A LEGAL FOUNDATION FOR BENEFIT-COST ANALYSIS: STANDING
IN LAW AND ECONOMICS
Richard O. Zerbe Jr.
I. INTRODUCTION
In State of Ohio v United States Department of Interior1, and in other cases2 the court has
recognized existence value.3 In Ohio court defined existence value as “the dollar amount
an individual is willing to pay although.4 he or she does not plan to use the resource,
either at present or in the future.5”
6
.”7 The Ohio the court said
1
880 F. 2nd 432, 279U.S. App.D.C. 109 (1989). This case defines contingent valuation
as including assessment of option and existence values (and cites 51 F.R. at 27,692,
27,721 for the definition of existence value).
2
For example, Ocean Conservancy v. Evans, 260 F.Supp.2d 1162 (M.D. Fla. 2003):
This case discusses existence value as being part of a balancing test for determining
environmental impact (and cites 50 C.F.R. 600.350(d) as listing existence value as a
factor) of fishing policies. National Audubon Society v. Hoffman, 132 F.3d 7 (2nd Cir.
1997): This case discusses the existence value of a brook to be considered as a factor
when creating an environmental impact statement. General Electric Co. v. U.S. Dept. of
Commerce, 128 F.3d 767 (D.C. Cir. 1997): This cites the Ohio case above with
approval, stating that existence values should be considered in a damage assessment.
Alaska Sport Fishing Ass'n v. Exxon Corp., 34 F.3d 769 (9th Cir. 1994): This case
states that an assessment of "natural resource damage" should consider existence value.
State of Utah by and Through Utah State Dept. of Health v. Kennecott Corp., 801
F.Supp. 553 (D. Utah 1992): This case contains a longer discussion of what existence
values are, and how they relate to natural resource damage claims. State of Idaho v.
Southern Refrigerated Transport Inc., 1991 WL 22479 (unpublished opinion): This
opinion has a section on existence value as related to fish. Texas Committee on Natural
Resources v. Berglund, 433 F. The Ocean Conservancy et al. v. Donald L. Evans et al.
Defendants, 260 F. Supp.2d 1162 (2003).
3
For earlier cases in which existence value is mentioned see Minnesota Public Interest
Research Group v. Earl V. Butz, 498 F. 2d 1314 (1974), Minnesota Public Interest
Research Group v. Earl Butz 401 F. Supp. 1276 (1975)and Texas Committee on
Natural Resources v. Bob Bergland et al. 433 F.Supp. 1235 (1977).
4
Supp. 1235 (E.D. Tex. 1977) Minnesota Public Interest Research Group v. Butz, 401
F. Supp. 1276 (D. Minn. 1975) ... and then on appeal at 498 F.2d 1314 (8th Cir. 1974).
5
Citing Final Rule, 51 Federal Reg. at 27,692,27,721. In Southern Refrigerated the
court defined existence value as “ the value the public places on the continuing
existence of that natural resource whether or not they will ever use the resource
1
“. . .we instruct DOI that its decision to limit the role of non-consumptive values,
such as option and existence values, in the calculation of use values rests on an
erroneous construction of that statue. . . . Option and existence values may
represent ‘passive’ use values but they nonetheless reflect utility derived by
humans from a resource and thus, prima facie, ought to be included in a damage
assessment.” (p.464)
The court goes on to note that existence values may be quite large, a finding that has been
substantiated elsewhere.8
The Ohio court notes that though lacking any interest in personally enjoying the
resource, an individual may attach some value to it because he or she may wish to have
the resource available for others to enjoy.9 Thus existence values reflect in part or whole
a type of moral sentiment. Moral sentiments are a concern for others.10 One may care
about others as a result of kinship, empathy, envy or hatred, or as a matter of justice.
Charity can be an expression of moral sentiment. One may care about the utility function
of others; this is called non-paternalistic altruism. One may care about others from one’s
own perspective, as when a parent requires a child to eat spinach when the child would
6
8
The law has also expanded the nature of injury required for standing to sue to include
enjoyment of nature and aesthetic harm. For example, in Sierra Club v. Robertson, 28
F.3d 753, 758 (8th Cir.1994), the Court held that “[c]omplaints of environmental and
aesthetic harms are sufficient to lay the basis for standing.” See also Mausolf v. Babbitt,
85 F.3d 1295 (8th Cir. 1996), citing Robertson with approval.
7
Op. cit at 2, p. ?
p 2. See Cross, Natural Resource Damage Valuation, 42 Vand. L. Rev. 269, 285-89 (1989).
Kristen Hite 16 Geo Invtl L. Rev. 763. Jonathan P. Vuotto, 22 B.U. Int. L. J. 219. (GIVE
FULL CITES)According to Johansson, it would not be uncommon for non-use values
such as bequest values and benevolence toward friends and relatives to account for 50 to
75 per cent of the total willingness to pay (WTP) for an environmental project. Per-Olov
Johansson, 1992. "Altruism in Cost-Benefit Analysis." Environmental and Resource
Economics 2: 605-613.
9
cite page (2 in westlaw)
Moral sentiments also include immoral sentiments as might arise when one wishes
harm to others.
10
2
rather not; this is called paternalistic altruism.
Existence value can reflect either
paternalistic or non-paternalistic altruism or both.
Yet the inclusion of moral sentiments in damage calculations and in benefit-cost
calculations in general is both disputed by many economists and is, arguably, at odds
with the underlying theory on which benefit-cost analysis (BCA) and efficiency
determination are based. The question is economics can be seen as one of economic
standing.11 Generally it is considered that all persons and all types of sentiments affected
have economic standing to determine economic efficiency, with one major exception.
The exception in theory is moral sentiments.
There is no good reason for this exception except for historical accident. Modest
changes to the foundations of BCA are, therefore, useful.
Modest but logical changes in
the requirements for BCA to account for standing issues can address most of the
criticisms of BCA. The view of BCA that disregards moral sentiments is the traditional
one. Yet it is not the only view; the newer view is more inclusive. A comparison of the
results of the application of these two views through a discussion of legal cases and the
consideration of criticisms of BCA, illustrates the superiority of the emerging view.
Although issues of economic and legal standing are relevant practically12 for
BCA, questions of both legal and economic standing are mainly foreign to the economic
11
Dale Whittington and Duncan MacRae, Jr., The Issue of Standing in Benefit-Cost
Analysis, 5(4) Jouranl of Policy Analysis and Management 665, (1986); William M.
Trumbull, Who Has Standing in Cost-Benefit Analysis? 9 (2) Journal of Policy Analysis
and Management 20, Richard O. Zerbe Jr. Comment: Does Benefit-Cost Analysis Stand
Alone? Rights and Standing, 10 (1) Journal of Policy Analysis and Management 96
(1991), RICHARD O. ZERBE, JR., ECONOMIC EFFICIENCY IN LAW AND ECONOMICS 181–
82 (2001)
12 The exception in practice is much wider. Municipal governments restrict the results of
their benefit-cost studies to effects on their own municipal revenues or on their own
residents, ignoring effects on non-residents who are thereby denied economic standing.
Federal benefit-cost studies routinely ignore effects on residents of foreign nations.
Economists usually omit giving values to outcomes associated with unattractive
emotions such as those of envy or jealousy, as well as to the sentiments of bad actors
such as a murderer, or a rapist, or, slightly more controversially, to the value of goods
in the hands of a thief. See Zerbe, Economic Efficiency.
3
theory underlying economic valuation.13 There is no good reason for the exclusion of
moral sentiments except for historical accident. The accident lies in the history of the
Kaldor-Hicks criterion.
II. HISTORY OF THE KALDOR-HICKS CRITERION
A. The Pareto Criterion
Although economists are themselves unclear about the core assumptions of BCA,
their understanding comes first from the form developed by Nicholas Kaldor. From a
consideration of its origins we derive what can reasonably be called the main view of it.
Kaldor built on the foundation provided by Vilfredo Pareto. Pareto (1896)
introduced a welfare criterion, the Pareto optimum, which became a foundational concept
in welfare theory. A Pareto optimum is a state of affairs such that no one can be made
better off without making someone else worse off.14 A change in the economy is said to
represent a Pareto improvement, or to be Pareto superior, if at least one person is made
better off as a result of the change and no person is made worse off.15 The Pareto criterion
is not useful for most practical purposes as it is similar to a rule for voting that requires a
unanimous vote for passage of a proposal.16 The practical substitute for the Pareto
criterion is the potential Pareto criterion, known also as the Kaldor-Hicks criterion.
13
See RICHARD O. ZERBE, JR., ECONOMIC EFFICIENCY IN LAW AND ECONOMICS 181–82
(2001) and Allen Bellas and Richard O. Zerbe Jr. A Primer for Benefit-Cost analysis,
Edward Elgar, 2005. See also RICHARD O. ZERBE, JR. & D. DIVELY, BENEFIT-COST
ANALYSIS IN THEORY AND PRACTICE, HARPER AND ROW 10 (1994).
14
In its strong from, Pareto efficiency states that state A is preferred to state B when state
A is ranked higher than state B for one person and all other persons rank A at least as
high as B. If the utility (well-being) of each individual is higher in state A, then state A
is preferred according to the weak form of Pareto efficiency. See ROBIN W. BOADWAY
& N. BRUCE, WELFARE ECONOMICS 62 (1984).
15
The attraction of the Pareto notion of efficiency is that it seems to eliminate
interpersonal comparisons of welfare. Some economists feel that “the inescapable
conclusion” is that if one precludes interpersonal comparisons of welfare the only
logically consistent foundation analysis is the Pareto principle.15 Its obvious limitation
is that it is not very policy relevant; few policies have no losers.15 This limitation
resulted in a search for a more applicable measure of welfare that continues to this day
and of which this article is a part.
16
See Duncan Black Jour. Of Law and Econ. About 1970=who shows that such a rule
did not work very well for the Polish legislature in ???
4
B. The Development of the Criterion
The Kaldor-Hicks criterion (KH) is the standard criterion for BCA. It arose out of
discussions among prominent British economists during the late 1930s in discussions
about repealing the Corn Laws.17 Before that time it was generally assumed that each
individual had an "equal capacity for enjoyment," and that gains and losses among
different individuals could be directly compared.18
By the late 1930s, however, leading
British economists, including the future Nobel Prize winner Sir John Hicks, were raising
questions about such policy prescriptions because they were seen to rest on interpersonal
comparisons of utility.19 Nicholas Kaldor provided a solution while acknowledging
Robbins’ point about the inability to make interpersonal utility comparisons on any
scientific basis; he suggested it could be made irrelevant.20 Kaldor suggested that where
a policy led to an increase in aggregate real income it was desirable as,
17
These include: Robbins, Hicks, Kaldor, and Harrod, all writing in THE ECONOMIC
JOURNAL. See generally Lionel Robbins, Interpersonal Comparisons of Utility: A
Comment, 48 ECON. J. 635 (1938); John R. Hicks, The Foundations of Welfare
Economics, 49 ECON. J. 696 (1939); Nicholas Kaldor, Welfare Propositions in
Economics and Interpersonal Comparisons of Utility, 49 ECON. J. 549 (1939); Roy F.
Harrod, Scope and Method of Economics, 48 ECON. J. 383 (1938).
