6.4 Evaluating projects and policies  (Page 3/14)

Control for associated market changes

A careful cost analysis must pay attention to market changes associated with cost increases. To illustrate, suppose the government is thinking of passing a ban on agricultural use of methyl bromide. This ozone-depleting chemical is widely used as an agricultural fumigant, and is particularly important in strawberry production and shipping. A ban on methyl bromide might, therefore, increase the marginal cost of producing strawberries. A simple approach to estimating the cost of the proposed methyl bromide ban would be to find out how many strawberries were sold before the ban and calculate the increase in the total cost of producing that many strawberries. However, the increase in production costs will drive up the price of strawberries and lower the number of strawberries sold in the marketplace. There is a cost to society with two parts: (a) deadweight loss associated with the net benefits of the strawberries not sold, and (b) the increased cost of producing the strawberries that still are sold. That total social cost is lower, however, than the estimate yielded by the simple approach outlined above because the simple approach includes increased production costs for strawberries that are not sold. An accurate cost estimate must take into account market changes.

The concept of net benefits was introduced above; in the context of policy or project evaluation, net benefits are, quite simply, the difference between the benefits and the costs of a policy in a given year. However, environmental policies typically have benefits and costs that play out over a long period of time, and those flows are often not the same in every year. For example, wetland restoration in agricultural areas has a large fixed cost at the beginning of the project when the wetland is constructed and planted. Every year after that there is an opportunity cost associated with foregone farm income from the land in the wetland, but that annual cost is probably lower than the fixed construction cost. The wetland will yield benefits to society by preventing the flow of some nitrogen and phosphorus into nearby streams and by providing habitat for waterfowl and other animals. However, the wildlife benefits will be low in the early years, increasing over time as the restored wetland vegetation grows and matures. It is not too difficult to calculate the net benefits of the restoration project in each year, but a different methodology is needed to evaluate the net benefits of the project over its lifetime.

Some analysts simply add up all the costs and benefits for the years that they accrue. However, that approach assumes implicitly that we are indifferent between costs and benefits we experience now and those we experience in the future. That assumption is invalid for two reasons. First, empirical evidence has shown that humans are impatient and prefer benefits today over benefits tomorrow. One need only ask a child whether they want to eat a candy bar today or next week in order to see that behavior at work. Second, the world is full of investment opportunities (both financial and physical). Money today is worth more than money tomorrow because we could invest the money today and earn a rate of return. Thus, if there is a cost to environmental cleanup, we would rather pay those costs in the future than pay them now.