Cost Benefit Analysis Scramble

Cost Benefit Analysis

One of the dark clouds on the week that was in the U.S. Supreme Court was the decision in Michigan v. the Environmental Protection Agency, one portion of which reads:

“Our reasoning so far establishes that it was unreasonable for EPA to read §7412(n)(1)(A) to mean that cost is irrelevant to the initial decision to regulate power plants. The Agency must consider cost—including, most importantly, cost of compliance—before deciding whether regulation is appropriate and necessary,…”

Important Distinctions

First, let’s differentiate between a CBA (a cost benefit analysis) and a Cost Effectiveness Analysis (CEA).   There are two important functions of a CBA: (1) To determine if an investment or a decision is justifiable or feasible. (2) To provide a way to compare and contrast alternative projects or proposals. Additionally, “In CBA, benefits and costs are expressed in monetary terms, and are adjusted for the time value of money, so that all flows of benefits and flows of project costs over time (which tend to occur at different points in time) are expressed on a common basis in terms of their “net present value.”

The most common use of the CEA is found in the health sector.  In a CEA  the outcome is expressed as a ratio.  The denominator is the quantified gain, while the numerator is the cost associated with the gains.  For example, we know that sterilized surgical theaters yield quantifiable positive results for patients, therefore the costs associated with sterilization far outweigh the costs of sanitizing the facilities.

Another analysis which gets folded into the mixture is the analysis of the Social Return on Investment, or abbreviated SROI.  There are four elements considered: Inputs (investments), Outputs (products), Outcomes (benefits), and Impact (difference between the policy or practice change and what would have happened if nothing had been done.) [Investopedia]

There are other formats for analysis:  Cost/utility analysis; Risk/benefit analysis; and the Economic impact/analysis.  The definitions and descriptions of these forms are readily available from online sources.

The problem is that the CBA isn’t a static form of analysis.  Just as each problem in both the public and private sector has unique factors, the CBA may take on some elements from other formats – the CEA, the SROI, and the others.  Often the term “CBA” is used with great precision, i.e. it returns a study yielding a net present value.  There are other examples illustrating how the term CBA in common parlance and news reporting is an admixture of individual studies speaking to the CEA ratios, or the SROI elements.

As in so many other unfortunate instances, the cost/benefit analysis has come to mean what the partisan advocates want it to mean. One of the pitfalls involved in being a good consumer of news and political rhetoric is that the listener is required to sort out precisely what analysis is being described or advocated. The most common source of confusion comes when a CBA is conflated with an Economic Impact Study:

“One industry’s outputs are inputs to other industries, and vice versa. Input-output analysis measures all of the linkages and flows within the matrix (the economy). Based on these linkages and flows, the cumulative effect of any given stimulus (or change) can be derived. This is how multipliers are calculated.” [Decision Analyst Ser]

A public sector example might be that of a decision to build a public broadband access system.  This would trigger spending for infrastructure necessities for the system, which in turn increases employee and contractor income, causing (in sequence) more disposable spending for the local (or national) economy.  If we study the “linkages and flows” as the the project impacts the community we can calculate the cumulative “economic impact.”

So, when politicians speak to the necessity of doing cost/benefit analyses on government regulation it’s important to pin them down on precisely what form of analysis they are advocating, and how the form of the analysis can influence the reported results.

Good news Bad news

The bad news from the Michigan v. EPA  decision is that the EPA is required to perform a cost benefit analysis on emission regulations promoted by the EPA.  The slightly better news is that the decision doesn’t do what corporate radicals want – dismantle the EPA. Nor does the decision declare that the EPA may not issue rules on carbon or other pollutant emissions, granted that it does constitute another shackle on the Agency’s attempt to clear the air.

One way to support the efforts of the EPA to enforce the provisions of the Clean Air and Clean Water Acts might be be advocate for more, not less, study – studies which incorporate the CEA elements (health benefits included) and SROI quadrants which incorporate social benefits.

The argument that government regulations should hinge upon the notion that private sector operations should agree that the regulations are “not too expensive,” is a narrow, corporatist, perspective, and one which would all but insure no regulation of exploiters and polluters.  A better approach is to take into consideration the cumulative economic impact of regulations and the social returns we can make on our national investments.

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