BENEFIT-COST ANALYSIS

Benefit-cost analysis is a technique for assessing the desirability of government projects and policies. The basic idea is simple: Consider alternative policies and identify the one that yields the greatest net gain to society. Benefit-cost analysis has been widely used to compare the positive and negative aspects—measured in terms of reduced mortality, morbidity, property damage, and losses to the natural environment—of policies that affect public health and the environment.

Benefit-cost analysis has been widely used in the design of environmental policies and to help resolve disputes under the U.S. legal system. Under the Comprehensive Environmental Response, Compensation, and Liability Act (CERLA; commonly called the "Superfund" law) governments (local, state, or federal) can seek financial compensation from responsible parties for natural resources that are damaged by releases of hazardous wastes. Benefit-cost analysis can be helpful in putting a price tag on the damaged resources.

Determining the benefits of pollution reduction generally requires assessing the magnitude of the damage caused by that pollution. This involves four key steps: (1) identification of the key types of damage; (2) establishing the physical relationship between the pollutant emissions and the extent of damages caused (dose-response curve); (3) identification of the responses by affected parties to mitigate some (or all) of the damage; and (4) placing a monetary value on the physical damage, including the damage to human health.

All four of these steps can involve difficult technical issues, especially when both scientific and ethical concerns limit the ability to obtain empirical information on the effect of pollution on humans. Expertise in various natural and social science disciplines is required. The focus of economics is on the fourth step of the process (ascertaining the monetary value of the physical damages, including the damage to human health) and on integrating the results of all the steps.

Some have argued, on both moral and technical grounds, that benefit-cost analysis is a flawed environmental management tool. Others have suggested that it is inevitable, since if it is not done explicitly, with a careful consideration of alternative options, it will occur implicitly. In that case, decision making will be driven by public fears, special-interest lobbying, and bureaucratic preferences.

Three major functions of economic analysis in the regulation of health, safety, and the environment have been identified: (1) arraying information about the benefits of proposed regulations;(2) revealing potentially cost-effective alternatives; and (3) showing how benefits and costs are distributed (e.g., geographically, temporally, and among income and racial groups). However, the same economists also argue that "in many cases, benefit cost analysis cannot be used to prove that the economic benefits of a decision will exceed or fall short of the costs … [but] … it can provide illuminating evidence for a decision, even if precision cannot be achieved" (Arrow et al., 1996).

Richard D. Morgenstern

(see also: Acceptable Risks; Benefits, Ethics, and Risks; Cost-Effectiveness; Environmental Impact Statement; Risk Assessment, Risk Management )

Bibliography

Arrow, K. et al. (1996). Benefit-Cost Analysis in Environmental, Health, and Safety Regulation: A Statement of Principles. Washington, DC: American Enterprise Institute, The Annapolis Center, and Resources for the Future.