COST-BENEFIT ANALYSIS

Cost-benefit analysis (CBA) is another way of integrating environmental and economic goals in policies and activities. CBA is a tool which deci­sion makers use to choose between alternative courses of action.

Uses of CBA

Assessing government projects

CBA has traditionally been used to weigh the benefits that would arise from a government project against the costs associated with it. A private firm that is producing goods or services for a market will make an invest­ment decision on the basis of whether it thinks it can make a reasonable profit from the investment. However, governments tend to provide serv­ices for which there are no buyers, or services for which there is a market but no profit objective. The provision of urban infrastructure - such as roads, water and sewerage - cannot be adequately evaluated on the basis of financial return on investment. CBA therefore provides a means of evaluating such projects and comparing them to assess priorities so that public money is spent wisely and efficiently. It is also used by interna­tional banks and aid agencies to evaluate projects.

Integrating environmental considerations

It has been argued that CBA should be applied to all private as well as public projects as a way of ensuring that environmental and social costs and benefits, as well as profit potential, are included in all project deci­sions. Indeed, undertaking a CBA is now a formal requirement for many large-scale projects undertaken by private enterprise, such as those in the mining sector and the building industry.

Assessing natural resource use and environmental projects

CBA can be applied to other matters requiring decisions, such as the rate of exploitation of scarce natural resources and the management of wilderness areas.

Assessing the merit of government regulations and policies

CBA is commonly used in the USA 'to weigh the various interests at stake' in a decision by government to introduce a regulation (de Sadeleer 2002: 199). Similar assessments are also made in Australia for environ­mental measures. In the USA, government agencies must undertake a full risk assessment and CBA before any major regulation can be intro­duced. The rationale embodied in the legislation is to 'provide more cost­effective and cost-reasonable protection to human health and the environment' by using 'scientifically objective and unbiased' considera­tion of risks, cost and benefits as a basis for decision making. Opponents of legislation argue that CBA is being used as a way of delaying and obstructing environmental regulation (see chapter 8).

The rationale behind CBA

In order to weigh costs against benefits, CBA usually attempts to put a monetary value on both so that they are expressed in the same units. The costs of a road project would include the cost of labour and materials used in construction, as well as other costs such as the loss of parkland and homes to make way for the road, and the resulting pollution, disrup­tion to neighbourhoods, and loss of peace and quiet. The benefits of such a project might include time saved to motorists, increased predictability of journey times, and increased accessibility of a particular location.

When the US EPA decided to phase all the lead out of petrol in the 1980s, it justified this decision on the basis of CBA, which calculated medical costs from lead poisoning as well as 'the costs of remedial edu­cation for children whose cognitive development had been impaired by lead, and the children's expected loss of future income due to their lowered IQs'.

Obviously, some costs and benefits are very difficult to put into mon­etary terms. But proponents of CBA see it as helping to make the deci­sion-making process more objective and rational. They argue that it is rational to choose a course of action in which the gains outweigh the losses and that, by putting the gains and losses in numeric terms, it is easier to be objective, consistent and rational in the assessment:

The use of money as a measure of these costs and benefits should not be controversial since it is simply a practical device which enables us to compare them. The issues of real importance in the evaluation are the amounts of money to be associated with each cost and benefit and the aggregation of these amounts so that the decision-maker can deter­mine the most beneficial course for society. (Abelson 1979: 197-8)

Economists argue that whenever people make a decision, they weigh the pros and cons of that decision, but often do so unconsciously or intu­itively. By undertaking a formal CBA, the values they are attaching to the costs and benefits are made explicit and are recorded for everyone to see rather than remaining inside someone's head. This means that people have to think about those values in a more systematic and reasoned way.

Discounting under CBA

Normally, future costs and benefits are discounted (reduced) because it is assumed that they are not worth as much to people as present costs and benefits. The reasoning behind discounting is as follows: if a person has the choice of receiving a sum of money now or waiting to get it later, most economists assume that, even if he or she ignores inflation, the person would prefer to get the money now. He or she will only be inter­ested in getting it later if the sum has become larger by then.

For the economist, $1 this year is worth $1 + r (the discount rate) next year. Therefore, $1 next year is worth less than $1 this year; it has to be discounted (reduced) if we are to consider it in today's values.

Whether a project goes ahead or not will often depend on what dis­count rate is used. Small differences in discount rates can make big dif­ferences in the final ratio of benefits to costs if long-term costs or benefits are being considered. For example, the net present value of an income or cost of $200 million in 50 years' time would be:

• $1.7 million if the discount rate is 10 per cent

• $ 17 million if the discount rate is 5 per cent

• $ 74 million if the discount rate is 2 per cent.

