the least.
Not All Uncertainty Is Created Equal
How should we take into account events whose likelihood of occurring is extremely small? The standard answer is that if the probability of occurrence is small enough we should basically ignore an event. This is not only convenient but also reasonable if the consequences associated with highly improbable events are of comparable magnitude to the consequences of much more probable outcomes.
However, what if the consequences of a highly improbable event are exceedingly large—bordering on the incalculable? Combine “incalculable” with “highly improbable” and you have two reasons for analysts to avoid what is now popularly referred to as a black swan—an event that is highly improbable but whose consequences if they do occur dwarf the consequences of more probable outcomes. Black swans are the nightmare everyone would like to ignore. However, when seeking to protect the public interest over generations, we ignore black swans at our peril….
When we feel safe, it makes sense to engage in CBA. When we feel safe, we can weigh the pros and cons of doing a little more of this or that. But when we do not feel safe, what makes sense is to buy insurance. When safety is the primary concern, it is the logic of insurance we should turn to, which is quite different from the logic of CBA. In situations where safety is foremost, arguments to the effect that the expected value of our insurance policy may be negative are completely beside the point.
Green Economics: Confronting the Ecological Crisis by Robin Hahnel is available from M.E. Sharpe.
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