18
See EZRA J. MISHAN, INTRODUCTION TO NORMATIVE ECONOMICS 120–21 (1981); Peter
Hammond, Welfare Economics, in ISSUES IN CONTEMPORARY MICROECONOMICS AND
WELFARE 406 (George Feiwel ed., 1985). For example, Harrod argued that the net
social benefit from a policy could be established on the assumption that the individuals
affected were equal in their capacity to enjoy income. That is, an improvement can be
assumed by looking at changes in income as long as, in modern terminology, the
marginal utility of income with respect to income changes are the same for all
individuals. See Harrod, supra note 31, at 387. Harrod used this reasoning to justify the
1846 repeal of the English Corn Laws, a classic test case for British economists. In
response, Lionel Robbins pointed out that interpersonal comparisons of utility couldn't
rest on a scientific foundation since utility cannot be measured, and that the justification
for such comparisons is more ethical than scientific.18 Harrod complained that in the
absence of comparability of utility of different individuals, “the economist as an advisor
is completely stultified.” See Harrod, supra note 31, at 396–97.
19
See Hicks, supra note 31, at 670. This debate about whether or not prescriptions of
economics were scientific is paralleled by the 1980s debate, mostly in the legal
literature, about the normative foundations of wealth maximization. For example, see 8
Hofstra Law Review, volumes 3 and 4 (1980). The 1980s debate was haunted, and
confounded, by the issues that I consider in this article.
20
See Kaldor, supra note 31, at 549–550; Robbins, supra note 31, at 640.
5
[T]he economist’s case for the policy is quite unaffected by the question of the
comparability of individual satisfaction, since in all such cases it is possible to
make everybody better off than before, or at any rate to make some people better
off without making anybody worse off.21
According to Kaldor, a project is desirable if the money measure of gains exceeds a
money measure of losses. Kaldor goes on to note that whether such compensation of
losers from a policy change should take place “is a political question on which the
economist, qua economist, could hardly pronounce an opinion.”22 Hicks, perhaps the
most prominent economist of the time, accepted the Kaldor approach.23
The approach
then became known as the Kaldor-Hicks (KH) criterion. The KH criterion is the usual
BCA criterion.24
C. The Separation of Efficiency and Equity
Originally equity was separated from efficiency on grounds that this was
necessary to prevent interpersonal comparisons of income. It was thought that equity
issues are avoided by the assumption that each dollar of benefit or cost is treated the same
21
Kaldor, supra note 31, at 549–550.
Kaldor, supra note 21, at 550. It was thought that politicians or non-economists should
make judgments and decisions about income distribution effects.
23
See Hicks, supra note 21, at 671.
22
24
As envisioned by Kaldor, non-pecuniary effects were to be included in benefit-cost
analysis. He noted, supra note 21 at ____?
"An increase in the money value of the national income (given prices) is
not, however, necessarily a sufficient indication of this condition [the potential
compensation test or Kaldor criterion] being fulfilled: for individuals might, as a
result of a certain political action, sustain loses of a non-pecuniary kind, e.g., if
workers derive satisfaction from their particular kind of work, and are obliged to
change their employment, something more than their previous level of money
income will be necessary to secure their previous level of enjoyment; and the
same applies in cases where individuals feel that the carrying out of the policy
involves an interference with their individual freedom. Only if the increase in
total income is sufficient to compensate for such losses and still leave something
over to the rest of the community, can the project be said to be 'justified' without
resort to interpersonal comparisons."
Clearly it is sentiments that are to be valued and not just objects.
6
regardless of who received it. 25 In technical terms, it is assumed that the marginal utility
of income is the same across all individuals. Kaldor proposed that decision makers
address sentiments regarding equity, outside the purview of BCA.26 The change in
aggregate gains was to be the measure of efficiency, so that there was a separation of
effects into those of efficiency and distribution.27 Kaldor endorsed the procedure adopted
by Pigou, which Kaldor describes as “dividing welfare effects into two parts: the first
relating to production, and the second to distribution.”28
Hicks agreed with this separation and noted that “if measures making for
efficiency are to have a fair chance, it is extremely desirable that they should be freed
from distributive complication as much as possible.”29 To Hicks it would be
“rather a dreadful thing” to have to accept the view that welfare analysis was
unscientific. If it were, its conclusions would “… depend on the scale of social
values held by a particular investigator. Such conclusions can possess no validity.
. . ; one’s welfare economics will inevitably be different according as one is a
liberal, or a socialist, a nationalist or an internationalist, a christian [sic] or a
pagan.”30
This separation of efficiency and equity has remained the common, though not universal,
basis of normative analysis to this day. The more modern justifications for the separation
25
See John Chipman & James C. Moore, The New Welfare Economics 1939–1974, in
INTERNATIONAL ECONOMIC REVIEW 19(3), at 578 (1978); Nicholas Kaldor, Welfare
Propositions in Economics and Interpersonal Comparisons of Utility, 49 ECON. J. 549,
551 (1939). Certainly Mishan was aware that questions of distribution belonged to
welfare economics and recognized that the separation was useful, since there was less
agreement about the income distribution issues. See Ezra J. Mishan, The Principle of
Compensation Reconsidered, 60 J. POLITICAL ECON. 312 (1952).
26
It cannot be said that this second assumption of equal marginal utility of income avoids
interpersonal comparisons; indeed it embraces them in a very particular way: all people
are treated equally in terms of the value they place on changes in income.
27
Kaldor, supra note 31, at 551.
28
The eagerness of economists to separate considerations of efficiency from those of
distribution arose from a desire to put economics on a firm base as a policy instrument.
Kaldor suggests, “the economist should not be concerned with prescriptions at all . . .
For, it is quite impossible to decide on economic grounds what particular pattern of
income-distribution maximizes social welfare.” Kaldor, supra note 31, at 551; see also
A.C. PIGOU, THE ECONOMICS OF WELFARE (4th ed. 1932).
29
Hicks, supra note 31, at 712.
30
Hicks, supra note 31, at 696.
7
are that changes in the income distribution are usually better affected through macro
policy rather than at the level of project analysis.31
This defense, however, leaves
unaddressed matters of particular equities or equities for particular peoples or sentiments
attached to particular projects that can not be handled by macro policy; equity is more
than a matter of just the general income distribution, and justice is particular as well as
general.32
D. Wealth Maximization
The benefit-cost approach also forms the core of a substantial portion of
normative thinking about the law associated with law and economics, usually under the
rubric of wealth maximization,33 a term created by Richard Posner.34 This term appears to
31
See generally MITCHELL A. POLINSKY, AN INTRODUCTION TO LAW AND ECONOMICS 5
(2d ed. 1989).
32
I note some rather random examples from reputable sources. Boardman, Greenberg,
Vining, and Weimer note that, “Strict use of the Kaldor-Hicks test means that
information on how benefits and costs are distributed among groups is ignored in
decision making.” See DAVID L. WEIMER & A.R. VINING, POLICY ANALYSIS:
CONCEPTS AND PRACTICE 412 (2d ed. 1992). Friedman also notes, “Some analysts
would like to ignore equity altogether and use the compensation test as the decisive
analytic test. . . .a second rationale for relying on the compensation test is the belief that
concern for equity is simply unfounded.” See LEE FRIEDMAN, MICROECONOMIC
POLICY ANALYSIS 170 (1984). Additionally, Posner notes that wealth maximization is
simply the Kaldor-Hicks tests and that wealth maximization ignores distributional
effects. See RICHARD A. POSNER, ECONOMIC ANALYSIS OF LAW 13 (3d ed. 1986);
Richard A. Posner, The Justice of Economics, 15 J. PUB. FIN. & PUB. CHOICE 23, 132–
33 (1987). McCloskey incorrectly contends that the consumer surplus measure of
social happiness is the same as the national income measure. See DONALD
MCCLOSKEY, THE APPLIED THEORY OF PRICE 229 (1982). Of course, the national
income measure contains no measure of income distribution.
33
"Wealth maximization . . . is achieved when goods and other resources are in the hands
of those who value them most, and someone values a good more only if he is both
willing and able to pay more in money (or in the equivalent of money) to have it."
Richard A. Posner, Wealth Maximization Revisited, 2 NOTRE DAME J.L. ETHICS & PUB.
POL'Y 85, 86–89 (1985). Wealth maximization on a technical level appears
approximately identical with mainstream benefit-cost analysis, though this identity has
not always been borne out in the use of the term. Posner sometimes uses wealth
maximization to mean KH but at other times seems to use it to mean an increase in
GDP or the maximization of monetary wealth ignoring psychic satisfaction unlike KH.
Id. at 88–89. In this regard, Posner uses it to support his tastes in favor of a work ethic
and the importance of production as compared with consumption. See Richard A.
8
be synonymous with KH, except that Posner would accommodate the value of altruism,
where this is expressed by a willingness to pay for it.35
E. Summary of the Mainstream View
The above discussion and set of characteristics outlined above partly define what can
reasonably be called the mainstream view of BCA, a view based on KH. A full spelling
out of the assumptions of the mainstream view of BCA is reasonably characterized by:
Posner, The Justice of Economics, 15 J. PUB. FINANCE & PUB. CHOICE 19–20 (1987).
This is, however, a different meaning from KH. See RICHARD A. POSNER, ECONOMIC
ANALYSIS OF LAW 12–13 (3d ed. 1986). The fact that economic efficiency is not the
same as national income is also shown by Harberger. See Arnold Harberger, Three
Basic Postulates for Applied Welfare Economics: An Interpretive Essay, 9 J. ECON. LIT.
785, 785 (1971). Economic efficiency is the opposite of common but narrow concepts,
such as workplace efficiency in which people are to be managed as machines. See
generally ROBERT KANIGEL`, THE ONE BEST WAY: FREDRICK WINSLOW TAYLOR AND
THE ENIGMA OF EFFICIENCY (1997).
34
The differences between mainstream benefit-cost analysis and wealth maximization
then are the latter’s willingness to accommodate altruism at least in the restrictive
condition when it benefits both donors and non-donors, its greater political and policy
assertiveness of wealth maximization and the differences in their histories; Posner’s
wealth maximization is explicitly normative while KH was attempting to be ‘scientific’
35
A strong theory of wealth maximization is said to have three crucial features. First,
wealth maximization is an aggregate concept. Id. at 251. That is, it is more concerned
with societal well-being than with individual welfare. For example, a wealth
maximizer is not concerned with the distribution of wealth among citizens, and any
coerced payment to affect distribution is presumed unproductive. See, e.g., Richard A.
Posner, Wealth Maximization Revisited, 2 NOTRE DAME J.L. ETHICS & PUB. POL'Y 85,
103 (1985) ("To the wealth maximizer, altruism is neither good nor bad; but given that
it exists, there is a legitimate if limited role for public wealth redistribution."). Second,
to the extent that altruism exists within society, public efforts to reduce poverty may be
justified because poverty reduction will benefit both non-donors and donors. Id.
Finally, questions of need and desires are irrelevant. Posner, supra note 6, at 61 ("The
individual who would like very much to have some good but is unwilling or unable to
pay anything for it – perhaps because he is destitute – does not value the good in the
sense in which I am using the term 'value.'"). Note that this is not the same as including
altruism in a benefit-cost analysis as its inclusion may change the sign of a benefit-cost
analysis yet the altruistic component might not benefit both parties as when the transfer
from altruists is greater than they would prefer. For example, a transfer of $100 from
altruists to users might cost altruists a net $90 due to an altruistic gain of $10, yet the
altruists have a net loss but the project has net aggregate gains of $10.
