September 2006

New Foundations of Cost-Benefit Analysis

Cost-benefit analysis (CBA) has been an important policy tool of government since the 1980s, when the Reagan administration ordered that all major new regulations be subjected to a rigorous test of whether their projected benefits would outweigh their costs. Many claim that CBA neglects important values, especially benefits, that are hard to measure. In their new book, New Foundations of Cost-Benefit Analysis, Matthew Adler and Eric Posner argue that CBA is a useful tool but should focus on overall well-being rather than on economic efficiency. Government agencies should recognize that the link between preferences and well-being is complicated, and that CBA should take some of those complexities into account. The authors discussed their findings at a September 20 book forum.

Matthew Adler
University of Pennsylvania

Traditionally, cost-benefit analysis measures economic efficiency. However, the economically efficient outcome does not necessarily maximize overall well-being. CBA should be modified to screen poorly informed preferences and make interpersonal welfare comparisons. CBA should be developed as a method--one of several--that in principle roughly tracks overall well-being rather than only economic efficiency.

Eric Posner
University of Chicago

One of the benefits of the CBA process is that it increases the transparency of the regulatory process. Legislators typically do not design regulations. Instead, specialized agencies design and implement them. Legislators may question the agency’s motivation for advocating a particular regulation, and an agency may focus on its particular area of expertise rather than on a broader measure of welfare. For example, the Environmental Protection Agency is likely to prioritize protecting the environment over other social goals. CBA provides agencies and legislators with an effective tool for communicating and understanding the proposed regulation.

Some outcomes cannot easily be monetized. Insofar that this is true, it constrains the utility of CBA. This critique, however, does not invalidate CBA. It merely highlights the point that CBA informs analysis, but does not necessarily offer the final word.

Christopher DeMuth
AEI

The Reagan administration promoted CBA not merely as a tool for improving the quality of regulation but also for reducing the quantity of regulations, arguing that the number and power of independent agencies had been growing tremendously. CBA addresses four current problems in the regulation process: 1) that agencies, rather than elected representatives, design many of the new regulations; 2) the increasing number of regulations and the associated compliance cost; 3) the obscurity of the rulemaking process; and 4) the unanticipated consequences of poorly conceived regulations. CBA encourages better and fewer rules and at the same time causes rule-making agencies to be more thoughtful about what they do propose.

Richard Revesz
New York University

The political climate is generally hostile towards regulation; this hostility limits discussion of CBA. CBA proponents in general want to see reduced state regulatory power. Groups interested in expanding the state’s regulatory power tend to view CBA as fundamentally flawed. Debate tends to focus on negative unintended consequences of regulation and rarely mentions positive unintended consequences.

AEI-Brookings Joint Center research assistant David Burk prepared this summary.