Monday, November 19, 2012

Weighing costs and benefits--a Carbon Based original

In deciding whether to undertake large projects, most managers and policymakers begin with a cost-benefit analysis, or CBA.  The advantage of CBA is its comparative simplicity. The choice with the largest net gains is the one we should select. This method shows a way forward using straightforward assumptions.

Unfortunately, when the first step in an important assessment is a CBA, policymakers have already closed off major alternatives, usually the ones that involve non-economic values.  And in a changing climate, a naive use of CBA creates a strong bias against, for example, cutting greenhouse gas emissions. 

Most economic theory struggles to explicitly addressing environmental goods and ills, which are not so readily translated into costs.  In fact, global warming is a market failure, perhaps the most significant market failure of all.

Most CBA users assume that the environment will remain stable over the life of the endeavor.  Yet climate change jeopardizes that stability. When farm productivity dropped because of environmental degradation during the Dust Bowl, recovery took decades.  A growing frequency of coastal property being inundated and disrupted by storm surges can dramatically alter the environmental picture --and therefore the economic outlook. But economists rarely call attention to these issues.

Environmental goods and ecosystem services are not readily quantified, and thus easy to take for granted in a business-dominated world. Insurance is one business mechanism that quantifies natural disaster costs to some degree, but the point of view is pretty limited and stylized. It's a distorted lens for getting the whole picture of climate change.

Risk is a blind spot for CBA, too. Even a mainstream economist such as Martin Weitzman notes that low probability but high impact scenarios tend to disappear from conventional CBA.  The destruction from Hurricane Sandy is a recent instance. Everyone knew that a hurricane hitting New Jersey and New York had a serious potential for tremendous losses. But long decades between storms lulled everyone, economists included, into postponing decisive action.  This is true even though the Bloomberg administration has actually done more than nearly any other American city. Sandy has shown how inadequate this effort was.

A more fundamental drawback is philosophical.  Cost-benefit analysis embodies norms that persistently steer us toward short-term ventures, consumption, and individualist standards -- the prevailing ideology of our era. The utilitarian bias of economists lead to scant regard to matters of morality, rights and justice. Personal relationships count for little, as does art, and even nature itself except where some natural feature has an obvious dollar equivalent.

In utilitarian style, CBA reduces values to mere preferences, which have to compete with a long list of stakeholder desires.  This group wants to preserve thriving wetlands, but other people want to buy houses that are "close to the land," and the alternatives compete in a CBA. If preserving ecosystem services imposes severe costs in the short term, then standard-issue property development will rule the day. It's left to environmentalists to object that, say, losing wetlands or species will result in overwhelming damage to property in a few years, or decades.

This raises another hitch for cost benefit analysis. CBA pays little attention to how the costs and benefits are distributed through time. By favoring the present generation, it allows those of us alive now to pass our knottiest difficulties on to our children and grandchildren. As I noted in an earlier post about the discount rate, economic theory struggles with how to coherently weigh the standing of later generations. Some economists openly declare that the present goods outweigh future utility -- which is why the future assigned a lower worth, using a discount rate. This may work well enough for financial investments, but it starts falling apart when ethics are involved.  And in climate change, ethics should be at the heart of the matter.

Dispensing with CBA altogether isn't possible, and it would be irresponsible to neglect the balance of costs and benefits of competing climate mitigation efforts. But when it comes to climate change, we have to be aware of the tool's limitations.

2 comments:

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