9
(1) the use of the willingness to pay (WTP) for gains and for losses;36 (2) a reliance on
potential compensation tests so that a project is KH efficient only when it passes a
potential compensation test; (3) an emphasis on efficiency that is separated from equity;
(4) an assumption that a dollar is to be treated the same regardless who receives it, so that
a dollar is assumed to have the same value to each person (equal and constant marginal
utility of income); (5) a recognition and inclusion of non-pecuniary effects; (6) the
omission of values represented by moral sentiments; (7) a reliance on externalities and
market failure to determine where BCA might be useful in making corrections; (8) an
assumption that transactions costs are zero37; (9) the treatment of BCA as a mechanism to
provide the answer rather then an approach proving information as part of an ongoing
discussion; and (10) the inclusion of wealth maximization as congruent with mainstream
BCA. The mainstream view of BCA is well shown in practice by the BCA’s of the
Federal developmental agencies, and well illustrated in theory by the analysis of
Lothrup.38
Because even mainstream BCA is incompletely defined, my characterization of it
is necessarily inadequate as it makes definite what is in fact vague.
However, it is a
useful starting point from which to consider other possibilities.
Also, this
characterization of the mainstream view is convenient as it is fairly close to the view
critics of BCA hold, although the critics' view is narrower than actual practice suggests.
36
Although it is recognized that the willingness to accept is the correct measure for
losses, traditional opinion has held that there is little difference between the two
measures so that WTP may be used in practice.
37
For an explanation of why this leads to difficulties See RONALD H. COASE, THE FIRM,
THE MARKET, AND THE LAW 5 (1988). Coase’s view is that the major failing of welfare
economics lies in its assumption of zero transactions costs. By transactions costs I mean
the costs necessary to transfer, establish and maintain property rights (See Douglas
Allen, What are Transaction Costs?, in RESEARCH IN LAW & ECONOMICS 14, at 4
(Zerbe & Goldberg eds., 1991).)
38
Robert C. Lothrup, “The Misplaced Role of Cost-Benefit Analysis in Columbia Basis
Fishery, Environmental Law 16: 517 (1986). Lothrup assumes BCA is unrelated to law
and to legal rights, that the willingness to pay is the correct measure for both gains and
losses and that moral and ethical values are excluded. He apparaently arrives at this
view in part from looking at actual BCA studies.
10
III. ANOTHER VIEW: THE KHM APPROACH
A. Definition
The mainstream views of BCA, in which moral sentiments and the tie of BCA to
legal rights are ignored, are not the only views of BCA. An alternative view is implicit by
a variety of work. An alternative view I call KHM-- Kaldor-Hicks-Moral. KHM builds
on KH.39 The characteristics of KHM relevant here are: first, the grant of standing to all
goods for which there is a willingness to pay or to accept; second, the recognition that the
WTP and willingness to accept (WTA) can differ materially; 40 and third, the explicit
recognition that BCA rests on the law and fourth the abandonment of the potential
compensation criterion 41
The KHM view shares with KH the use of WTP and WTA, but grounds their use
in the legal-psychological framework. As with KH it gives each person the same weight
and includes non-pecuniary effects. Unlike KH it includes all goods for which there is a
WTP, including equity goods and those represented by moral sentiments. Unlike KH it
39
This view is essentially identical to the view that has been presented elsewhere as the
KHZ view.
40
Richard Posner has communicated to me in private correspondence that he believes
there are no differences in the WTP and WTA measures when transactions costs are
zero. This view runs into the face of a mountain of contrary theoretical and empirical
evidence. It applies more strongly to market goods for which the market price will
often measure both the WTP and WTA as one can both buy and sell at this price.
However, even here it does not hold, particularly for expensive goods as the WTP is
much more severely constrained by income than the WTA. Moreover this view is
grossly inaccurate for important non-priced goods including many environmental
amenities.
41
More formally the characteristics are the following: (1) the use of the WTP for gains
and the WTA for losses, (2) the use of WTP and WTA from a legal status quo, (3) the
exclusion of gains or losses that are legally illegitimate, as with goods held by the thief,
or that violate well accepted moral principles, (4) a recognition and inclusion of nonpecuniary effects, (5) an efficiency test that is passed when and only when the
aggregate benefits exceed aggregate losses (no use of the potential compensation test),
(6) the inclusion of all goods, including moral sentiments, as economic goods as long as
there is a WTP from them, (7) an assumption of equal marginal utility of income so
that each person is treated the same, (8) the absence of reliance on market failure or
externalities to justify the use of benefit-cost analysis, (9) the inclusion of transactions
costs of operating a project, and (10) an understanding that the role of benefit-cost
analysis is to provide information to the decision process and not to provide the answer.
I do not explore all of these assumptions here.
11
excludes values that are illegal or widely considered immoral where the exclusion is
justified by an underlying benefit-cost test itself. Unlike KH, it makes no use of potential
compensation tests. And, unlike KH, it does not rely on market failure to indicate where
BCA will be best used. Most importantly, it rests on a different concept of the role of
BCA as one of providing information to a decision process rather than one of providing
the answer. It sees BCA as providing information about choices. In what follows I will
explain and provide justification for those attributes of KHM that differ from KH.
This KHM approach codifies what has to a considerable extent been occurring in
practice.42 Economists have shown how and why WTP and WTA need to be embedded
in legal rights.43 The nexus between legal rights and economic measurement has become
apparent and is mentioned in relevant literature. Many have argued for the inclusion of
equity effects, including those on income distribution, and suggested various schemes to
accomplish it,44 and some have applied these suggestions to actual policy issues.45
Recently economists have found it important to understand the role of social and cultural
factors like altruism and “warm glow.”46 Finally since Coase’s work in 1960, the focus
has been shifting from market failure and externalities to transactions costs.47 Thus
economists’ view of BCA is not represented simply by the mainstream version of KH.
B. Measurement of Benefits and Costs Under KHM
42
See ZERBE, supra note 2, at 15–27.
See Jack L. Knetsch, Assumptions, Behavior Findings, and Policy Analysis, 14 J. POL'Y
ANALYSIS & MGMT. 1, 68–78 (1995).
44
See Arnold Harberger, On the Use of Distributional Weights in Social Cost-Benefit
Analysis, in J. POL. ECON. 86, at 87 (1978); Robert E. Willig & Elizabeth E. Bailey, The
Economic Gradient Method, 69 AM. ECON. REV. 2, 96–101 (1979); Richard O. Zerbe,
Jr., An Integration of Equity and Efficiency, 73 WASH. L. REV. 349, 361 (1998).
45
For example, see Richard O. Zerbe, Jr. & Sunny Knott, The Merger of Superior
Propane and ICG Propane: A Case Study (working paper on file with author) (2004).
46
Andreoni, supra note 98, at 891.
47
An extensive flowering of the market failure concept has occurred in the field of law.
The number of law review articles and court decisions using the concept run into the
thousands, with 239 references turned up by a search of law review articles for the
twelve months between June 1995 and June 1996 alone. Similarly, court decisions
referring to market failure and to externalities are made with great frequency The
bankruptcy of this approach is shown in Richard O. Zerbe, Jr. & H. McCurdy, The
Failure of Market Failure, 18 J. POL'Y ANALYSIS & MGMT. 4, 558–578 (1999).
43
12
Benefits and costs are measured, respectively, by the WTP and by the WTA.48
The WTP reflects the amount that someone who does not have a good would be willing
to pay to buy it; it is the maximum amount of money one would give up to buy some
good or service, or would pay to avoid harm.49 The WTA reflects the amount that
someone who has the good would accept to sell it; it is the minimum amount of money
one would accept to forgo some good, or to bear some harm. The benefits from a project
may be either gains (WTP) or losses restored (WTA). The costs of a project may be
either a loss (WTA) or a gain forgone (WTP).
Both the benefits and the costs are the
sum of the appropriate WTP and WTA measures. Thus, the relation of benefits and costs
to the WTP and the WTA may be measured in the following manner:
Benefits: The sum of the WTPs for changes that are seen as gains and of the
WTAs for changes that are seen as restoration of losses.
Costs: The sum of the WTAs for changes that are seen as losses and of the WTPs
for changes that are seen as forgone gains.
The justification for adopting these methods of measurement is that they correspond with
the psychological sense of gains and losses.50 The measurements are summarized in table
1 below.51
48
See Zerbe & Dively, supra note 107 .
These are non-technical definitions and, as such, are not wholly accurate. The
compensating variation (CV) is the sum of money that can be taken away or given to
leave one as well off as one was before the economic change. The equivalent variation
(EV) is money taken or given that leaves one as well off as after the economic change.
See Zerbe & Dively, supra note 107, at Ch. 5, for a derivation of these concepts in
terms of indifference curves.
50
See Daniel Kahneman & Jack Knetsch, Anomalies: The Endowment Effect, Loss
Aversion, and Status Quo Bias, in J. ECON. PERSPECTIVES 5(1), at 193–206 (1991).
51
The difference between benefits and costs is simply their sign: positive for benefits and
negative for costs. Thus, without loss of accuracy, costs can be counted as negative
benefits and benefits can be counted as negative costs.
49
13
Table 1. The Measurement of Benefits and Costs in Terms of Gains and Losses
The Compensating Variation (KH
Measure)
Benefits
GAIN: WTP–the sum of CVs for a positive
change–is finite.
LOSS RESTORED: WTA-the sum of CVs
for a loss restored-could be infinite A
Costs
LOSS: WTA–the sum of CVs for a
negative change–could be infinite.
GAIN FORGONE: the sum of CVs is
finite.
The economic worth of a good to an individual is determined by the desire for it, whether
a gain or a loss is involved, the income and wealth of the person, and the uniqueness of
the good. These features are all captured by the WTP and WTA measures. Whether or
not one has something or seeks to gain it is fundamental to the choice of WTP or WTA
measure. Whether or not one believes he has or doesn’t have a good will be in turn
determined by legal rights. That is, the definition of having or not having a good is
determined by legal rights.
C. KHM And Legal Rights:
1. Rights and Standing
Legal rights provide a guide to social preferences. Legal rights largely determine
which sentiments should be denied standing.52 Economic theory takes for granted, far
more extensively than either economists or the critics explicitly recognize, the normative
52
Compare William Trumbull, Who Has Standing in Cost-Benefit Analysis?, 9 J. POL'Y
ANALYSIS & MGMT. 201, 218 (1990), with Richard O. Zerbe, Jr., Comment: Does
Benefit-Cost Analysis Stand Alone? Rights and Standing, 10 J. POL'Y ANALYSIS &
MGMT. 96, 105 (1991).
14
force of established rights and obligations.53 For some time it has been recognized that
the policy and welfare implications of any substantive economic analysis depend upon
the legitimacy of the property rights that underlie the relevant supply and demand
functions.54 Heyne goes on to note that, “because this legitimacy depends on existing
law. . ., the foundations of economics may be said to rest in the law.”55 It is fair to say,
however, that economists have not always, or even usually, been clear on this point. And
in this unclarity, the connection between normative analysis and existing institutions gets
lost.
Mishan notes that an economist might as well flip a coin when trying to decide
between using the CV measure (which uses the WTP for benefits and the WTA for costs)
and the EV measure (which uses the WTA for benefits and the WTP for costs).56 Indeed
as Knetsch notes,57 the conventional assumption has been that the WTP and WTA
measures will usually lead to similar valuations – “under conventional assumptions
economists expect that the difference between them will be small in most cases.”58
KHM is explicit about this connection that is usually shadowy. The connection of
KHM to the legal system adds to KH a grounding in legal rights, in psychological
expectations and a rationale for choosing between the WTP and WTA.59 The choice
between WTP and WTA is based on legal ownership and its connection to psychological
expectations. Benefits and costs are to be measured as changes from the status quo.
