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Cost-benefit analysis: assessing efficiency

6 important questions on Cost-benefit analysis: assessing efficiency

The basic principle underlying CBA is the Kaldor-Hicks criterion:

A policy should be adopted only if those who will gain could fully compensate the losers and still be better of -> produce net benefits. Of course, distributional and other values my be relevant to the choice of good policy in any particular case. However, if the Kaldor-Hicks criterion is applied consistently, it is likely that the resulting portfolio of adopted polices would actually be Pareto improving.

Current policy provides the baseline against which the impacts of alternative policies should be compared. The identification and clear description of a current policy can be complicated in a number of respects:

Current policy in any policy area is usually a complex bundle of laws, rules and norms, which ones are relevant?
The impacts of current policy may change over time.
Policy changes at superior levels of government may be relevant to specifying "current policy" over time.

-> the net benefits that CBA reports for alternatives to current policy are actually incremental net benefits reduced relative to current policies.

Relevant experimental evidence is often not available for a number of reasons: the policy being assed is unique; it applies to units that cannot be reasonably randomized; or, because experiments are costly, none have been done and resources do not permit one to be done. Possibilities are:

Natural experiments, or situations in which fortuitous random assignment provides treatment and comparison groups for inferring impacts.
Absent the random assignment provided by true experiments, or the near-random assignment of natural experiments, reasonable comparison groups can nonetheless often be constructed for estimating impacts (difference-in-differences design)
When policies change the effective prices seen by consumers or producers of goods, it is reasonable to use predictions based on elasticities available in the economic literature.
When quantitive evidence to support predictions is unavailable, it may be necessary to rely on expert opinions.

The willingness to pay (WTP) is:

The sum of the maximum amounts that people would be willing to pay to obtain the increases in consumption of the good.

The willingness to accept (WTA) is:

The sum of the minimum amounts people would be willing to accept as compensation for the decreases in consumption of the good.

The present value of consumption os defined as:

The highest level of consumption that can be obtained the present period. We can write the present value for a cost (or benefit) accruing N in the future as periods as CN/(1+r)^N-1, were CN accrues ash the end of the Nth period. When doing BBA, we apply the discounting procedure by converting benefits and costs to present values.