Cost-benefit analysis links
This page provides annotated links to online material related to the Pareto improvements and Kaldor-Hicks efficiency criterion page, which discusses the role and the limitations of the concepts of Pareto improvement, Kaldor-Hicks efficiency and cost-benefit analysis in the development and implementation of Government and regulatory policies, programmes and projects.
Public sector guidance documents
(See also Regulatory impact assessments.)
HM Treasury (2003) "Green Book" Appraisal and Evaluation in Central Government
Available from http://greenbook.treasury.gov.uk/
This UK Government guidance document on policy assessment outlines an approach to cost-benefit analysis in which all impacts are to be identified and quantified wherever possible:
"The Green Book describes how the economic, financial, social and environmental assessments of a policy, programme or project should be combined."
The 2003 edition of the Green Book marks a few important changes in approach from the previous version, notably:
- A proposed schedule of distributional factors to cause greater value to be placed on benefits to lower-income groups. This might be seen as a move away from a Kaldor-Hicks compensation principle and (back) towards the idea that it is possible to aggregate some sort of utility function across the population. Alternatively, it might be seen within a Kaldor-Hicks approach as the addition of a notional social willingness to pay for moves towards a more uniform distribution of wealth.
- A reduction of the main discount rate and the introduction of a correction for "optimism bias" in public spending estimates. The old 6 per cent real discount rate took account of the costs of capital prevailing in financial markets, and was designed to avoid undue displacement of private-sector investment by (presumed less efficient) public investment. The new 3.5 per cent discount rate is based on an analysis of time preferences, without much regard to the financial markets, and the main mechanism used to discourage excessive public capital expenditure is now the correction for "optimism bias": thus, means that civil servants are now "discouraged" from undertaking investment rather than from financing it.
Commissariat au plan (2004) Révision du taux d'actualisation des investissements publics
http://www.plan.gouv.fr/intranet/upload…x%20actualisation%2024-01-05.pdf
French Government report on public sector discount rates which recommends a reduction from 8 per cent to 4 per cent (real) and the "political rehabilitation" of social cost-benefit analysis as a method of policy analysis, which it argues should be used to assess all forms of public spending, not just for infrastructure investments.
The report notes some of the difficulties with a Kaldor-Hicks criterion when there are other, e.g. distributional, policy objectives, but suggests that the calculations are nevertheless informative in order to assess the costs, in terms of economic efficiency, of decisions which might be primarily motivated by other objectives.
Articles and comments
- Gowdy, J. (2003) Toward a New Welfare Foundation for Sustainability
http://www.rpi.edu/dept/economics/www/faculty/gowdy/fff/Gowdy2003.pdf
Points out some of the problems that prevent the use of economic efficiency criteria in the context of policies for sustainable development, because of the absurdity of a notional compensation test applied across generations, and the shortcomings of the optimisation of personal consumption as a proxy for happiness or a basis for understanding human behaviour. The author suggests that the way to escape from the failure of welfare economics is to develop theories that bring together anthropology, biology, and psychology with economics to explain human behaviour. But it is not clear how such an explanation would contribute to the legal or ethical questions that take centre stage once the failure of the attempt to create value-neutral economic efficiency criteria has been recognised.
- Gowdy, J. (2004) "The Revolution in Welfare Economics and Its Implications for Environmental Valuation and Policy", Land Economics, vol. 80 (2), p 239-257
http://www.heednet.org/Gowdy04-revolutionwelfareeconenvvaluation.pdf
Argues that the process of obtaining willingness-to-pay and similar estimates involving an undue "filtering out" of actual behaviour and preferences that do not fit within the homo economicus model, such as lexicographic preferences and the significant influence of considerations such as legitimacy of policy means and the fairness of possible changes (as well as the end result in terms of consumption or similar outputs) on policy valuations. It also claims that the theoretical problems of the Kaldor-Hicks criterion would preclude its practical application anyway. The article endorses the view that policy recommendations should only be reached on the basis of explicit value judgements, and enjoins (environmental) economists to turn away from the "sterile" application of new welfare economics and to take more account of recent work on actual human behaviour.
- Koning, N. and R. Jongeneel (1997) Neo-Paretian welfare economics: misconceptions and abuses
http://www.sls.wau.nl/mi/mgs/publicatio…n_Economic_Papers/0597/wep05.htm
Argues (through a reasoned elimination of other hypotheses) that the desirability of a potential Pareto improvement is an "arbitrary postulate of economists themselves", and that "economists are introducing their own norm, while refusing to admit it". The article concludes that the Kaldor-Hicks test may be primarily upheld as a way of sustaining the current mainstream form economics and the neo-classical advocacy of free markets on the basis of "efficiency". Economists are accused to be uncritical in their acceptance of such methods in order to defend "the far-reaching authority to judge economic policies with which neo-Paretian theory invests the economic profession, and the appearance of objectivity which this theory lends to really normative elements of neoclassical micro-economics".
- Monateri, P. G. (1995) Rules v Outcomes
http://www.jus.unitn.it/cardozo/Review/…ts/Monateri-1995/Rules/rule.html
A critique of the "Law and Economics" approach to ascertaining what the law is (or should be) by reference to efficiency concepts. The paper briefly reviews arguments based on the Austrian economics idea that, since the key feature of the market is to convey information, it is impossible for a lawyer or judge to use any efficiency concept to be "maximised" over society as a whole. Therefore the law should not be seen as a means to any end, but instead as a system to ensure the overall order within which individuals pursue their ends.
- Zerbe, R. O. (2001) A Place to Stand For Environmental Law and Economic Analysis?
http://www.cserge.ucl.ac.uk/Zerbe.pdf
Proposes a modified version of the Kaldor-Hicks criterion that only counts the willing to pay or willingness to accept of people who have the requisite "standing" in the context of the relevant decisions. Thus, only the preferences of some individuals who have a legitimate interest or standing in the decision under consideration would be taken into account in the cost-benefit analysis. This seems likely to lead to the same practical approach as suggested above: once one has understood the relevant rights and obligations that inform the decision, then it is likely that it will be possible to re-express the decision-making process that is found to be mandated by law, moral or convention as a Kaldor-Hicks "sum of preferences" modified by a suitable "standing" test. But the superficial simplicity of Zerbe's modified Kaldor-Hicks test may merely hide the difficulties involved in understanding the rights, obligations and/or objectives of the legal or other principles under consideration, if such an understanding is necessary to assess standing.
- The Becker-Posner blog
http://www.becker-posner-blog.com/
Blog by Gary Becker and Richard Posner, featuring articles and comments on the application of economics to a range of social issues. Besides their Nobel prize and senior US judicial position respectively, the authors are both at the University of Chicago and representatives of the "law and economics" movement and the "Chicago school", movements of thought which might sometimes be vulnerable to the criticism of over-reliance on economic efficiency criteria to inform social decisions expressed in Pareto improvements and Kaldor-Hicks efficiency criterion.
Additional references and contributions welcome.
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Last changed by Franck at 5:47 AM on Tuesday 6 February 2007.