Gains from the status quo are measured by the WTP, losses by the WTA. 60 The status
53
See Paul Heyne, The Foundations of Law and Economics, in RESEARCH IN LAW AND
ECONOMICS 56 (Richard O. Zerbe, Jr. ed., 1988).
54
Id. at 53–71.
55
Id. at 11.
56
EZRA J. MISHAN, COST-BENEFIT ANALYSIS 183 (3d ed. 1982).
57
See Jack L. Knetsch, Experimental Tests of the Endowment Effect and the Coase
Theorem, 98 J. POL. ECON. 6 (1990).
58
See REPORT OF THE UNITED STATES ENVIRONMENTAL PROTECTION AGENCY 60 (2000);
see also Robert Willig, Consumer Surplus Without Apology, in AM. ECON. REV. 66(4),
at 589–597 (1976).
59
KH recognizes the potential relevance of both the WTP and the WTA measures, but it
does not provide a methodology for choosing between WTA and WTP in measuring an
individual’s interest in a good.
60
See Daniel Kahneman & Amos Tversky, Prospect Theory: An Analysis of Decision
Under Uncertainty, in ECONOMETRICA 47(2), at 263–290 (1979); Daniel Kahneman &
15
quo position is determined by one’s expectations of what one has, and legal rights mainly
define these expectations.61
From a legal perspective, the use of the WTA to measure losses and the WTP to
measure gains rests on a normative decision to recognize ownership. Gains and losses are
to be measured from a psychological reference point, which stems from one’s beliefs
about ownership. Legal rights largely determine one's beliefs about ownership. The
WTP measure assumes that one does not have psychological or legal ownership of the
good, and asks how much one would pay to obtain it. The WTA measure assumes that
one owns the good, and asks how much one would accept to sell it.62
Ownership establishes a reference point, from which losses are to be calculated
by the WTA, and gains by the WTP. In a sense, this has long been noted. Atiyah (1979)
pointed out that Hume and Adam Smith both said that expectations arising out of rights
of property deserved greater protection than expectations in regard to something that had
never been possessed. To deprive somebody of something which he merely expects to
R. Thaler, Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias, in J.
ECON. PERSPECTIVES 5(1), at 193–206 (1991); Jack L. Knetsch, Assumptions, Behavior
Findings, and Policy Analysis, in J. POL'Y ANALYSIS & MGMT. 14(1), at 68–78 (1995).
61
The older generation of economists, say those writing before the 1940s, well
recognized the complexity of the notion of a standard of living, of measuring economic
value and the role of human perceptions. Hewins, for example, providing a description of
economics for the 1911 edition of Encyclopedia Britannica, notes:
The concept of the standard of life involves also some estimate of the efforts and
sacrifices people are prepared to make to obtain it; of their ideas and character; of
the relative strength of the different motives which usually determine their
conduct. . . . it is doubtful whether the most complete investigation in terms of
money (q.v.) would ever enable us to include all the elements of the standard of
life in a money estimate See ENCYCLOPEDIA BRITANNICA 900 (1911).
This insight was lost in subsequent developments until the 1970s when economists were
confronted with the unpleasant fact that many of their predictions about human behavior
under uncertainty were incorrect. Kahneman and Tversky were instrumental in
clarifying gains and losses as psychological concepts as well as measures of economic
value. See Kahneman & Tversky, supra note 129, at 263. The psychological issues they
addressed in the 1970s were not ones of individual idiosyncrasies, but rather concerned
the way most people actually thought, valued, and made decisions.
62
See Daniel Levy & D. Friedman, The Revenge of the Redwoods? Reconsidering
Property Rights and the Economic Allocation of Natural Resources, 61 U. CHI. L. REV.
493 (1994).
16
receive is a less serious wrong, deserving of less protection, than to deprive somebody of
the expectation of continuing to hold something which he already possesses.63
The law has long recognized that it is more serious to stop an owner from
conducting an ongoing activity than to prohibit the owner from undertaking the same
activity if he has not yet begun it. The currently fashionable expression of this may be
found in Justice Brennan’s phrase in Penn. Central Trans. Co. v. City of New York,64 that
a restriction is more likely to cause a taking if it destroys “investment backed
expectations.”
One’s sense of psychological ownership will usually conform to one’s knowledge
of legal ownership. Most people feel that they have a moral right to what they legally
own, and do not feel that they have the moral right to something they do not own. For
most cases, then, the law will determine whether the WTP or WTA will be used even if
the economic standard is psychological ownership. The common assumption is that a
choice based on assigned legal entitlements will usually be correct, but it is correct
because of the correspondence between the legal and psychological states; it is not
correct as a matter of economic principle, and it is economically incorrect in important
cases. Levy and Friedman incorrectly assert that “the determination of the conceptually
appropriate form of CV65 query is a matter of property rights, not economics or
psychology.”66 They imply, that where the law and a psychological sense of ownership
establish different reference points, the law ought to govern.67 This is incorrect from the
logic of BCA. It is, of course, true that the law will be the major determinant of
psychological reference points. This is different, however, from saying, as Levy and
Friedman imply, that the law ought to govern.68 Economic efficiency in the KHM form
would recognize the psychological status quo as primary and change ownership to
conform to it. As a matter of practice the relevant psychological reference point cannot
63
See P.S. ATIYAH, THE RISE AND FALL OF FREEDOM OF CONTRACT 5 (1979).
Penn. Central Trans. Co. v. City of New York, 438 U.S. 104 (1978). I would like to
thank Professor William B. Stoebuck for this reference.
65
The authors use the term “CV query” in reference to questionnaire studies. “CV” here
stands for “contingent valuation,” not compensating variation.
66
See Levy & Friedman, supra note 131, at 509.
67
See id.
68
See id.
64
17
be just that of the individual but rather of society generally. In so far as the law embodies
the general understanding, Levy and Friedman are correct that the law should govern.
Because the underlying basis is the general psychological reference point, however,
where this differs from the law, it furnishes a guide for further development as indeed it
has done with the development of common law.69
Even though BCA is necessarily rooted in the legal rights and the sentiments of
society, many critics find these wanting. One set of criticisms concerns the fact that the
pattern of benefits and costs will reflect the pattern of wealth. Those with greater wealth
and income will have a greater WTP or WTA, other things being equal. 70 Just as people
with more income or wealth can purchase more goods, so also will the values for projects
reflect the incomes of the individuals affected. Some critics see this as a major problem.71
They criticize BCA for failing to provide what the legal and political systems have failed
to provide: a pattern of rights that the critics find acceptable. This misunderstands the
69
This approach makes clear the irrelevancy of the critical legal studies objection to
benefit-cost analysis as Heyne has shown. See Paul Heyne, The Foundations of Law and
Economics, in RESEARCH IN LAW AND ECONOMICS 53–71 (Richard O. Zerbe, Jr. ed.,
1988). The KHM approach shows the failure of the Critical Legal Studies argument that
the measurement of benefits and costs is incoherent. Put briefly the Critical Legal
Studies argument is that we cannot use the concept of efficiency without endorsing some
concept of property rights, from which it is seen to follow that the concept of efficiency
cannot be used to resolve disputes over property rights without begging question.
Benefit-cost analysis, as does the law, takes the existing structure of rights as extant. But
there are disputes that reflect uncertainty about some small portions of these rights.
benefit-cost analysis merely furnishes information relevant to the legal decision about the
allocation of such a right. Take a simple case. A change in technology makes valuable
rights to the radio wave spectrum which has hitherto been unowned. No party has a
superior claim. The assignment of the right to a particular party will be a gain. Gains in
economic analysis are to be measured by the WTP. The WTP will in turn be partly by
the existing pattern of wealth which rests on the existing system of rights. Economic
analysis suggests auctioning off the right. The right in general should go to that party
who would pay the most for it if transactions costs were zero. Cases in which conflicting
prior claims exist raise more difficult questions but these are answerable and elsewhere I
have provided answers. See Zerbe, supra.
70
Sagoff sees voting superior in this regard. I have argued elsewhere that it is not
superior just different. See Zerbe, supra note 138; see also Richard O. Zerbe, Jr., An
Integration of Equity and Efficiency, 73 WASH. L. REV. 349, 361 (1998).
71
See Jules Coleman, Efficiency, Utility, and Wealth Maximization, 8 HOFSTRA L. REV.
509, 551 (1980); Markovits, supra note 25.
18
role of BCA.
It asks what result or new pattern of rights would express public
preferences given the existing pattern of rights and sentiments. Benefit-cost is not meant
to, and given its structure cannot, rise above the extant rights and sentiments of society.
It affects rights only at the margin.72 Thus in any BCA wealth will play a role in the
outcome. The recognition of the existing pattern of legal wealth is simply consistent with
the KHM recognition of existing legal rights. The objection is, at base, not to BCA but to
the existing pattern of rights. KHM provides a mechanism for changing this pattern by
the recognition of sentiments toward greater equity.
Consider a project to locate a municipal incinerator in one of two neighborhoods,
one rich and one poor.
Neither neighborhood wants it.
The amount required to
hypothetically compensate the persons in the richer neighborhood will be more than for
those in the poorer neighborhood: the WTA payment to put up with the incinerator by the
rich will be greater than the WTA payment by the poor. In addition, the land for the
incinerator will generally be cheaper in the poorer neighborhood. Thus the benefit-cost
criterion will lead to the placement of a NIMBY (not in my backyard) in a poorer rather
than a richer neighborhood. The result can be changed, however, by changing existing
rights. For example, suppose that each neighborhood had a right to reject the incinerator.
The authority would then have to purchase the right from the neighborhood so that there
would be actual rather than hypothetical compensation. The result would still be the
placement of the NIMBY in the poorer neighborhood, as its WTA would be less than the
WTA of the richer neighborhood. The poorer neighborhood, however, would be better
off, assuming informed consent and honest agency; it would now be somewhat richer.
Otherwise, if the poorer neighborhood is not compensated, it deteriorates and is even
more likely to lose out in any BCA in the location of the next NIMBY. Under KHM,
moral sentiments are included so that moral objections to locating NIMBY’s in poorer
neighborhood without compensation are included in the BCA.
Thus such location
without compensation is less likely to the degree BCA has influence.
2. The Choice of WTP or WTA.
72
See Heyne, supra note 138.
19
Until recently, it was thought that the choice between WTP and WTA made little
difference, aside from exceptional cases, and that the source of the difference was solely
income effects.73 However, in important circumstances the WTP and WTA will differ
greatly. 74 They can differ because of income effects, substitution effects, and loss
aversion.75 That is, the difference will be greater when the good is expensive, or when it
is unique, or when there is a psychological attachment to it. First, when one owns an
expensive good, one’s wealth is greater, so that the money measure of the value of a thing
is also greater (income effects). That is, one values money less, relative to an additional
amount of the good. Second, when one owns a unique good, there are no substitutes for
it, so that the money required to induce one to sell it is greater than one could pay to buy
it. Thus, the Sierra Club might require a large amount to sell the Grand Canyon if it
owned it because of its unique nature, but could pay only a much smaller amount to gain
it if it did not own it. Third, psychological attachment exists for most goods, so that even
for quite ordinary goods a difference can arise (loss aversion). Losses, then, are felt more
than gains, so that the value function, which reflects the value of changes from the
psychological reference point, is steeper for losses than for gains.76
Knetsch notes widely reported findings from a comprehensive array of replicated
survey, experimental, and field studies indicate that people systematically value, instead
of equivalence, losses (measured by their minimum WTA) more than they value
73
See Willig, supra note 127, at 589.
