Sample Term Paper on: Economist Cost / Benefit Approach To Government Regulation

Running Head: ECONOMIST COST / BENEFIT APPROACH

     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. Government agencies now routinely use CBA. 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 (Pildes & Sunstein, 1995), and Congress has enacted numerous statutes requiring agencies to perform cost - benefit analyses (Morrison, 1998).

     The Environmental Protection Agency (EPA) alone has spent tens of millions of dollars on CBA over the last fifteen years. Other agencies are as committed as EPA to using and improving the techniques of CBA. Are the academic criticisms of CBA valid?

     This Article provides a qualified defense of the use of CBA by administrative agencies. 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. 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. 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. Third, CBA suitably revised to reflect these concerns is consistent with a broad array of popular theories of the proper role of government. We also claim that the traditional economic defenses of CBA, based on the Pareto principle and the Kaldor-Hicks principle, are wrong.

     Modern CBA is the outgrowth of three historical developments. 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. The popularity of CBA among administrative agencies increased rapidly thereafter with the growth of the federal government (Porter, 1995; David Pearce, 1998). The second development was the rise of Progressivism at the end of the nineteenth century and the beginning of the twentieth century. Modern welfare economics can be traced back to Vilfredo Pareto. Few projects satisfy the criterion, because just about every worthwhile government project will hurt people, and compensating those people is usually infeasible. The compensation tests would become the basis of modern CBA.

     The compensation tests, however, were received unenthusiastically by theoretical welfare economists. 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. (Chipman & Moore, 1978)

     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.

     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. 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. Whatever the case, the modern rebirth of CBA has not been accompanied by a theoretical defense. The original theoretical objections to CBA still have not been rebutted.

     Understanding the problems and advantages of modern CBA, however, is difficult. First, the academic literature on CBA is deeply fragmented; critics from different disciplines rarely pay attention to each other's arguments. Second, understanding CBA as described by textbooks is not the same thing as understanding CBA as practiced by government agencies. Agencies sometimes appear to use CBA to rationalize decisions made on other grounds. At other times, agencies may be sincere, but depart from CBA without explaining their departure. For example, they may calculate costs or benefits by using national averages when the project would affect a non-representative subset of the population. The literature ignores these complications, and instead debates CBA as an abstraction, not as a real practice.

     What is the real practice of CBA? Federal law requires EPA to regulate lead contamination of drinking water. In 1991, EPA decided to revise earlier regulations it had issued under the law, using a CBA of several proposed rules. On the cost side, using a three percent discount rate, EPA estimated the cost of treating contaminated water that enters the distribution system; the cost of maintaining water quality (pH level, temperature, etc.); the cost of replacing lead pipes; the cost of warning the public of high lead levels and informing it of precautions; and the cost of monitoring water quality. For each rule, EPA calculated total costs by aggregating the cost of implementing the rule in each of the water distribution systems in the United States , which, of course, varied in the severity of lead contamination. For adults, EPA estimated a willingness to pay of $1 million to avoid nonfatal heart attacks and strokes, $628 per case of hypertension for medical costs and lost productivity, and $2.5 million per death. Total benefits (in terms of costs avoided) were estimated by multiplying these amounts by the estimated number of cases avoided, and summing the products. Although EPA estimated the benefits from reducing lead damage to plumbing components, it did not include this estimate in the CBA published with the final rule.

     EPA concluded that the total health benefits from corrosion control alone would be $63.8 billion over a twenty-year period, which vastly exceeded estimated costs of $4.2 billion. Federal law authorizes EPA to regulate the labeling and use of pesticides. In 1983 EPA decided to revise earlier regulations and to evaluate new rules using CBA. One branch of the literature proposes that economists should evaluate projects on the basis of social welfare functions that include proper distributional weightings.

Richard H. Pildes & Cass R. Sunstein, (1995) Reinventing the
     Regulatory State, 62 U. CHI. L. REV. 1, 6-7

Edward R. Morrison, (1998), Judicial Review of Discount Rates
     Used in Regulatory Cost - Benefit Analysis, 65 U. CHI. L.
     REV. 1333, 1333

Theodore M. Porter, (1995) Trust in Numbers: The Pursuit of
     Objectivity in Science and Public Life 148-89

David Pearce, (1998) Cost-Benefit Analysis and Environmental
     Policy, 14 OXFORD REV. ECON. POL'Y 84, 88-91

John S. Chipman & James C. Moore, (1978) The New Welfare
     Economics 1939-1974, 19 INT'L ECON. REV. 547, 548