Cost-Benefit Analysis as a Tool for Policy

1. Cost-Benefit Analysis as a Tool for Policy Alan Krupnick, PhD Senior Fellow and Division Director Resources for the Future March 2, 2007

2. Policy Context • Environmental and health regulations are often very costly to society, and deliver benefits of very different types and quantities • So need to identify those that deliver the greatest benefit for the resources expended, i.e., are efficient • Requires estimating the benefits and costs of regulatory intervention. • Other factors matter at least as much: equity, legality

3. Two Types of Policy Analyses • Cost-Benefit Analysis (CBA) = Monetary benefits minus costs • Cost-Effectiveness Analysis (CEA) = Cost/Effectiveness Effectiveness measures • Physical units, e.g., emissions, lives saved • Quality adjusted life years

4. Uses of CBA • Accounting framework • Prioritization • Normative Decision: Is it worth it to take any action? • Policy Choice: Which policy is better (on efficiency grounds)? How can policy design be improved?

5. Limitations • Only addresses efficiency under a utilitarian model • Discounting; growth and change • Hard to monetize everything

6. Example of cost-effectiveness analysis

8. Many major applications of cost-benefit analysis (CBA) • Social cost of Electricity (e.g., U.S., Europe (EXTERNE)) • EXTERNE: Social cost of Transportation, CAFÉ • U.S.: BENMAP • IPCC: Ancillary Benefits of climate change Many of above are “integrated assessments.”

17. Experience with CBA at U.S.EPA (Morgenstern, 1997) • All CBA’s studied “ended up improving the rules” • Guiding development of rules • Adding/eliminating/adjusting alternatives • Supporting decisions • Broad educational value

18. Example for Mexican Brick Kilns The Benefits and Costs of Informal Sector Pollution Control: Mexican Brick Kilns, Allen Blackman*, Jhih-Shyang Shih, David Evans, and Michael Batz, Stephen Newbold, Joseph Cook, April 2006

19. Figure 1. Brickyards, formal industrial facilities, and population in Ciudad Juárez

21. Effect on Policy • Wanted to try natural gas approach: Pipeline costs (fixed) were too high • NMSU kilns: Introduced from cross-border emissions trading in El Paso; 60 of 350 kilns converted • Some center city kilns were relocated outside city

22. Example of CBA for Shanghai “Quantifying the Human Health Benefits of Curbing Air Pollution in Shanghai” Li, Guttikunda et al., Journal of Environmental Management, 70 (2004), 49-62.

23. Overview of the Case Study • Examines 2 options to control pollution from stationary sources in Shanghai • Integrated Gasification Combined Cycle for power plants • Relocation and reduction in coal use by the industrial sector • Analysis conducted for the year 2020, assuming baseline emissions fall • RAINS-Asia model used to predict future energy use and emissions; UrBAT used to calculate ground-level concentrations of SO2 and PM

24. Shanghai Urban Air Quality Management Emission Estimates Units: Gg/year 1995 2020 BAU

25. Shanghai Urban Air Quality ManagementAnnual Average PM10 Concentrations Units: mg/m3 PM10 in 1995 2020 BAU

26. Shanghai Urban Air Quality Management2020 Control Scenarios Power Sector Control • Integrated Gasification Combined Cycle (IGCC) for coal combustion Industrial Sector Control • 75% coal consumption reduction • Remaining 25% relocated to neighboring provinces

27. Shanghai Urban Air Quality ManagementAnnual Average PM10 Concentrations 2020 Power Control 2020 Industrial Control Units: mg/m3 PM10

28. Shanghai Urban Air Quality ManagementAnnual Average Reduction in 2020 Units: mg/m3 PM10 2020 Power Control 2020 Industrial Control

29. Shanghai Urban Air Quality ManagementHealth Benefit Analysis No. of cases avoided

31. Conclusion on Case Study • Both scenarios are welfare improving  CBA can help show whether it is desirable to take action • Industrial scenario is the more efficient in spite of having lower health benefits: • $417-$395 = $23 vs $266-$94 = $172  CBA can help choose the best policy

32. Embedding a CBA Process into the government • Location of process • An OMB-like agency • Centralized within SEPA • De-centralized Provincially • Commit resources • Issue Guidance Document • Develop appropriate regulatory process: early analyses, broad set of options • CBA/CEA AS TOOLS NOT A JUSTIFICATION • Development of analytical tools • E.g., ECM

33. STOP

35. Key Unquantified BenefitsSOURCE: The Benefits and Costs of the Clean Air Act, 1990 to 2010, Tables 5-1 and 7-5 (p.53, 88)

37. Defining and Measuring Cost • On a conceptual level, the definition of cost is the same as benefits, i.e., the opportunities given up by a choice. • Agencies often measure costs in terms of expenditures. Too narrow. • Compliance cost — the cost of all the actions necessary to comply with a particular regulation is better, but still a poor measure.

38. Proper Cost Accounting: Opportunities Forgone • Example: Ban on ozone depleting substances • The diverted resources necessary to develop the substitute products • The value of services of specialized capital and technology necessary to manufacture the banned products • Increased costs of production for the replacement product vis-à-vis the banned product/Differences in the retail price of the replacement product • Decline in the quality of the replacement product

39. Other Critiques • Preference satisfaction is not important/not important enough • Economic value doesn’t measure preferences • Social well-being is not the aggregate of individual well-being • Some things should not/cannot be priced

40. Other Issues in CBA • Equity integration • Tax interaction effects • E.g., CBA and the Clean Air Act • Valuation of natural resources