See Levy & Friedman, supra note 131; Donald J. Coursey & W.D. Schulze, The
Disparity Between Willingness to Accept and Willingness to Pay Measures of Value, in
QUART. J. ECON. 102(3), at 679–690 (1987); Kahneman & Thaler, supra note 129.
75
See Michael W. Hanneman, Willingness to Pay and Willingness to Accept: How Much
Can They Differ?, in AM. ECON. REV. 61, at 635 (1991). In important cases there will be
no difference in the WTP and the WTA. A supplier may value a good as a purely
commercial good, a good whose value is just the present value of its income stream and
thus for which there is no divergence between the WTP and the WTA. I shall call the
supplier of a purely commercial good a producer.
74
76
See Kahneman & Tversky, supra note 129. There is some complexity here that is being
passed over. It will be efficient to assign the right to the right person initially, of
course, as this may save transactions costs. In Part IV, I argue that this means, in effect,
holding an auction. But in our static world, the efficient rule for assigning rights would
already be in place. For more detail, see ROBERT H. FRANK, MICROECONOMICS AND
BEHAVIOR 256 (4th ed. 2000).
20
otherwise commensurate gains (measured by their maximum WTP). In a widely cited
study of changes in risks associated with the consumer use of pesticides, people were
found to demand nearly nine times more to accept a small increase in risk of injury than
they were willing to pay for a commensurate decrease in this risk.77 Horowitz and
McConnell, in a recent review of 45 tests of the valuation difference, found the mean
ratio of WTA values over WTP values to be over seven. 78 Further, these differences “do
not appear to be experimental artefacts,” and they are, as one would expect, generally
larger for non-market goods (such as the value of a statistical life) than ordinary private
goods.79
Researchers have demonstrated repeatedly that WTA questionnaires generate
values from three to nineteen times greater than those elicited by WTP questionnaires. 80
These differences are not found just in questionnaires, but also in experiments using a
wide array of methods, and they are found, as well, in many cases of real decisions. 81 Nor
are these differences only empirically driven; they are based on the psychology of
valuation. Thus the legal and psychological foundation for the choice of WTP and WTA
is important.
D. KHM and Moral Sentiments
1. The Transformation Process
An important example of the transformation process from KH to KHM is found in
the economics literature dealing with moral sentiments. The impetus to explain real world
behavior requires an interest in moral sentiments, and is reflected in recent interest in
donations to charity, funding of public goods, and environmental valuation. Economists
have been interested in the fact that private donations to public goods occur at a level far
77
See Kip Viscusi & Wesley A. Magat, An Investigation of the Rationality of Consumer
Valuations of Multiple Health Risks, in RAND J. ECON. 18(4), at 465–479 (1987).
78
See John K. Horowitz & K.E. McConnell, A Review of WTA/WTP Studies, in J.
ENVIRONMENTAL ECON. & MGMT. 44, at 426-47 (2002).
79
Id. at 442.
80
See Levy & Friedman, supra note 131, at 493, 495 n.6; see also Coursey & Schulze,
supra note 143.
81
See, e.g., Knetsch, supra note 129.
21
higher than expected due to free riding possibilities.82 For many economists it has
become important, as Andreoni notes, “to understand the role of social and cultural
factors like altruism and “warm glow.””83 Similarly environmental economics’
recognition of the importance of non-use values is intrinsically bound up with issues of
moral sentiments. Respondents to surveys and to experiments show a willingness to pay
reflecting moral sentiments for the existence of environmental amenities that will be used
by people other than the respondents.
More generally, the particular sentiments and the way they attach to goods is still
a work in progress. Moral sentiments fall into the economists' categories of impure or
pure altruism. Impure altruism exists when respondents are concerned with both public
and personal giving. Purely altruistic preferences are those that occur when an
individual’s utility increases with the group payoff, holding constant the individual
payoff.84 Warm glow preferences are those that arise when the act of contributing,
independent of group payoff, increases a subject’s utility by a fixed amount.85 That is,
warm glow preferences arise from the act of giving itself. It seems certain that the trend
toward the inclusion of moral sentiments in welfare analysis, including BCA, will
continue. They are simply too important; and if they are being examined in the
experimental literature, they will, in time, also come to be incorporated into the policy
and benefit-cost literature.
82
See James Andreoni, Warm-Glow Versus Cold-Prickle: The Effects of Positive and
Negative Framing on Cooperation in Experiments, 110 QUARTERLY JOURNAL OF
ECONOMICS 1, 1–21 (1995); James Andreoni, Why Free Ride? Strategies and Learning
in Public Goods Experiments, 37 J. PUB. ECON. 3, 291-304 (1988); Mark R. Isaac &
James M. Walker, The Assurance Problem in a Laboratory Market, in PUBLIC CHOICE
62, at 217-236 (1989); Mark R. Isaac & James M. Walker, Group Size Effects in Public
Goods Provision: The Voluntary Contribution Mechanism, 103 QUARTERLY JOURNAL
OF ECONOMICS 179 (1988).
83
Andreoni, supra note 98, at 891.
84
See Thomas R. Palfrey & Jeffrey E. Prisbrey, Anomalous Behavior in Public Goods
Experiments: How Much and Why?, 87 AM. ECON. REV. 829, 846 (1997); see also
Thomas R. Palfrey & Jeffrey E. Prisbrey, Altruism, Reputation, and Noise in Linear
Public Goods Experiments, 61 J. PUB. ECON. 409, 427 (1996).
85
Susan M. Chilton & W. George Hutchinson, Valuing the Recreational Benefits From
the Creation of Nature Reserves in Irish Forests (Working Papers 1999.11).
22
Modern formulations of the foundations of BCA tend to be more inclusive than
KH with respect to goods such as moral sentiments and thus closer to KHM. For
example, modern foundational statements about BCA do not contemplate missing values.
The philosopher Talbot Page expresses a common view.
You are asked to compare two worlds. The first is the status quo: the world the
way it is now. The second is identical with the status quo except for a change
brought about by the project. In the comparison, you take into account the
ramifications of the project, differences in income to you and others, differences
in habitat, and so on; but except for the changes brought on by the project, the two
worlds are the same.
Suppose that you value the first world more highly than the second. Then
you are asked what is the minimum you need to be compensated so that you
would value the change (with the compensation) just as much as the status quo. If
you value the world with the project more than the status quo, then you are asked
how big a payment you could make in the changed world (with the project) so
that you would just value equally the status quo. . . . The economic criterion says
that if the sum of all the compensations (to those who would lose by the project)
is less than the sum of the equilibrating payments (from the gains from the
project), then the change from the status quo is worth making.86
KHM includes all changes related to well being would include moral sentiments, equity
and non-pecuniary effects, and in general all goods for which there is a willingness to
pay. Indeed this inclusiveness is captured in modern theoretical statements. The KH
compensation test is formalized in modern literature as the proposition that:
state a is preferable to another state if, in state a, it is hypothetically possible to
undertake costless (lump-sum) redistribution and achieve an allocation that is
superior to the other state according to the Pareto criterion.87
In less formal language, KH is passed if in the new state, costless redistributions
are possible that would create a state Pareto superior to the original state.88:
86
Talbot Page, Environmental Existentialism, in ECOSYSTEM HEALTH 102 (Robert
Contanza, Bryan Norton and Benjamin Haskel eds., 1992).
87
ROBIN W. BOADWAY & N. BRUCE, WELFARE ECONOMICS 96 (1984).
23
There are no restrictions on the goods that are to be considered in these formulations so
that equity goods and moral sentiments are not excluded from consideration. In modern
language the goal of BCA is to produce a social ordering and modern literature indicates
the inclusivity of this concept. As Boadway and Bruce note:
A social ordering permits one to compare all states of the world and rank each one
as ‘ better than,’ ‘worse than,’ or ‘equally good as’ every other. Ideally we would
like the (social) ordering to be complete (so that all states could be ranked or
ordered) and transitive . . . . The term ‘state of the world’ can be interpreted as a
complete description of a possible state of an economy including economic
characteristics, political conditions such as freedom of speech and nondiscrimination, physical characteristics such as the weather, and so on.89
Clearly these formulations do not contemplate missing values. Among the goods of
value are human concerns for equity and in general the welfare of others. Thus the recent
interest issues of moral sentiments as well as the modern formulations of the foundations
of BCA are consistent with KHM.
2. Missing Values
No criticism of BCA is as widespread as the one that, even in principle, it is
missing values.90 The criticisms arise from the original separation of efficiency and
equity in the development of BCA. Among the values listed as missing are personal
values such as integrity,91 consideration of effects on the income distribution and equity
88
Similarly the Scitovsky additional criterion is stated more formally as:
“. . . state a is preferable to another state if, in the other state, it is not possible,
hypothetically, to carry out lump-sum redistribution so that everyone could be made as
well off as in state a. This additional criterion requires that there are no redistributions
in the original state that would produce a situation Pareto superior to the new state.
Boadway & Bruce, supra note 103, at 97. They mistakenly call this the Hicks criterion.
89
BOADWAY & BRUCE, supra note 103, at 1.
90
See ANDERSON, supra note 19, at 194; JOHN C. SMART & BERNARD WILLIAMS,
UTILITARIANISM: FOR AND AGAINST 97–98 (1973); Martha Nussbaum, The Costs of
Tragedy: Some Moral Limits of Cost-Benefit Analysis, 29 J. LEG. STUD. 1005, 1032
(2000) (counseling against cost-benefit analysis on the ground that the results reached
may be subject to "serious moral wrongdoing").
91
See SMART & WILLIAMS, supra note 48, at 98; Kelman, supra note 16, at 35.
Williams (Smart and Williams, 1967, p. 97f) considers the case of George: George, who
has taken his Ph.D. in chemistry, finds it extremely difficult to get a job. An older
24
and fairness in general,92 community values and non-commodity values, that is, in
general moral values.93
No criticism of KH has been more widespread and trenchant than that it ignores
distributional effects.94 The views of the former Solicitor General of the United States,
Charles Fried, are representative. He sees the economic analysis of rights as using a
concept of efficiency that is removed from distributional questions.95 He believes that
economic analysis does not consider whether the distribution is fair or just. He then
concludes from this that the fact that a given outcome is efficient does not give it “any
privileged claim to our approbation.”96
Moreover, the separation of equity and efficiency does not perform the job for
which it was created. As Chipman and Moore in their trenchant survey of post-1939
welfare economics conclude:
chemist who knows about the situation says that he can get George a decently paid job in
a certain laboratory, which pursues research into chemical and biological warfare. George
says that he cannot accept this, because he is opposed to chemical and biological warfare.
The older man replies that George’s refusal is not going to make the job or the laboratory
go away; what is more, he happens to know that if George refuses to take the job, it will
certainly go to a contemporary of George’s who is not inhibited by any such scruples, and
who is likely, if appointed, to push along the research with greater zeal than George
would. What should George do?
Williams argues that under a utilitarian analysis, George must accept the job,
since it improves the position of his family, and advances the work more slowly (a
desirable aim. Kelman extends this sort of analysis to benefit-cost on the grounds that it is
derivative of utilitarianism.
But this line of attack does not work as benefit-cost analysis does not rest on
utilitarianism of this sort, as Posner, Nussbaum and Zerbe has noted. See RICHARD A.
POSNER, THE ECONOMICS OF JUSTICE 55–60 (1981); Zerbe, supra note 50; Nussbaum,
supra note 21. Rather benefit-cost analysis is a pragmatic approach whose justification
must lie in its usefulness; economist understand this and this is why they have paid little
attention to this sort of criticism.