Objectivity of CBA

Proponents of CBA argue that, by placing explicit numbers on proposed actions, the process is more open to scrutiny by others. However, what tends to happen is that the analysis is highly technical, and neither avail­able nor accessible to the public. The inevitable value judgments involved in attaching a price to environmental and social benefits are hidden beneath a mass of figures that give the impression that the analysis is rational, neutral and objective. Public debate over the options is therefore inhibited.

Even in the case of a willingness to pay (contingent valuation; see page 135) survey, which is supposed to objectively reflect values of the population, economists exercise value judgments about which answers are to be included in the analysis. In the case of the North Carolina study of the value of chronic bronchitis described later in this chapter, the answers of only two-thirds of those interviewed were included. Some answers were excluded because the economists judged the inter­viewees to be inconsistent. Other answers were excluded because they were thought by the economists to be far too high or too low (Ackerman amp; Heinzerling 2004: 96).

In reality, environmental value is highly subjective:

The same patch of trees can be valued by international conservation­ists and scientists as an embodiment of the world's precious biolog­ical diversity, mapped by an Indonesian commercial timber concession as merely another block containing so many cubic feet of exportable tropical hardwood, or seen and claimed by a local Dyak community as the site of a cultivated forest garden, inhabited by orchards of fragrant Durian trees and memories of family members gathering honey.

Averaging such values does not give an objective outcome. Nor does converting them into some sort of universal measure.

Justifying projects

CBA, far from being an objective source of information, is often used to justify projects. Ian Barbour (1980: 170), a professor emeritus of Science, Technology and Society, argues that the 'formulation of problems and the preselection of alternatives, which are frequently the most important decisions, occur before the analysis is made. In the analysis itself, an agency typically overstates benefits and understates costs'. He claims that environmental effects and other indirect costs tend to be neglected, while indirect benefits are searched for: 'While the assignment of mone­tary values appears to be a technical question, it often reflects the biases of analysts or their judgments of what the public wants'.

Barbour's claims have been borne out by various studies and reports. In 2000, for example, an internal Pentagon investigation found that the US Army Corps of Engineers had been manipulating CBA's to justify civil works projects that the Corps wanted to undertake (Ruch 2000). Similarly, the numbers of people who will be displaced by dam projects around the world are often grossly underestimated to ensure that CBAs support the projects (Corner House 1999).

The same bias can be found in estimates of national assets. During the Clinton presidency the US Forest Service estimated that by 2000, recreation in the nation's forests would contribute $111 billion to its GDP. In contrast, the Forest Service under the George W Bush presidency esti­mated that it was worth only $11 billion in 2002. The new figure provides much more justification for logging and mining in national forests (Eilperin 2005).

Undermining environmental regulations

CBA is also used to attack environmental regulations. When new envi­ronmental regulations are being proposed, the industries affected tend to exaggerate their compliance costs, which influences government esti­mates of the cost of regulation.

A recent study by the Center for Progressive Reform in the USA found that the Office of Management and Budget (OMB) had consis­tently used CBA to argue for less and weaker regulation (Driesen 2005). Ackerman and Heinzerling (2004: 9, 213) argue that CBA is in fact used to promote deregulation under the cover of scientific objectivity. They claim opponents attack environmental regulations as being uneconomic, and use complicated and contrived economic analyses to discredit legis­lation, rather than publicly debating its merits.

What is rational?

Economists argue that weighing costs against benefits is the only rational way to make a decision. They argue that trade-offs are necessary and can only be made rationally if measurement is involved. However, even if one agrees that trade-offs are necessary, this bureaucratic method of deciding trade-offs by measuring costs and benefits is not necessarily the most rational way of making a decision. People make decisions all the time that do not involve converting everything to a single measure for simple comparison.

Good judgement is founded on the existence of capacities of percep­tion and of knowledge based in education and experience. Indeed, it is attempts by economists to force the measuring rod of money or any other unit onto rational deliberations which lead to arbitrariness, contrivance and obstruction of the process of reasoned debate. (O'Neill 1996: 98)

In fact, some would argue that the attempt to find a common measure for ranking 'all objects and states of affairs' is actually irrational or, at the very least, limiting (O'Neill 1996: 98). Values cannot be reduced to one overarching measure. Larry Lohmann (1997) points out:

Looking to criteria such as weight and monetary value to define rational choice is insufficient in contexts in which people need to reason not just about means but also about clusters of interlocked, mutually irreducible ends and how to develop them in light of those means.

Similarly, John O'Neill (1996: 98) comments that the 'fact that I prefer A to B with good reason is not evidence that A possesses more of some overarching super-value that is present in all my other potential choices as well'. A person may make one choice on the basis of cost and another on the basis of friendship. There is no single measure (money or utility etc.) that can encompass both decisions. Nor is the balancing of costs and benefits appropriate to both decisions.