Jump to main content.

1. INTRODUCTION TO BENEFIT-COST ANALYSIS

Quick Links

Benefits of Clean Air and Water


In the 1960s, the people of the United States became increasingly aware that the fruits of economic development were infected by the rot of environmental deterioration. Late in the decade and early in the 1970s, concern grew to such an extent that a number of laws were passed by the Congress aimed at not only stemming the deterioration of the environment, but improving its quality as well. As we move into the 1980s, environmental concerns, as attested by public opinion polls, are still vividly alive, but are being increasingly balanced by economic considerations. In this atmosphere, there has been heightened interest in the question of whether the costly environmental regulations that have been put in place are, in fact, worthwhile. To try to shed some light on this question, appeal is often made to an economic evaluation method called benefit-cost analysis.

Benefit-cost analysis was developed initially to evaluate water re-sources investments by the federal water agencies in the United States, principally the United States Bureau of Reclamation and the United States Corps of Engineers. The general objective of the method in this applica-tion was to provide a useful picture of the costs and gains associated with investments in water development projects. The intellectual "father" of benefit-cost analysis was the nineteenth century Frenchman, Jules Dupuit, who in 1844 wrote an often cited study "On the Measure of the Utility of Public Works." In this remarkable article, he recognized the concept of consumers' surplus (which is explained in the next chapter) and saw that as a result, the benefits of public works usually are not the same thing as the direct revenues that the public works projects will generate.

In the United States, the first contributions to development of benefit-cost analysis did not come from the academic or research communities, but rather from government agencies. Water resources development officials and agencies in this country have from the very beginning of the nation been aware of the need for economic evaluation of public works projects. In 1808, Albert Gallatin, President Jefferson's Secretary of the Treasury, produced a report on transportation programs for the new nation in which he stressed the need for comparing the benefits with the costs of proposed water improvements. Later the Federal Reclamation Act of 1902, which created the Bureau of Reclamation and was aimed at opening western lands to irrigation, required economic analysis of projects. The Flood Control Act of 1936 proposed a feasibility test for flood control projects which requires that the benefits "to whomsoever they accrue" must exceed costs.

In 1946, the Federal Interagency River Basin Committee appointed a subcommittee on benefits and costs to coordinate the practices of federal agencies in making benefit-cost analysis. In 1950, the subcommittee issued a landmark report entitled "Proposed Practices for Economic Analysis of River Basin Projects." This document was fondly known by a generation of water, project analysts as the "Green Book." While never fully accepted either by the parent committee or the pertinent federal agencies, this report was remarkably sophisticated in its use of economic analysis and laid an intellectual foundation for research and debate in the water re-sources area which made it unique among other major reports in the realm of public expenditures. It also provided general guidance for the routine development of benefit-cost analysis of water projects which persists until now, even though a successor report does presently exist which is more adapted to the conditions of the present day.

Following the "Green Book" came some outstanding publications from the research and academic communities. Several volumes which appeared over the past two-and-a-half decades have gone much further than ever before in clarifying the basic ideas underlying benefit-cost analysis and the methods for quantifying them. Otto Eckstein's Water Resource Development: The Economics of Project Evaluation (Harvard University Press), which appeared in 1958, is particularly outstanding for its careful review and critique of federal agency practice with respect to benefit-cost analysis. A clear exposition of principles together with applications to several important cases was prepared by Jack Hirshleifer, James DeHaven, and Jerome W. Milliman in Water Supply: Economics and Policy (University of Chicago Press, 1960). A later study which was especially notable for its deep probing into applications of systems analysis and computer technology within the framework of benefit-cost analysis was produced by a group of economists, engineers, and hydrologists at Harvard and published under the title Design of Water Resource Systems in 1962 (Harvard University Press). The intervening years have seen considerable further work on the technique and a gradual expansion of it to areas outside the water resources field, some of them more or less natural extensions of the work on water resources. For example, the last two decades have seen many attempts to evaluate the benefits of outdoor recreation--both water-related and otherwise. A relatively recent book which looks at some applications other than water-related ones, but which is in the mainline of the traditional benefit-cost analysis, is Ezra Mishan, Cost-Benefit Analysis (Praeger Publishers, 1976).

But the most striking development in benefit-cost analysis in recent years has been its application to the economic and environmental conse-quences of new technologies and scientific and regulatory programs. For example, the Atomic Energy Commission (before the Energy Resources and Development Administration and then the Department of Energy were created) used the technique to evaluate the fast breeder reactor program. A report on this study is found in U.S. Atomic Energy Commission, Division of Reactor Development and Technology, Updated (1970) Cost-Benefit Analysis of the U.S. Breeder Reactor Program, Washington 1184 (January 1972). The technique has also been applied to other potential sources of environmental pollution and hazard. Two studies which come to quite contrary conclusions have been made of the Automotive Emissions Control. Volume 4, The Costs of Benefits of Automotive Emissions Control Series No. 19-24, Washington GPO (September 1974) was prepared by a committee of the National Academy of Sciences. The other study from a major automotive producer is reported in Clement J. Jackson, et al., "Benefit-Cost Analysis of Automotive Emissions Reductions," Research Laboratory, General Motors Corporation, Warren, Michigan, CMR 2265 (October 15, 1976). Other studies have been or are being conducted in the area of water quality improvement policies, emissions control from stationary and mobile air pollution sources, and regulation of toxic substances.