92
See FRIED, supra note 22, at 16.
See FRIED, supra note 22, at 15; see generally Derek Parfit, An Attack on the Social
Discount Rate, in VALUES AND PUBLIC POLICY (Claudia Mills ed., 1992).
94
See Richard O. Zerbe, Jr., Comment: Does Benefit-Cost Analysis Stand Alone? Rights
and Standing, in J. POL'Y ANALYSIS & MGMT. 10(1), at 96–105 (1991).
95
See CHARLES FRIED, RIGHT AND WRONG 93 (1978).
96
Id. at 94.
93
25
“Judged in relation to its basic objective of enabling economists to make welfare
prescriptions without having to make value judgments and, in particular
interpersonal comparisons of utility, the New Welfare Economics must be
considered a failure.”97
This can hardly be a surprise. Any principle for aggregating preferences necessarily will
make interpersonal comparisons. There is then no justification to be found in the desire
to avoid interpersonal comparisons for separating efficiency and equity.
The mainstream view extends the prohibition on considering equity as part of
BCA to exclude moral sentiments generally. The recent though controversial use of
existence values for environmental goods has brought the issue of the place of moral
sentiments in BCA into sharp relief, but no consensus as to their proper place exists.98
The possibilities of including moral sentiments have also opened up the issue of the
inclusion of what might be called immoral sentiments such as envy and malice. Such
inclusion is objected to as contaminating BCA.99
3. Missing Values and KHM
The particular criticisms directed at the values implicit in BCA apply with less
force, or are in many cases vitiated when applied to KHM. For example, we have seen
that the most fundamental criticism of BCA is that it is missing values. KHM defines
economic goods as any good for which there is a willingness to pay. Thus sentiments
about equity, income distribution and fairness are included in KHM to the extent they are
represented by willingness to pay. The extension of BCA to include moral sentiments is
a logical extension of the use of willingness to pay (or to accept) to measure value. The
extension obviates extensive criticism of benefit-cost and in fact gives a measure that
better expresses actual preferences. Consider the following sources of missing values:
a. Tragic Choices as Missing Values
97
See John Chipman & James C. Moore, The New Welfare Economics 1939–1974, in
INT'L ECON. REVIEW 19(3), at 548 (1978).
98
For example, in the Tennessee Valley Authority analysis of the Tellico dam, the value
of sacred burial grounds to the Cherokee was ignored. This might, however, be more
properly regarded as a failure of the legal system to specify rights in accord with
reasonable psychological expectations. See infra Part V.
99
See John Quiggen, On the Optimal Design of Lotteries, 58 ECONOMICA 1,2 (1991).
26
Nussbaum’s variant of the missing values criticism focuses on tragic choices. Her
critique finds that BCA “does not help us either pose or answer the tragic question.” By
tragic question she means one in which there are moral objections to any course of action.
As Nussbaum advances the argument, BCA is unable to weigh the moral values involved;
her examples concern duty. This is an objection to BCA not as a matter of principle but
of practice; that is, it is an empirical objection. Nussbaum argues that “too much reliance
on cost-benefit analysis . . . can therefore distract us from an issue of major importance
(the tragic element in choice), making us believe that we have only one question on our
hands, when in fact we have at least two.”100 This criticism has weight against KH since
it ignores moral values and thus may misdirect attention away from crucial moral values.
It has little weight against KHM. Consider Brodie’s life of Sir Richard Burton, which
furnishes an example of tragic choice.
Richard Burton while working as a civil servant in Kind, Pakistan, discovered the
practice in which wealthy criminals condemned to death by British justice would buy
replacements to be hung in their stead. This replacement buying was purely voluntary.
Burton interviewed one pauper “Baudal” who had agreed to be executed for a murder he
had not committed and asked him why he had agreed to do this.
“Sain,” came the answer, “I have been a pauper all my life. My belly is empty.
My wife and children are half starved. This is fate, but it is beyond my patience. I
got two hundred fifty rupees. With fifty I will buy rich food and fill myself before
going out of the world. The rest I will leave to my family. What better can I do,
Sain?”101
This dilemma is tragic both to the Baudal and to the British system of justice. To forbid
the exchange between the merchant and the Baudal is tragic as is allowing it. To forbid
the exchange between the Baudal and the wealthy criminal is to forbid a wealthmaximizing voluntary exchange, and more to the point, reduce the ability of the Baudal
to provide for his family.
But the parties are not limited to the Baudal and the merchant, so we cannot say
the exchange is Pareto superior. One should also consider the whole system of British
100
101
See Nussbaum, supra note 21.
See FAWN M. BRODIE, THE DEVIL DRIVES 63–64 (1967).
27
justice and the moral weight which others attach to it. The obvious choice is clear:
uphold British law. Once third parties, including the British justice system, are brought
into the matter, however, it is clear that there is a non-obvious question that one might
address. How can the condition of Baudals be relieved so that they need not face such
tragic choices? One might imagine a morally superior alternative to this voluntary
market exchange, that, while not Pareto superior, creates wealth for the Baudal obviating
the necessity of tragic choice both for the Baudal and for British justice.102
The problem here is not with BCA but with the distribution of rights and of
wealth. We can say that BCA is of limited help in considering these matters, not because
it does not pose or answer the tragic question, contrary to Nussbaum, but because, where
there are disagreements about fundamental rights, the status quo will govern. BCA is not
the best language to discuss issues of fundamental rights not only because it has difficulty
in measuring the subtleties of moral distinctions, but more fundamentally because it only
provides an answer to fundamental disagreements dictated by the status quo. Nussbaum’s
criticism echoes that of Dorwkin and Kelman who complain that BCA does not always
tell us the right thing to do. Who would expect that it would?
b. Bad Values: Can Benefit-cost Analysis Make the Necessary Exclusions?
Including moral sentiments in KHM potentially opens up the possibility of
including bad sentiments. Quiggin notes, "the unattractive policy implications . . . may be
illustrated by the case when some individuals have sectarian preferences, characterized
by altruism toward members of their own racial or religious group and zero or negative
altruistic WTP for others."103 This issue, sometimes referred to as the issue of bad utility,
is discussed extensively in the philosophic and legal literature.104 Critics are concerned
that BCA will count “bad utility” along with the good.
102
Notice that once the existence of a morally preferred alternative is made known, the
original seemingly Pareto superior alternative is no longer Pareto superior, since those
who prefer the morally superior alternative would not consent, and would be harmed by
the choice of the original alternative.
103
John Quiggin, Altruism, Total Valuation and Benefit-Cost Analysis, in AUSTRALIAN
ECONOMIC PAPERS 36(68), at 151 (1997).
104
See generally PHILIP MIROWSKI, MORE HEAT THAN LIGHT: ECONOMICS AS SOCIAL
PHYSICS, PHYSICS AS NATURE'S ECONOMICS (1991); ROBERT H. NELSON & MAX L.
28
Martha Nussbaum makes the general point.105 Willingness to pay does not make
the necessary exclusionary moves, e.g., omitting preferences based on ignorance or haste,
preferences deformed by malice, envy, resentment or fear, and preferences that reflect
adaptation to a bad state of affairs. Indeed Lothrop goes so far as to claim that BCA
ignores legal and moral rights.106 First, BCA makes those exclusionary moves grounded
in law.
Since 1986 and certainly since 1991, BCA has incorporated the concept of
“standing” that determines whether one’s values are to count in an economic analysis.107
On this basis I have argued that the thief’s valuation of his stolen goods is not to count,
since theft is illegal.108 The illegality of theft may be taken, in a benefit-cost context, to
reflect a social judgment that the value of goods to the thief do not count. So that if one
were in fact to conduct a BCA of society generally this would be the finding. This
understanding clarifies the problem of the thief.
The Thief
Derek sues Amartya for stealing his book. He asks for return of the book and
costs. Derek is poor and Amartya is rich. Derek loves the book but Amartya cares
only a little for it. Derek would have sold the book to Amartya for $2 had he had
it. Amartya values it at $3. A benefit-cost analyst hired by Amartya testifies at
trial that the value of the book is greater for Amartya than for Derek in the sense
that Amartya’s willingness to pay exceeds Derek’s willingness to accept. So, the
BCA suggests that wealth is maximized if the book goes to Amartya. The court
finds, however, that Amartya did, in fact, steal the book, and awards the book the
Derek, the BCA notwithstanding.
STACKHOUSE, ECONOMICS AS RELIGION: FROM SAMUELSON TO CHICAGO AND BEYOND
(2003).
105
See Nussbaum, supra note 20.
106
Lothrop notes that “. . . cost-benefit analysis is generally blind to legal rights…” See
Robert C. Lothrup, The Misplaced Role of Cost-Benefit Analysis in Columbia Basin
Fishery, in ENVIRONMENTAL LAW 16, at 517 (1986).
107
See Dale Whittington & Duncan MacRae, Jr., Judgments About Who Has Standing in
Cost Benefit Analysis: A Comment, in J. POL'Y ANALYSIS & MGMT. 9(4), at 536–47
(1986); Richard O. Zerbe, Jr., Comment: Does Benefit-cost Analysis Stand Alone?
Rights and Standing, in J. POL'Y ANALYSIS & MGMT. 10(1), at 96–105 (1991).
108
See Zerbe, supra note 201; see also Zerbe, supra note 181.
29
KHM does not, however, award the book to Derek as Posner and i have made
clear because its value to Amartya in the role of thief is counted as zero. Note that were
we considering the issue of whether theft should be illegal, Amartya’s values would
count fully. Consider a real world analog to the Derek-Amartya problem that arose when
I was consulting with the Federal Trade Commission (FTC). A major national utility
collected payments one month in advance. When customers discontinued service, the
company kept the credit balances unless explicitly requested by the customer to return
them. The result was that the company in this way retained several million dollars. The
company agreed to stop this practice. The issue that arose was whether they should be
required to return the existing credit balances.
Any BCA approach (ignoring any
deterrence effects) that gives the thief’s valuation of the stolen goods standing will result
in the conclusion that the company should keep the funds as there are transactions costs
incurred in their return.
The KHM answer to both the Derek-Amaryta problem and the FTC’s problem is
that the thief can have no claim to the funds or to the book; the value of stolen goods in
the hands of the thief is zero. Such a conclusion is derived from the legal status of theft.
As we have seen, any well-grounded BCA not only does not ignore such rights but is
grounded in them. The exclusionary moves it makes are also grounded in law and
sentiment; these moves rely on existing rights as embodied by the legal system, which
shows that certain values have no standing.
Although KHM makes the necessary exclusionary moves, it cannot, however, do
this on its own.109 The values calculated in BCA necessarily and by definition rests on
the sentiments of society so that they are dependent on the prior determination of rights
particularly as embodied in law.110
By extension one can reject values of envy or malice. Neither furnishes a cause
of action at law and neither should be the source of gain in BCA. Of course there will
arise instances in which one’s values are at odds with society’s or in which society’s
109
See Zerbe, supra note 181; Richard O. Zerbe, Jr., Is Cost-Benefit Analysis Legal?
Three Rules, in J. POL'Y ANALYSIS & MGMT. 17(3), at 419–456 (1998).
110
Id. at 419.
