CostBenefit Analysis as a Tool for Policy

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Cost-Benefit Analysis as a Tool for Policy

• Alan Krupnick, PhD
• Senior Fellow and Division Director
• Resources for the Future
• March 2, 2007

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Policy Context

• Environmental and health regulations are often
  very costly to society, and deliver benefits of
  very different types and quantities
• So need to identify those that deliver the
  greatest benefit for the resources expended,
  i.e., are efficient
• Requires estimating the benefits and costs of
  regulatory intervention.
• Other factors matter at least as much equity,
  legality

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Two Types of Policy Analyses

• Cost-Benefit Analysis (CBA) Monetary benefits
  minus costs
• Cost-Effectiveness Analysis (CEA)
• Cost/Effectiveness
• Effectiveness measures
• Physical units, e.g., emissions, lives saved
• Quality adjusted life years

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Uses of CBA

• Accounting framework
• Prioritization
• Normative Decision Is it worth it to take any
  action?
• Policy Choice Which policy is better (on
  efficiency grounds)? How can policy design be
  improved?

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Limitations

• Only addresses efficiency under a utilitarian
  model
• Discounting growth and change
• Hard to monetize everything

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Example of cost-effectiveness analysis
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Many major applications of cost-benefit analysis
(CBA)

• Social cost of Electricity (e.g., U.S., Europe
  (EXTERNE))
• EXTERNE Social cost of Transportation, CAFÉ
• U.S. BENMAP
• IPCC Ancillary Benefits of climate change
• Many of above are integrated assessments.

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Experience with CBA at U.S.EPA (Morgenstern,
1997)

• All CBAs studied ended up improving the rules
• Guiding development of rules
• Adding/eliminating/adjusting alternatives
• Supporting decisions
• Broad educational value

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Example for Mexican Brick Kilns

• The Benefits and Costs of Informal Sector
  Pollution Control Mexican Brick Kilns, Allen
  Blackman, Jhih-Shyang Shih, David Evans, and
  Michael Batz, Stephen Newbold, Joseph Cook, April
  2006

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Figure 1. Brickyards, formal industrial
facilities, and population in Ciudad Juárez
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Effect on Policy

• Wanted to try natural gas approach Pipeline
  costs (fixed) were too high
• NMSU kilns Introduced from cross-border
  emissions trading in El Paso 60 of 350 kilns
  converted
• Some center city kilns were relocated outside
  city

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Example of CBA for Shanghai

• Quantifying the Human Health Benefits of
  Curbing Air Pollution in Shanghai Li, Guttikunda
  et al., Journal of Environmental Management, 70
  (2004), 49-62.

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Overview of the Case Study

• Examines 2 options to control pollution from
  stationary sources in Shanghai
• Integrated Gasification Combined Cycle for power
  plants
• Relocation and reduction in coal use by the
  industrial sector
• Analysis conducted for the year 2020, assuming
  baseline emissions fall
• RAINS-Asia model used to predict future energy
  use and emissions UrBAT used to calculate
  ground-level concentrations of SO2 and PM

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Shanghai Urban Air Quality Management Emission
Estimates
Units Gg/year
1995
2020 BAU
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Shanghai Urban Air Quality ManagementAnnual
Average PM10 Concentrations
Units mg/m3 PM10
in 1995
2020 BAU
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Shanghai Urban Air Quality Management2020
Control Scenarios

• Power Sector Control
• Integrated Gasification Combined Cycle (IGCC) for
  coal combustion
• Industrial Sector Control
• 75 coal consumption reduction
• Remaining 25 relocated to neighboring provinces

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Shanghai Urban Air Quality ManagementAnnual
Average PM10 Concentrations
2020 Power Control
2020 Industrial Control
Units mg/m3 PM10
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Shanghai Urban Air Quality ManagementAnnual
Average Reduction in 2020
2020 Power Control
2020 Industrial Control
Units mg/m3 PM10
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Shanghai Urban Air Quality ManagementHealth
Benefit Analysis
No. of cases avoided
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Conclusion on Case Study

• Both scenarios are welfare improving ? CBA can
  help show whether it is desirable to take action
• Industrial scenario is the more efficient in
  spite of having lower health benefits
• 417-395 23 vs 266-94 172
• ? CBA can help choose the best policy

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Embedding a CBA Process into the government

• Location of process
• An OMB-like agency
• Centralized within SEPA
• De-centralized Provincially
• Commit resources
• Issue Guidance Document
• Develop appropriate regulatory process early
  analyses, broad set of options
• CBA/CEA AS TOOLS NOT A JUSTIFICATION
• Development of analytical tools
• E.g., ECM

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STOP
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Key Unquantified BenefitsSOURCE The Benefits
and Costs of the Clean Air Act, 1990 to 2010,
Tables 5-1 and 7-5 (p.53, 88)
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Defining and Measuring Cost

• On a conceptual level, the definition of cost is
  the same as benefits, i.e., the opportunities
  given up by a choice.
• Agencies often measure costs in terms of
  expenditures. Too narrow.
• Compliance cost the cost of all the actions
  necessary to comply with a particular regulation
  is better, but still a poor measure.

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Proper Cost Accounting Opportunities Forgone

• Example Ban on ozone depleting substances
• The diverted resources necessary to develop the
  substitute products
• The value of services of specialized capital and
  technology necessary to manufacture the banned
  products
• Increased costs of production for the replacement
  product vis-à-vis the banned product/Differences
  in the retail price of the replacement product
• Decline in the quality of the replacement product

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Other Critiques

• Preference satisfaction is not important/not
  important enough
• Economic value doesnt measure preferences
• Social well-being is not the aggregate of
  individual well-being
• Some things should not/cannot be priced

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Other Issues in CBA

• Equity integration
• Tax interaction effects
• E.g., CBA and the Clean Air Act
• Valuation of natural resources