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Cost-Benefit Analysis as a Tool for Policy
Alan Krupnick, PhD
Senior Fellow and Division Director
Resources for the Future
March 2, 2007
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
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
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?
Limitations
Only addresses efficiency under a utilitarian model
Discounting; growth and change Hard to monetize everything
Example of cost-effectiveness analysis
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.”
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
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
Figure 1. Brickyards, formal industrial facilities, and population in Ciudad Juárez
Annual net benefits of pollution control strategies for brick kilns and formal industrial facilities ($millions)
Brick kilns Iron foundry Chemical plant
Scenario
Natural gas
NMSU kilns
Relocation
No-burn days
Baseline
= no controlsa
Baseline = 50% U.S.
controlsb
Baseline
= no controlsa
Baseline = 50% U.S.
controlsb High 232.22 231.01 132.05 4.59 16.23 8.12 90.27 45.13 Mean 75.46 75.02 43.10 1.49 6.63 3.31 33.42 16.71 Low 9.12 9.08 5.20 0.17 1.42 0.71 5.94 2.97
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
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.
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
202
0
202
0
BA
UB
AU
Units:Gg/year
Economic SectorEconomic Sector PMPM1010
(C )(C )PMPM1010
(M)(M)PMPM2.52.5
( C)( C)PMPM2.52.5
(M)(M)SOSO22 NONOxx
Power 11.2 5.1 394.3 112.7
Industry 52.1 18.6 19.6 5.3 214.2 73.2
Domestic 5.2 3.6 16.8 5.4
Transport 31.1 16.7 32.0 276.6
Other 0.0 36.4 0.0 9.3 0.0 0.0
Total 99.699.6 55.055.0 45.045.0 14.614.6 657.2657.2 468.0468.0
Economic SectorEconomic Sector PMPM1010
(C )(C )PMPM1010
(M)(M)PMPM2.52.5
( C)( C)PMPM2.52.5
(M)(M)SOSO22 NONOxx
Power 40.6 18.1 214.1 80.4
Industry 49.2 31.5 18.3 9.0 199.9 71.1
Domestic 10.4 6.8 31.9 5.9
Transport 10.1 6.0 11.6 125.8
Other 7.0 18.0 5.9 4.6 1.0 2.5
Total 117.2117.2 49.549.5 55.155.1 13.713.7 458.4458.4 285.8285.8
199
51
995
Shanghai Urban Air Quality Management
Emission Estimates
in 1995in 1995 2020 BAU2020 BAU
120.8 121 121.2 121.4 121.6 121.8 122
30.8
31
31.2
31.4
31.6
31.8
32
5102030405060708090100110120
Units: g/m3 PM10
120.8 121 121.2 121.4 121.6 121.8 122
30.8
31
31.2
31.4
31.6
31.8
32
Shanghai Urban Air Quality Management
Annual Average PM10 Concentrations
Shanghai Urban Air Quality Management
2020 Control Scenarios
Power Power Sector Control Integrated Gasification Combined Cycle (IGCC) for coal
combustion
IndustrialIndustrial Sector Control 75% coal consumption reduction
Remaining 25% relocated to neighboring provinces
Scenario ==> C1 C2% Emission Reduction Industrial Power SectorSulfur 14 41NOx 6 13TSP 9 3PM10 12 4PM2.5 13 4
2020 Power Control2020 Power Control 2020 Industrial Control2020 Industrial Control
5102030405060708090100110120
Units: g/m3 PM10
120.8 121 121.2 121.4 121.6 121.8 122
30.8
31
31.2
31.4
31.6
31.8
32
120.8 121 121.2 121.4 121.6 121.8 122
30.8
31
31.2
31.4
31.6
31.8
32
Shanghai Urban Air Quality Management
Annual Average PM10 Concentrations
2020 Power Control2020 Power Control 2020 Industrial Control2020 Industrial ControlUnits: g/m3 PM10
120.8 121 121.2 121.4 121.6 121.8 122
30.8
31
31.2
31.4
31.6
31.8
32
0
5
10
15
20
25
30
120.8 121 121.2 121.4 121.6 121.8 122
30.8
31
31.2
31.4
31.6
31.8
32
Shanghai Urban Air Quality Management
Annual Average Reduction in 2020
