6.4 Evaluating projects and policies  (Page 5/14)

Efficiency, cost effectiveness, innovation, and equity

Cost-benefit analysis gives us a rough sense of whether or not a project is a good idea. However, it has many limitations. Here we discuss several other measures of whether a project is desirable. Economists use all these criteria and more when evaluating whether a policy is the right approach for solving a problem with externalities, public goods, and common-pool resources.

Efficiency

A policy is efficient if it maximizes the net benefits society could get from an action of that kind. Many projects and policies can pass a cost-benefit test but still not be efficient. Several levels of carbon dioxide emission reduction, for example, could have benefits exceeding costs, but only one will have the largest difference between benefits and costs possible. Such efficiency will occur when the marginal benefits of the policy are equal to its marginal costs. Sometimes a cost-benefit analysis will try to estimate the total costs and benefits for several policies with different degrees of stringency to try to see if one is better than the others. However, only information about the marginal benefit and marginal cost curves will ensure that the analyst has found the efficient policy. Unfortunately, such information is often very hard to find or estimate.

Cost effectiveness

As we saw in the Module Environmental Valuation , it can be particularly difficult to estimate the benefits of environmental policy, and benefit estimates are necessary for finding efficient policies. Sometimes policy goals are just set through political processes—reducing sulfur dioxide emissions by 10 million tons below 1980 levels in the Clean Air Act acid rain provisions, cutting carbon dioxide emissions by 5% from 1990 levels in the Kyoto protocol—without being able to know whether those targets are efficient. However, we can still evaluate whether a policy will be cost effective and achieve its goal in the least expensive way possible. For example, for total pollution reduction to be distributed cost-effectively between all the sources that contribute pollution to an area (e.g. a lake or an urban airshed), it must be true that each of the sources is cleaning up such that they all face the same marginal costs of further abatement. If one source had a high marginal cost and another’s marginal cost was very low, total cost could be reduced by switching some of the cleanup from the first source to the second.

Incentives to innovate:

At any one point in time, the cost of pollution control or resource recovery depends on the current state of technology and knowledge. For example, the cost of reducing carbon dioxide emissions from fossil fuels depends in part on how expensive solar and wind power are, and the cost of wetland restoration depends on how quickly ecologists are able to get new wetland plants to be established. Everyone in society benefits if those technologies improve and the marginal cost of any given level of environmental stewardship declines. Thus, economists think a lot about which kinds of policies do the best job of giving people incentives to develop cheaper ways to clean and steward the environment.

Fairness

A project can have very high aggregate net benefits, but distribute the costs and benefits very unevenly within society. We may have both ethical and practical reasons not to want a policy that is highly unfair. Some people have strong moral or philosophical preferences for policies that are equitable. In addition, if the costs of a policy are borne disproportionately by a single group of people or firms, that group is likely to fight against it in the political process. Simple cost-benefit analyses do not speak to issues of equity. However, it is common for policy analyses to break total costs and benefits down among subgroups to see if uneven patterns exist in their distribution. Studies can break down policy effects by income category to see if a policy helps or hurts people disproportionately depending on whether they are wealthy or poor. Other analyses carry out regional analyses of policy effects. . For example, climate-change mitigation policy increases costs disproportionately for poor households because of patterns in energy consumption across income groups. Furthermore, the benefits and costs of such policy are not uniform across space in the U.S. The benefits of reducing the severity of climate change will accrue largely to those areas that would be hurt most by global warming (coastal states hit by sea level rise and more hurricanes, Western states hit by severe water shortages) while the costs will fall most heavily on regions of the country with economies dependent on sales of oil and coal.

Some of our evaluative criteria are closely related to each other; a policy cannot be efficient if it is not cost-effective. However, other criteria have nothing to do with each other; a policy can be efficient but not equitable, and vice versa. Cost-benefit analyses provide crude litmus tests—we surely do not want to adopt policies that have costs exceeding their benefits. However, good policy development and evaluation considers a broader array of criteria.

Review questions

References

Braden, J. B.&A. W. Ando. 2011. Economic costs, benefits, and achievability of low-impact development based stormwater regulations, in Economic Incentives for Stormwater Control , Hale W. Thurston, ed., Taylor&Francis, Boca Raton, FL.

Carson, R. T., Mitchell, R. C., Hanemann, M., Kopp, R. J., Presser, S., and Ruud, P. A. (2003).Contingent valuation and lost passive use: Damages from the Exxon Valdez oil spill. Environmental and Resource Economics, 25 (3), 257-286. DOI: 10.1023/A:1024486702104.

Dawson, D.&Shogren, J. F. (2001). An update on priorities and expenditures under the Endangered Species Act. Land Economics, 77 (4), 527-532.

EDV&CBN (2000). Environmental groups protest alteration of U.S. Army Corps cost benefit analysis. Environmental Damage Valuation and Cost Benefit News , 7(4), 1-3. (External Link) .