Cost-benefit Analysis

Cost-benefit analysis (C-BA) is a form of economic analysis in which costs and benefits are quantified and compared. C-BA is used primarily to evaluate public expenditure decisions with regard to such factors as esthetics, ethics, and long-term environmental costs (e.g., pollution costs).

Origins in the 1930s

C-BA had its origins in 1936 with the dam projects of the Works Progress Administration (WPA) in the western United States. At the time the federal government's policy was that projects would only be started if accrued benefits exceeded accrued costs. Although such a statement would be judged quite simplistic by today's standards, this philosophy is still the basis for C-BA.

Costs vs. benefits. The power of C-BA lies in its ability to organize and evaluate an action's likely effects and overall impact on economic welfare. CB-A states that if a project is to proceed on a successful basis, then total benefits should outweigh total costs. Consider, for instance, the following hypothetical scenario. The construction of an industrial complex next to an existing residential community will provide a needed boost to the community, which has a high unemployment rate. However, the new businesses will also cause substantial localized air and water pollution. CB-A will sum up all the benefits and costs in order to determine whether the new arrangement will be positive or negative for local residents and businesses.

Evolution into a Sophisticated Technique

C-BA has evolved into a highly technical subject, which normally requires that all costs and benefits (whether tangible or intangible) be expressed in monetary units. Tangible means that costs and benefits are capable of being understood and evaluated. An example of a tangible cost is the price of land for locating a new company. Intangible means just the opposite, that the economic costs and benefits are difficult to define clearly. The measurement of intangibles causes the most difficulty for C-BA. Pollution is one such intangible that is exceptionally difficult to measure because of its unique problems. For example, it is not easy to determine the value of clean air vs. degraded air quality due to pollution from a proposed manufacturing complex.

A number of sophisticated techniques have been developed to successfully measure such intangibles as pollution. In the earlier hypothetical case, one such technique estimates how much an individual is willing to pay to use or retain clean air. Another technique is a subsidy offered to individuals to live with polluted instead of clean air. A third technique involves the measure of today's intrinsic value of clean air vs. the future costs of remedying the consequences of polluted air (such as respiratory problems and environmental cleanup).

Oklawaha River Canal

A good example of C-BA with respect to pollution was a 1962 U.S. Army Corps of Engineers proposal for a 177-kilometer (110-mile) canal to be dug across central Florida. The canal would have provided a shortcut for barge traffic from Texas and Louisiana to the Atlantic Coast by, in part, expanding 80 kilometers (50 miles) of the pristine Oklawaha River. Numerous citizen and environmental groups opposed the canal, citing the pollution and general environmental degradation it could potentially cause.

To the Rescue. A C-BA was undertaken with respect to various interest groups that would be affected, such as shippers using the canal and fishers using the river. The analysis determined that few benefits would be realized, and that the proposed project would be detrimental to most interest groups. Because of the evidence provided by the C-BA, the project was halted in 1971 by a citizen's group lawsuit and a presidential executive order.

Although C-BA has many strengths as a tool, it also has numerous weaknesses such as the inability to conclude anything without the use of financial costs and benefits and the inherent problem of introducing uncertainty of data when using intangible items unable to be analyzed even with sophisticated techniques. Even so, it is still a valuable tool for governments to consider in making decisions about the most effective use of their resources. C-BA can gather all the essential data related to an issue and establish reasonable economic, demographic, and technical assumptions that will serve as the ground-rules for the ensuing debate. C-BA is thus an important ingredient in the decision-making process concerning proposed projects that impact the environment and, especially, pollution.

Bibliography

Dorfman, Robert, and Dorfman, Nancy S., eds. (1993). Economics of the Environment: Selected Readings, 3rd edition. New York: W.W. Norton.

Florida Defenders of the Environment. (1970). Environmental Impact of the Cross-Florida Barge Canal with Special Emphasis on the Oklawaha Regional Ecosystem. Gainesville, FL.

Internet Resources

College of Agriculture and Life Sciences, University of Arizona. "A Student's Guide to Cost Benefit Analysis for Natural Resources: Lesson 3—Cost-Benefit Analysis in Theory and Application." Available from http://ag.arizona.edu/classes .

Florida Defenders of the Environment. "Oklawaha River Restoration: History of Restoration Efforts." Available from http://www.fladefenders.org/publications .

Food and Agriculture Organization of the United Nations. "Chapter IV—Methods for Environmental Cost-benefit Analysis for Agricultural Lending." Available from http://www.fao.org/docrep .

Kopp, Raymond J.; Krupnick, Alan J.; and Toman, Michael. Resources for the Future. "Cost-Benefit Analysis and Regulatory Reform: An Assessment of the Science and the Art." Discussion Paper 97-19. Available from http://www.rff.org/disc_papers .

Margetts, Steve. "Cost Benefit Analysis." Available from http://www.revisionguru.co.uk/economics .

National Center for Environmental Decision-Making Research. "Cost-Benefit Analysis and Environmental Decision Making: An Overview." Available from http://www.ncedr.org/tools .

William Arthur Atkins