The Effectiveness of Social Cost Benefit Analysis - Assignment Example

Order 115952 Topics: Social Cost Benefit Analysis Introduction This paper seeks to respond to the question on whether cost benefit analysis is really an imperfect calidus or indispensable aid to decision making in both private and public sectors. It starts therefore with the discussion of the concept of cost benefits analysis and the manner it is being including the various steps. The pros and cons are also discussed and an evaluation will be made whether there is really basis to say so. The paper ends with a position taken with corresponding reasons. 2. Analysis 2.1 Concept of Cost- Benefit Analysis Cost-benefit analysis (CBA) is defined by Tutor2 Limited, (2005) as “a framework for evaluating the social costs and benefits of an investment project.” Tutor2 Limited, (2005) adds: “This involves identifying, measuring and comparing the private costs and negative externalities of a scheme with its private benefits and positive externalities, using money as a measure of value.” To further understand the CBA concept, Ackerman and Heinzerling, (2005) applied the concept in health, safety and environmental regulation, saying: Cost-benefit analysis seeks to translate all relevant considerations into monetary terms. Economists “monetize” both the costs of regulation, such as the money spent to install a scrubber on a power plant to reduce air pollution, and the benefits of regulation, such as saving human lives and preventing disease. When benefits of regulation will happen in the future, the economists first quantify those benefits in dollars. Then they “discount” their value to reflect how much we would have to invest today to have that much money when the benefit is delivered. Cost-benefit analysis sets out to do for government what the market does for business: add up the benefits of a public policy and compare them to the costs. The two sides of the ledger, however, raise very different issues. Comment: On the basis of the above statements, we can now understand the extent of the use of the CBA. It is being used by both the government and business sector for decision making because of market forces. Ackerman and Heinzerling (2005), however, raise concerns of the application of the CBA, which is the subject inquiry of this paper. Hence on the following discussion we will be evaluating the advantages and disadvantages of CBA and the validity of the criticisms on the advantages. But before doing that, let us first understand the steps in CBA, since it is a process. 2.1.1 What are steps in cost benefit analysis? Tutor2 Limited (2005) enumerates the following steps: Step 1: identify all costs and benefits using the principle of opportunity cost Step 2: measure the benefits and costs using money as a unit of account Step 3: consider the likelihood of the cost or benefit occurring (i.e. sensitivity analysis) Step 4: take account of the timing of the cost and benefit (i.e. discounting). A £1,000 benefit now is worth more than £1,000 benefit in 10 years time. 2.1.2 How discounting is done? Ackerman and Heinzerling (2005) say: Discounting is a procedure developed by economists to evaluate investments that produce future income. The case for discounting begins with the observation that $100, say, received today is worth more than $100 received next year, even in the absence of inflation. For one thing, you could put your money in the bank today and earn a little interest by next year. Suppose that your bank account earns 3 percent interest. In that case, if you received the $100 today rather than next year, you would earn $3 in interest, giving you a total of $103 next year. Likewise, in order to get $100 next year you only need to deposit $97 today. So, at a 3% discount rate, economists would say that $100 next year has a present value of $97 in today’s dollars. The authors also state that this application of discounting is essential, and indeed commonplace, for many practical financial decisions. They argue saying: “If offered a choice of investment opportunities with payoffs at different times in the future, you can (and should) discount the future payoffs to the present in order to compare them to each other. The important issue for environmental policy is whether this logic also applies to outcomes far in the future, and to opportunities – like long life and good health – that are not naturally stated in dollar terms.” Comment: It is very important to recognize the advantages of cost benefit analysis when there is basis to express decisions in term of dollars. But as we noted there could be errors in assigning monetary values to different items like in case life, health and the environment. (Ackerman and Heinzerling, 2005) We can now discuss the advantages and disadvantages. 2.2.0 Advantages and Disadvantages of CBA 2.2.1 Advantages We have two advantages as expressed by Ackerman and Heinzerling (2005). 2.2.1.1 CBA leads to more efficient allocation. Ackerman and Heinzerling (2005) state that the use of cost-benefit analysis ostensibly leads to more “efficient” allocation of society’s resources by better identifying which potential regulatory actions are worth undertaking and in what fashion. Comment: This is expected of economists since they treat the world in terms of resources to be used and hence they try to express everything in dollars just to make it sure everything is measure for purposes of decision making. Economics is a social science which deals with study of unlimited human needs and wants and the allocation of limited to resources to said needs and wants. But what is the problem? Will there by any objection if such practice is resorted to by the economist? Ackerman and Heinzerling (2005) posit: Whether policies protecting health, safety, and the environment will be rejected if they do not pass a narrow economic test requires the translation of human lives, human health, and nature itself into dollars. Comment: This would mean that the application and non-application of CBA will affect government policies in protecting health, safety and environment. When government policies are implemented funds are used and therefore if certain programs does not pass the criteria of the CBA, there is a great possibility that people are denied of their rights of protection health, safety, and environment should the using the CBA may turn out to be the right means to adopt or reject a policy. 