Even while the technique was limited largely to the relatively straightforward problem of evaluating public works, there was much debate among the economists about appropriate underlying concepts and methods of making quantitative estimates of benefits and costs--especially of bene-fits. Some of the discussion surrounded primarily technical issues, e.g., ways of computing consumer surplus (the idea referred to earlier and ex-plained later) and how best to estimate demand functions (also explained later) for various outputs of projects. Others were more clearly value and equity issues, e.g., whether the distribution of benefits and costs among individuals or regions needed to be accounted for or whether it was proper to consider only the sums over all affected parties. Another central issue was what the proper weighting of benefits and costs occurring at different points in time was to be. This is known as the "discounting" issue. The term refers to the question of how to take into account the fact that normally the further into the future gains or losses accrue, the less heavily they are weighted by those who stand to do the gaining or losing.

Application of benefit-cost analysis to issues such as nuclear radiation, the storage of atomic waste, and the regulation of toxic substances in the various environmental media (both those substances which are imme-diately toxic to man and those which affect his life support or value systems) aggravate both the conceptual and quantification problems which existed in water resource applications. There are several reasons for this.

Firstly, while water resource applications often involved the evaluation of public goods (in the technical economic sense which is explained in the next chapter), the bulk of outputs from such projects are irrigation water, navigation enhancement, flood control, and municipal and industrial water supplies. These outputs can usually be reasonably evaluated on the basis of some type of market price information because often private developments produce similar or closely related outputs. In the new application, we are dealing entirely with situations in which useful information from existing markets is difficult, if not impossible, to establish.
Secondly, such matters as nuclear radiation and toxic materials relate to exposure of the whole population or large subpopulations to very subtle influences of which they may be entirely unaware. It is difficult to know what normative value individual preferences have under these circumstances, and clever methods of quantifying damages (negative benefits) have to be evolved.

Thirdly, the distributional issues involved in these applications concern not only monetary benefits and costs, but the distribution of actual physical hazard. For example, residents of an industrial city may suffer ill health resulting from pollution associated with the production of goods consumed in another locality. While it is not out of the question that monetary equivalents to these risks could be developed, the ethical value issues involved appear to be deeper than just the associated economic returns. This is especially so if compensation is not actually paid to damaged parties as in practice it is usually not.

Fourthly, we are in some cases dealing with long-lived effects of a policy decision which could extend to hundreds of thousands of years and many, many human generations. This situation raises the question of how the rights and preferences of future generations can be represented in this decision process. Realistically, the preferences of the existing generation must govern. The question is whether the simple direct desires of existing persons are to count exclusively or whether justice demands that the present generation adopt some ethical rule or rules of a constitutional nature in considering questions of future generations.

Thus the new application of benefit-cost analysis bristle with ethi-cal, value, and quantification issues. A group of researchers located principally at Resources for the Future and the Universities of Wyoming, New Mexico, and Chicago have, for the last several years, been working on a research program aimed at making progress in the basic understanding and analysis of these issues. In the present book, a nontechnical summary of results from one of the most substantial thrusts of this research--methods development and quantitative estimation of benefits from air and water pollution control (air and water quality maintenance or improvement) is presented. This program of research has received sustained support from the U.S. Environmental Protection Agency. A person wishing to study the details and technicalities of the research studies underlying this brief nontechnical volume describing these studies is referred to the bibliography at the end of this book. For simplicity, references are held to a minimum in the exposition itself.

Before proceeding specifically to a discussion of the methods and results of the research, it will be useful to describe, in general terms, some of the basic ideas from the discipline of economics which were central to this research enterprise. Also the next few chapters display its inherently interdisciplinary character.

But before doing so, I wish to underline what this book is and what it is not. It is not an effort to provide a comprehensive review of environmental benefits studies in general. The case material in it comes from EPA-sponsored studies of air quality and water quality, conducted in a coordinated way over the course of a number of years primarily at the University of Wyoming, the University of New Mexico, and Resources for the Future. While this therefore is not an entirely comprehensive review of research in the area, some bounds had to be set, and the one chosen seems reasonable on three grounds: (1) I have had some personal involvement in nearly all of the projects discussed and therefore feel more qualified to write about them than if I had only read about them; (2) these projects span the range of methodologies that have been developed for benefits assessment work including bidding games, surveys, property value studies, wage differentials, risk reduction evaluation, and mortality and morbidity cost estimation (all of these will be explained subsequently); and (3) they represent the results of a reasonably coherently planned program of research. Accordingly, the book contains a relatively complete picture of the state of the art of benefits measurement for environmental improvements as of 1983. However, a further point should be made, and that is that these studies are deliberately at the frontiers of the benefit measurement craft. Their chief intent was methodological improvement, and the reader should give primary attention to that aspect. Quantitative estimates of benefits are given but they should be regarded as preliminary and experimental in character, and at best an order of magnitude indication of the actual numbers. For this reason, I have not adjusted results for inflation even though they accrued over several years. They are in the dollars of the late seventies and early eighties. To refine them further would confer on them an unfounded aura of accuracy.

Local Navigation


Jump to main content.