30
values are in conflict with another’s.111 Yet it would be worse for the analyst or the
philosopher who should substitute her own values or those of say Quiggen and Nussbaum
for those of society more generally in undertaking a BCA whose values purport to
reasonably represent those of society. BCA cannot do what philosophy has not provided,
namely rest on a set of widely accepted ethical principles that stand apart from social
sentiments. As Nussbaum notes, such a set of principles is needed but does not yet
exist.112
Just as legal rights determine whether one has standing so that a thief has no
standing to have his value of the stolen goods count even in BCA, so also will reasonably
clear public sentiment about value determine whether envy or malice or such sentiments
count. Sen provides the example of Ali modified here as follows:113
Ali is a successful shopkeeper who has built up a good business in London since
emigrating from East Africa. He is hated by a group of racists, and a particular gang of
them, the bashers, would like to beat him up. The WTP of the bashers, because there are
so many of them, exceeds the WTA of Ali to avoid bashing. In most cases Ali’s WTA
will be infinite so that the example is not allowed by KH but, as we have seen in the
example of the Baudal, not in all cases. Yet allowing the bashing of Ali does not pass
KHM as the bashers have no standing to have their desire to bash counted; it is against
the law. In the context of BCA itself, the law can be taken as the results of a prior BCA
that justifies making assault and battery illegal. Were we to consider the question of
whether battery should be illegal, in a BCA framework the sentiments of the bashers
should count. It is not unreasonable to extend this sort of clear case to instances in which
envy or malice or similar values are ignored because there is a social decision that they
should be, that is, to ignore such values would itself pass KHM. The fact is that I have
never encountered an instance in which values of envy or malice were counted in a BCA.
111
See Steven Kelman, Cost-Benefit Analysis: An Ethical Critique, in REGULATION 5(1),
at 33–40 (1981).
112
See Nussbaum, supra note 21.
113
See Amartya Sen, Rationality and Social Choice, in AM. ECON. REV. 85(1), at 1–24
(1995).
31
c .Community and Commodity Values
That BCA must properly rest on community values is recognized by Mark Sagoff
and Elizabeth Anderson, who devote a good deal of effort to distinguishing between our
preferences as consumers and our choices as citizens.114 They maintain that BCA treats
goods such as health, safety, and environmental quality as mere commodities, and that
BCA assumes that the public nature of some instances of these goods is merely a
technical fact about them, and not itself a valued quality. The possibility that national
parks or public safety might be valued as shared goods does not enter into their
evaluations. Anderson sees BCA as assuming that the preferences people express in
private consumer choices should be those used in making public choices, as if the
valuations people make as consumers exhaust their concerns.115
Anderson and Sagoff adopt the mainstream view of BCA and take it to assume
that BCA measures people’s valuations of non-commodity goods only as “they are
privately appropriated, exclusively enjoyed goods.”116 For example, Anderson finds that
the opportunity to earn a living is “a need and a responsibility.”117 She finds, therefore,
that using wage premiums for risk as the basis to estimate the cash values people place on
their lives is incorrect, because these premiums also reflect the risks people feel obliged
to accept in order to discharge their responsibilities. That is, using wage premium data to
measure the cost of risk results is a miscalculation, because what is being measured also
includes the values of responsibility and duty, which are not included in the wage
premium. Sagoff uses child labor laws as an example where choices based on narrow,
market consequentialist ends, may differ from our choice as citizens.118 These views of
Anderson and Sagoff are based on their assumption about the “commodity fetishism of
welfare economics: the assumption that people intrinsically care only about exclusively
114
See ELIZABETH ANDERSON, VALUE IN ETHICS AND ECONOMICS 189 (1993); MARK
SAGOFF, THE ECONOMY OF THE EARTH 10 (1988).
115
ANDERSON, supra note 73, at 193–194.
116
ANDERSON, supra note 73, at 193.
117
ANDERSON, supra note 73, at 199.
118
SAGOFF, supra note 73, at 25.
32
appropriated goods, and that they care about their relationships with others only for their
instrumental value in maximizing private consumption.”119
These criticisms do not apply to KHM. The general rule in BCA even of a KH
variety is that those values are relevant to the decision. That is, if there are community
questions it is community values that are relevant, not just values as private purchasers.
KH, however, is unable to deal adequately with this issue because of its exclusion of
equity values. No such limitation applies to KHM so that KHM is taken to incorporate
the suggestions of Anderson and Sagoff.
4. Market Values
Values used in BCA are not only said to be missing but also degraded. They are
degraded by putting a price on them as if the value of life could or should be monetized
or that one would, for example, put a monetary value on friendship or preventing the
abuse of one child. In general, critics of BCA object to what they see as the limitations of
market values, which are embedded in normative economic analysis; in this view,
economics is concerned only with market values.120 The view of BCA as expressing only
market values is consistent with both the mainstream view and with wealth
maximization. This view unnecessarily limits BCA.
The purpose of BCA, however, is not to monetize values, but rather to provide a
ranking of choices expressed in monetary terms. In the language of BCA, the market is a
metaphor for a mechanism for determining value. Market values, in the language of the
metaphor, need not represent “mere commodities” but instead represent choices.
Choices, of course, exist outside a commodity-type market. Goods that are not purchased
with money may nevertheless be ranked in monetary terms.
The distinction is crucial. For instance, the value that I place on a friendship is
not one that is or that I wish was determined in a commodity market. When I harm my
119
ANDERSON, supra note 73, at 203.
The criticism is elegantly expressed by Lumley: “[I]f a single discount rate is applied
to environmental resources, the implications of non-monetary aspects of those resources
are often ignored for these intangible factors are the ends to which money is not a
means.” See Sarah Lumley, The Environmental and the Ethics of Discounting: An
Empirical Analysis, in ECOLOGICAL ECON. 20, at 72 (1996).
120
33
friend by canceling a lunch appointment at the last minute in order to attend a lecture of
particular interest,121 I do not compensate nor offer to compensate my friend by offering a
sum of money. Yet I might perform other acts – perhaps acts with a monetary value –
which are consistent with friendship, to show its value to me. I might offer to drive him
when he needs a lift, I might give him a present, I might agree to participate in an activity
he enjoys. So when I talk about the value of friendship and its value in the “market for
friendship,” I am merely calling attention to the fact that friendship has a value. More
importantly, in missing the lunch to attend the lecture, I am making a choice, and the role
of BCA is to reflect that choice. The value of friendship, in principle, has been neither
missed nor undervalued by BCA. The legitimate concern is whether presenting values in
monetary terms, as BCA does, distorts their discussion. There is no evidence that it does
but this remains a possibility.
5. Utility as a Missing Value
Economists continue to treat utility as a measure of happiness or well being. This
is at best unscientific as utility cannot be measured. At worst it leads to confusion. This
consideration of utility as a thing rather than purely as a tool for modeling choice has
caused trouble for the consideration of moral choice in economics. Thus we find
economists arguing that “. . . a moral commitment to others---regardless of the
consequences to one’s own well being –challenges neoclassical theory” 122. Sen carries
forward this view of utility as a thing in noting that
“commitment is counterpreferential choice, . . . Commitment . . . drives a wedge
between personal choice and personal welfare and much of traditional welfare
relies on the identity of the two.”123 .
That is by regarding utility as a thing choice becomes different from utility. Such
treatment is a holdover from utilititarianism. No good reason has yet been advanced for
treating utility as a thing.
121
See CASS SUNSTEIN, FREE MARKETS AND SOCIAL JUSTICE 73–74 (1997). Sunstein
comments that “we may believe that goods are comparable without believing that they
are commensurable.” Id. at 81. I would say further that the use of monetary figures to
rank preferences can be done even where the choices are not made with respect to a
monetized frame of reference. We don’t think of friendships in terms of money, but we
make trade-offs with respect to them. The problem of the effect that using the discount
rate has on future generations and the problem of estimating losses are endemic to any
decision process that uses information.
122
Steven Edwards, Rethinking Existence Values, Land Economics 68(1), 120 (1992)
123
Amartya Sen, Rational Fools: A Critque of the Behavioral Foundations of Economic
Theory, Philosophy and Public Affairs 6: 317, 328-29 (1977).
34
Utility is better regarded as a mechanical device for modeling problems of
choice. When we say that we are maximizing utility we should mean only that we are
predicting or explaining choice.
The consequence of treating utility as a thing has been to attempt to determine
existence values separate from moral considerations.
IV. KHM AND KH COMPARED
Because it provides better information, KHM will give different and better
answers from KH or wealth maximization. The inclusion of non-paternalistic altruistic
sentiments can affect both the sign and the magnitude of net benefits. Where the value of
moral sentiments is not zero, their inclusion will affect the magnitude of the net present
value (NPV). This magnitude is relevant to policy. When inclusion of moral sentiments
serves to increase an already positive NPV, it can affect the ranking of projects. In
comparing projects, one chooses the project with the highest NPV.
Because it is
desirable to know the magnitude of NPV, inclusion of moral sentiments is desirable.
Consider the following examples.
A. The KH Potential Compensation Test
Excluding moral sentiments can lead to inconsistencies within KH. Suppose that
group A are altruists and group U are non-altruistic users. U’s benefits from the project
are $100. A’s benefits from a project are $40 + 1.5 times U's net surplus. The project has
costs of $160 which are borne entirely by A. Then A’s has costs of $160 and benefits of
$40 + (1.5)($100) = $190. Both parties gain. Yet the project would fail KH. Thus KH
can reject a project that passes a potential compensation test. More strikingly, in this
example, KH rejects the project even though it is a Pareto improvement as both A and U
gain. Following KH therefore leads us afoul of what may be the most fundamental
principle of cost-benefit analysis: never pass up an opportunity to make a Pareto
improvement.124
124
For almost twenty years it has been known that a positive sum of compensating
variation, the standard benefit-cost test, is a necessary but not a sufficient condition for
the passage of a compensation test (Boadway and Bruce, 1984). Symmetrically, the sum
of equivalent variations is a sufficient but not a necessary condition for passage of such a
test. The EV test will result in rejection of projects that in fact pass the compensation test.
35
Baker (1980, p. 939) points out a legally relevant failure of KH to pass a PCT. He
notes that when rights are in dispute, the usual case in matters at law, the sum of the
expectations of the parties will normally exceed the value of the right so that no potential
compensation is possible. For example, suppose a piece of property is worth $120 to
Ronald and $100 to Richard. The ownership of this property is in dispute between
Richard and Ronald but each believes with 80% percent probability that he owns the
property. The total value of expectations is $176 and the winner could not in principle
compensate the loser. If the property is awarded to Ronald, he has a gain of $24, which is
not sufficient to compensate Richard, who suffers a loss of $80. As long as the sum of
expected values is greater than the actual value, the project cannot pass the PCT. Baker
maintains that the inability to determine the efficient allocation is an indictment of
benefit-cost analysis generally and of KH in particular.125
Altogether, these arguments call into question the value of the PCT. The argument for
dropping the PCT is that it does no work for us that is not already done by the criterion
that net benefits should be positive. In the case of KH, the PCT as it is actually used tells
us only that net benefits are positive. But whether net benefits are positive is better told
by KHM, as it is more inclusive of sentiments.
The PCT has no claim to our moral sentiments. The fact that a project passes the PCT
does not mean that losers can actually be compensated. Actual compensation is not
costless, so actual compensation can take place only if the net gains are sufficient to
cover both the compensation of losers and the cost of making the compensation. Thus
PCT cannot claim the virtue of providing for actual compensation when desired.
Moreover, this sort of information about compensation is valuable only if we value moral
sentiments.
125
The argument for KH or for KHM would still stand even if the PCT were required
(Zerbe, 2001). A move from a legal regime that does not use (KH or KHM or KHZ)
efficiency as a rule for legal decisions to one that does use efficiency would pass the
PCT. For example a rule that inefficiently awarded the property to Richard would result
in a loss of $120 instead of just $100 so there would be a net social WTP of $20 to
move to a regime that used an efficiency criterion.