2.2.1.2 CBA will produce better regulatory process because of being more objective and more transparent, thus greater accountability to public. Ackerman and Heinzerling (2005) state that, according to CBA advocates, a second important set of arguments holds that cost-benefit analysis would produce a better regulatory process – more objective and more transparent, and thus more accountable to the public. Cost-benefit analysis has been offered as a means of preventing an agency from just doing anything it wants or, more invidiously, from benefiting politically favoured groups through its decisions. Comment: From these advantages, the authors framed the disadvantages. This we will see in next discussion. 2.3.1 Disadvantages of the Cost benefit analysis The disadvantages as argued by Ackerman and Heinzerling (2005) are framed in such a way so as to destroy or discredit the claimed advantages of CBA, and they are as follows: 2.3.1.1 The process of monetizing is inherently flawed, hence, no efficient decision. Ackerman and Heinzerling (2005) argue: In fact, cost-benefit analysis is incapable of delivering what its proponents promise. First, cost-benefit analysis cannot produce more efficient decisions because the process of reducing life, health, and the natural world to monetary values is inherently flawed. Efforts to value life illustrate the basic problems. Cost-benefit analysis implicitly equates the risk of death with death itself, when in fact they are quite different and should be accounted for separately in considering the benefits of regulatory actions. Cost-benefit analysis also ignores the fact that citizens are concerned about risks to their families and others as well as themselves, ignores the fact that market decisions are often very different from political decisions, and ignores the incomparability of many different types of risks to human life. The same kinds of problems arise in attempting to define in monetary terms the benefits of protecting human health and the environment. Comment: Opponents just say the process of reducing life, health and natural world to monetary values is inherently flawed because of the equating the risk of death with death itself and that CBA ignores citizen’s concern about risk to their families, market decision’s being different from political decisions and incomparability of many different types of risk to human life. Analysing text however, show that Ackerman and Heinzerling (2005) have not backed up with evidence to support their criticisms. Moreover, there are no alternative guides for decision making that is counter offered. Given the criticism there is basis to remedy and to provide allowance in applying the criteria. Moreover, as stated earlier, CBA does not deny variability of assignment of monetary values for life. By analogy in law, the courts also assign values to human life, although life is priceless. The court as matter of convenience awards minimum amount of damage for death of a victim. Additional damages could come as function of the degree of culpability of the accused and the relationship of the acts done in relation to the damage done to the victim. In other words, this world of ours is finite and our lives may be believed to be priceless, yet we cannot deny the allocation of our limited resources, which are actually measured in terms of money. If we sustain the argument that there is no monetary equivalent for damages done, then we seems to be arguing that a defendant who has caused physical injury damaged to another person must also suffer the same injury. This would be going back in time where the rule is a “tooth for a tooth”. 2.3.1.2 CBA improperly downgrades the importance of environmental regulation. Ackerman and Heinzerling (2005) also argue as follows: Second, the use of discounting systematically and improperly downgrades the importance of environmental regulation. While discounting makes sense in comparing alternative financial investments, it cannot reasonably be used to make a choice between preventing harms to present generations and preventing similar harms to future generations. Nor can discounting reasonably be used even to make a choice between harms to the current generation; choosing between preventing an automobile fatality and a cancer death does not turn on prevailing rates of return on financial investments. In addition, discounting tends to trivialize long-term environmental risks, minimizing the very real threat our society faces from potential catastrophes and irreversible environmental harms, such as those posed by global warming and nuclear waste. Significantly, all of the studies suggesting that regulation kills people because it is so expensive employed discounting, which caused regulatory benefits to appear to shrink and regulatory costs to grow. Comment: Again this objection to the CBA does not offer an alternative. The article expresses the importance of environmental regulation, but how could we express importance? Do we not quantify what is important? Is it not a fact that in budget allocation, the one that is more important will have more funds? It did not explain further the statement about preventing harms to present and future generations. Of course decision makers have different attitudes on treating the present from the future but the allocation of resources for the environment on the basis of cost benefit analysis is a move to prevent harms both in the present and in the future. But man is limited, much at it wants to travel to the future soon, he must not neglect the present in order to reach the future. The authors’ criticism fails to appreciate the value of discounting of values. Its essence is to discount future values into their present value because, although future is important, the present is still the most important for it always appears to be at the crossroads of decision making. Is not economics concerned with the best allocation of resources to unlimited needs and wants? By putting more values to the present, CBA acknowledges uncertainty of the future, which is true? Could anyone be very sure of what will happen tomorrow? 