Shanghai Urban Air Quality Management
Health Benefit Analysis
No. of cases avoidedNo. of cases avoided
Health EndpointHealth Endpoint Power Scenario Power Scenario
(no. of cases)(no. of cases)
Industrial ScenarioIndustrial Scenario
(no. of cases)(no. of cases)
Mortality 2,808 1,790
Hospital Visits 96,293 61,379
Emergency Rm Visits
48,506 30,918
Hospital Admissions
43,482 27,716
Chronic Bronchitis
1,753 1,117
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
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
STOP
Benefit Categories and Estimation Approaches
BENEFIT CATEGORY ESTIMATION APPROACHa
To Individuals Property Value (hedonic price)
Health
Mortality Wage Compensation, Stated Preference Averting Behavior, Human Capital (foregone earnings)
Morbidity (acute,
Chronic)
Stated Preference, Cost of Illness (medical, earnings, pain and suffering, avoidance), Averting Behavior
To Production/consumption
Crops/Forests/Fisheries Consumer plus producer surplus
Water-using industry Same
Municipal Water Supply Authorities
Opportunity Cost (alternative aquifer) Service Replacement (Municipal treatment, bottled water)
To Economic Assets
Materials (corrosion, soiling)
Replacement Cost, Service Values, household production function
Property Values Hedonic Price Models
To Environmental Assets
Use
Recreation Unit Day, Stated Preference , Property Value, Travel Cost, Random Utility, Hedonic Travel Cost
Other (visibility) Service Replacement Stated Preference Property Value
Passive Use (Nonuse)
Stated Preference Models
Key Unquantified BenefitsSOURCE: The Benefits and Costs of the Clean Air Act, 1990 to 2010, Tables 5-1 and 7-5 (p.53, 88)
Ozone Acidic Deposition
Mortality Commercial forest effects
Pulmonary effects Commercial freshwater fishing effects
Non-asthma emergency room visits Watershed damage (filtration, flood control)
Effects on recreation in terrestrial
Particulate Matter Reduced existence and options values
Neo-natal mortality
Pulmonary effects Nitrogen Deposition
Non-asthma emergency room visits Commercial forest effects
Commercial freshwater fishing effects
Carbon Monoxide Agriculture effects
Behavioral effects Watershed damage (filtration, flood control)
Other hospital admiss ions Effects on recreation in estuar ine ecosystems
Other cardiovascular effects Reduced existence and options values
Developmental effects
Tropospheric Ozone Exposure
Nitrogen Oxides Effects on recreation in terrestrial
Pulmonary effects Reduced existence and options values
Non-asthma emergency room visits
Sulfur Dioxide Hazardous Air Pollutants
Respiratory symptoms in non- All health effects
Pulmonary effects All ecological effects
Non-asthma emergency room visits
Table II-1: A sample of externalities assessed in studies of electricity generation. Health Forests
Mortality Morbidity
Materials
Crops Timber Other
Amenity 2/
Eco- Systems
PM10 Y Y Y n.e. n.e. n.e. Y n.e. SO2 1/ Y Y Y Y Y Y Y Y NOx 1/ Y Y Y Y Y NA n.e. Y Ozone Y Y Y Y Y NA n.e. n.e.
Mercury and other
heavy metals
NA NA n.e. n.e. n.e. n.e. n.e. ?
Water
pollutants4/
n.e. n.e. n.e. n.e. n.e. n.e. Y
Noise n.e. NA n.e. n.e. n.e. n.e. AM n.e.
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.
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
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
Other Issues in CBA
Equity integration Tax interaction effects
E.g., CBA and the Clean Air Act
Valuation of natural resources
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