2.3.1.3 CBA ignores the question of who suffers as a result of environmental problem. Ackerman and Heinzerling (2005) further argue: Third, cost-benefit analysis ignores the question of who suffers as a result of environmental problems and, therefore, threatens to reinforce existing patterns of economic and social inequality. Cost-benefit analysis treats questions about equity as, at best, side issues, contradicting the widely shared view that equity should count in public policy. In fact, poor countries, communities, and individuals are likely to express less "willingness to pay" to avoid environmental harms, simply because they have fewer resources. Therefore, cost-benefit analysis would justify imposing greater environmental burdens on them than on their wealthier counterparts. With this kind of analysis, the poor get poorer. Comment: This criticism appears logical but it again lacks the necessary evidence to prove itself. If we sustain this argument, we would be saying that the decision makers in budget allocation for the use of resources in the environment are not considering their constituents’ needs and that these decision makers do not support equity. The arguments also assume that the poor will be less willing to pay to avoid environmental harms, simply because they have fewer resources. This statement seems to be bias in favour of a charitable spirit for poor but fails to appreciate the deeper concept of capitalism which may have caused its inference. The fact that one is poor does not make one less willing, it is simply that you cannot choose, meaning its not a choice but by force of circumstance. In capitalism money begets money; hence, it is logical to argue that poor may get poorer. CBA in turn may actually be an offspring of capitalism since CBA is also an economic concept. 2.3.1.4. CBA fails to produce the greater objectivity and transparency promised by its proponents. Ackerman and Heinzerling (2005) furthermore argue: Finally, cost-benefit analysis fails to produce the greater objectivity and transparency promised by its proponents. Cost-benefit analysis rests on a series of assumptions and value judgments that cannot remotely be described as objective. Moreover, the highly complex, resource-intensive, and expert-driven nature of this method makes it extremely difficult for the public to understand and participate in the process. Thus, in practice, cost-benefit analysis is anything but transparent. Comment: This criticism appears logical but offers again no substantial evidence to support itself and offers also no alternative. It further fails to appreciate the value of decision making. To decide is to take risk. It is to cross to a ‘bridge’ believing that on the other side of the bridge is better road to tread. Hence, there is an element of risk. There is an element of risk because of the assumption that is made which may turn out to be false or optimistic or pessimistic. The moment the bridge is crossed, the man cannot be stopped crossing another bridge. A wise man will just have to change and fine tune his assumptions in case he assumed a false or a wrong one in the first, but whether he likes it or not he will have to make an assumption about the other side of the bridge in order to cross the bridge. In CBA, we do the same thing, every assumption that is made is a risk taken because of the assumption. Of course the assumption could not always be exact or correct or objective, but one may learn by experience to improve on that assumption. One may not choose to have to no assumption but that would be more a dangerous. In other words, a wise social scientist has a sense of history; he knows how to look back and uses past to predict the future. 3.0 Conclusion and Recommendation 3.1 Conclusion Cost-benefit analysis is a means to an end but a means may not necessarily accomplish all ends. It may provide a criterion for deciding the acceptability or non-acceptability of a project concerning society. While it does not offer itself as a panacea to all political decisions, it has its basis on reason to exist in protecting life, health and environment. Society is a big organisation where we have people, resources, and systems and choices. The power to choose is a reality. It is a thing that political governments cannot avoid and such power of choice must have a basis. The CBA offers itself to be one where a policy has cost and benefits from regulation pursuant to the same policy. Although it is not all easy to express external things in monetary terms by a set of assumptions, it is still a better alternative than nothing. On the basis of the statement that “what you can measure you can manage”, using CBA to measure variables for decision making is a better option than nothing. The cost and benefits necessarily occur over period of time, of which the decision maker allocates more value to points closer to present. Such assumption has basis in math and in logic. Assumptions are given also because of uncertainty of the future. If we know the future we don’t need to assume, but we would not be making a decision in the real sense, we would following what is dictated upon us by the future. Of course assumptions could be faulty, they could lack objectivity. The solution is however not to remove the CBA as criteria for decision making but to refine the same based on experience. Well, one might argue: “How about the exceptional case where it deviated from the criteria?” We live in an imperfect world and out of out imperfections should be a testimony and hope that we could still attain perfection and the same is only possible by learning from experience. Therefore, it a safer to state that CBA is a useful, rather than an indispensable aid or tool in decision making both in private and public sector. Between therefore imperfect calidus and indispensable aid, the middle ground between the two seems to be fairer to accept if what it means by imperfect calidus is to put no value to CBA for decision making. Just like in medicine, a doctor will not refuse to prescribe medicine that could to a possible uncertain side effect, since he believes that prescribing a medicine will far outweigh the disadvantage. 3.2 Recommendation It is recommended that any would be user of CBA should apply the same where it finds application, but never on those that may find itself contradictory. In case it will be applied in areas where it is hard to quantify or monetise variables, the researcher or the report maker or the user should disclose the limitations of the analysis. Bibliography: 1. Ackerman, F. and Heinzerling, L. (2005), Cost-benefit Analysis, {www document} URL http://www.progressiveregulation.org/perspectives/costbenefit.cfm, Accessed on March 13, 2006 2. Tutor2 Limited (2005), Cost Benefit Analysis, {www document} URL http://www.tutor2u.net/economics/content/topics/marketfail/cost_benefit_analysis.htm, Accessed on March 13, 2006 Read More