36
The moral basis of KH, rather, lies powerfully in the argument that its use will
increase wealth and will likely result in all, or at least most, groups gaining over time
from its application so that losers in one period become winners in the next. This
justification, however, applies, a fortiori, to KHM. Indeed one common argument against
KH is that it is dependent on income so that the losers are more likely to be the poor, and
that having lost, they are ever more likely to lose in subsequent rounds (Richardson,
2000). This is less likely under KHM as long as there are moral sentiments in favor of
avoiding income losses by the poor. In sum, the PCT does not convey useful information
about whether or not a project is desirable beyond the requirement that net benefits be
positive.
B. Including Moral Harm
1. The Discount Rate Problem and Moral Harm
It is argued that the utility of future generations should count equally with the
utility of the present generation.126
For example, Parfit contends that “the moral
importance of future events does not decline at n % per year . . . . .”127 This sort of
criticism has been noted with favor by economists,128 lawyers,129 and philosophers.130
Similarly Brown notes that " . . . discounting imperils the future by undervaluing it."131
The following is an example of the sort of problem that concerns these critics:
126
See William D. Schultze et al., The Social Rate of Discount for Nuclear Waste
Shortage: Economics and Ethics, in NATURAL RESOURCE JOURNAL 21, at 811–832
(1981); DAVID PEARCE & R. KERRY TURNER, ECONOMICS OF NATURAL RESOURCES
AND THE ENVIRONMENT (1989).
127
Derek Parfit, An Attack on the Social Discount Rate, in VALUES AND PUBLIC POLICY
86 (Claudia Mills ed., 1992).
128
See Schultze et al., supra note 218; PEARCE & TURNER, supra note 218.
129
See ZGYMUNT PLATER ET AL., ENVIRONMENTAL LAW AND POLICY: NATURE, LAW,
AND SOCIETY 107–109 (1998).
130
See Parfit, supra note 220; see also Derek Parfit, The Social Discount Rate, in
POLITICS OF THE ENVIRONMENT (R.E. Goodwin ed., 1994).
131
Stephen P. A. Brown, The Fairness of Discounting: A Majority Rule Approach, in
PUBLIC CHOICE (Oct. 1987). Shrader-Frechette has argued that both the decision and the
process by which it is made require informed consent. See Kristin Shrader-Frechette,
Duties to Future Generations, Proxy Consent, Intra and Intergenerational Equity: The
Case of Nuclear Waste, in RISK ANALYSIS 24, at 771–778 (2000). This is not possible
37
A nuclear project is being considered that produces benefits of about $100
billion at a cost of about $60 billion but, in addition, produces a toxic time
bomb that will cause enormous environmental costs sometime in the far
future.132 (I remove questions of uncertainty of the discount rate from this
example). Suppose that current waste-disposal technology will contain this
waste for 500 years after which it escapes its sarcophagus but will remain
toxic for 10,000 years.
The estimated cost of the future environmental
damage in constant, year 2000 dollars will be about $48 trillion, about
twice the size of the current U. S. GDP. The present value of these
damages discounted at a 3 percent real social rate of time preference
(SRTP), assuming the waste escapes at the first opportunity 500 years
from now, is about $18 million. This amount is not insignificant, but it is
far less than the damage that will occur in 500 years and far too small to
affect the results of the benefit-cost analysis. Discounting future damages
then results in the project going forward as the benefits are determined to
exceed the costs by almost $40 billion.
It is said that this project would be unfair to future generations and on this basis it is
argued that the use of discount rates is immoral. A commonly proposed solution to the
problem of unethical harm to future generations is to use low, or even negative, discount
rates or not to use discount rates at all.133 This sort of argument is a moral plea about
what our sentiments should be toward future generations, but not an effective statement
about which or whether discount rates should be used or even about the relevant actual
moral sentiments. The proposed solution of using no or low discount rates is ad hoc and,
when decisions affect future generations. See John F. Ahearne, Intergenerational Issues
Regarding Nuclear Power, Nuclear Waste, and Nuclear Weapons, in RISK ANALYSIS 24,
at 763–770 (2000).
132
Cases in which this sort of issue have arisen include Baltimore Gas & Electric v.
Natural Resources Defense Council, Inc. 462 U.S. 87, (1983); and Pacific Gas and
Electric Co et al. v. State Energy Resources Conservation and Development
Commission, 461 U.S. 190, (1991). See also 123 U. S. 45 (1999).
133
See William D. Schultze et. al, The Social Rate of Discount for Nuclear Waste
Shortage: Economics of Ethics, in NATURAL RESOURCE JOURNAL 21, at 811–832
(1981); Derek Parfit, The Social Discount Rate, in POLITICS OF THE ENVIRONMENT
(R.E. Goodwin ed., 1994).
38
if generally applied, will lead to other ethical problems – for example, the adoption of
projects that give less benefit to both present and future generations.134
Under KHM we can give standing to moral sentiments of the present generation
about future generations. This allows a solution to the ethical dilemma of the discount
rate problem that acknowledges ethical concerns as valid while acknowledging the values
that commend use of a discount rate. In Table 1 below, a standard KH benefit-cost
approach is compared to KHM applied under four different scenarios. In the example,
the administrative costs of compensation as determined by the current generation for
harm done to the future generation is $10 billion and mitigation costs are $7.5 billon. An
example of mitigation might be to create a more secure holding container or shipment
into space. Additionally the WTP for moral harm to the future is $50 billion. In KH
moral harm is ignored so that the result when compensation and mitigation are feasible is
the same as when neither is feasible. This result gives the highest NPV under KH. Under
KHM, however, the NPV for this result is negative. Consequently the NPV calculated
under mainstream BCA is nearly $40 billion, but the result including moral sentiments is
a negative $10.018 billion. Under KH neither compensation nor mitigation appears
worthwhile as their costs exceed the present value of damage to future generations. The
KHM approach demonstrates that when compensation is less expensive than mitigation
and moral harm, compensation is the preferred alternative (2).
When compensation is
not feasible (3), but mitigation is feasible and less than the moral harm, then mitigation is
preferred. When neither mitigation nor compensation is feasible, the project is rejected
by the aggregate approach (4) as the inclusion of moral harm shows a negative NPV.
134
For example, consider two projects with initial costs of $100. Project A has benefits
of $150 in the first period. Project B has benefits of $150 in 100 years. With negative
or sufficiently low discount rates, project B is preferred. Project A however may result
in greater wealth in 100 years so that it is superior for both the current generation and
the 100th year generation. One may object that these future benefits to the 100th year
generation associated with project A that arise from reinvestment of proceeds need to
be counted. This is not required, however, where the discount rate is equal to the
growth rate and serves to show only the peculiar adjustments that would need to be
used to get the best decisions with too low or negative discount rates.
39
Comparison of KH and KHM*
Present Values of Gains and Losses
BENEFITS AND
COSTS
[1]
[2]
[3]
No
Compensation
Mitigation
Compensation or
Occurs
Occurs
Mitigation
(PV Billions) Compensation is
Occurs
Not Feasible
(PV Billions)
(PV Billions)
[4]
Neither
Compensation
Nor Mitigation
Are Feasible
(PV Billions)
Ordinary Benefits
100
100
100
100
Ordinary Costs
60
60
60
60
Harm to future
Generations
Administrative Costs of
Actual Compensation
Mitigation Costs
0.018
0.018
[0.018]
0.018
[10]
10
infinite
infinite
[7.5]
[7.5]
7.5
125
Moral Harm to Present
Generation
KH NPV
50
[50]
[50]
50
39.982
29.982
32.5
39.982
KHM NPV
-10.018
29.982
32.5
-10.018
Conclusion
Neither
Compensation
Mitigation
Moral harm
compensation
eliminates
eliminates moral renders project
nor mitigation
moral harm
harm
undesirable under
appear
KHM
worthwhile
under KH as
moral harm is
ignored
*Figures in brackets are costs not included in the given scenario. Note that not all figures
are relevant to KH and that mitigation and compensation are substitutes so that one or the
other but not both are included in the KHM calculation.135
135
Critics of BCA suggest that the values individuals hold as private persons are used in
BCA but that these differ from those they hold for public decision-making. See
ELIZABETH ANDERSON, VALUE IN ETHICS AND ECONOMICS (1993); MARK SAGOFF, THE
ECONOMY OF THE EARTH (1988). This criticism, however, works better as a caution to
measure the actual values than of benefit-cost analysis methodology. See Richard O.
40
C. Including Equity
Equity concerns are a type of moral sentiment. The KHM assumption is that all
goods are to be included for which there is a WTP. Equity values are then to be included
in just the same manner as values for other goods. Suppose for example there is a project
that will increase the welfare of one group of the rich by $1 billion and decrease the
welfare of the poor by $900,000,000; according to KH this is a good project. This result
is, however, regarded by others as unjust even though none of them are directly affected
by it. They are willing to pay in aggregate $20 to prevent it from happening. The KHM
evaluation then finds gains of $100 but costs of $90 plus $20 so that the net benefit is $10 and the project fails the KHM test. 136 The question that KHM asks that is not asked
by KH is whether those unaffected directly by a policy, but with moral sentiments
concerning it, would be willing to pay to promote it or prevent it.
V. WHY BCA IS SO WIDELY CRITICIZED
Criticisms aimed at BCA are not so much of BCA as a possible technique but of
a single narrow view of it, the KH view. The failure of critics to properly come to grips
with the methodology is partly the fault of its practitioners. The responsibility to provide
a clear definition for BCA lies with economists. As the inventors, users and, in general,
the proponents of BCA, economists have responsibility of explaining the foundations of
their methodology. This they have failed to do. They have failed to understand and to
make clear the relation of benefits and costs to legal rights. They have inadequately
addressed the question of whether “bad” utility is to be counted in such forms as envy or
malice or sadism or gains from theft. The question of whether the value of moral
sentiments is to be counted as part of BCA is unresolved. As is the question of the
whether the role of BCA is one of simply providing information to a decision process or
Zerbe, Jr., What is Economic Efficiency? A New Paradigm, University of Washington
Evans School of Public Affairs (working paper on file with author) (2001).
136
Recently I have shown how this approach can be applied in practice.See Richard O
Zerbe, Jr. & Sunny Knott, The Merger of Superior Propane and ICG Propane: A Case
Study, Working Paper, University of Washington Evans School of Public Affairs
(2004), available at http://www.evans.washington.edu/FAC/Zerbe/pdf/merger_2-2602.pdf.
41
instead one of providing the answer to a public policy question. Clearly answers to these
questions bear on the moral stature of BCA and its acceptability.137
The criticisms concern moral and ethical limitations and, to a lesser extent,
technical ones.138 Economists and other practitioners actually doing BCA generally
ignore these criticisms. There are three reasons for this. One is that the critics fail to offer
viable substitutes, except for rather sketchy references to political discussion. The critics
do not compare the results of BCA with those of alternative approaches, so that they are
unable to answer the question of whether BCA is better than alternatives. Second they
fail to address the issue of whether BCA is useful and, if it is, how it might be improved
139
Defects found by the critics are generally uncontaminated by actual BCA so that it is
unclear whether, as a matter of fact, these defects exist.140 Not surprisingly practitioners
find little to learn from the criticisms. Without determining its usefulness, how is it
possible to argue persuasively against the use of BCA?
Without suggesting
improvements why should practitioners pay attention? The criticisms fundamentally fail
at a policy level as little or no information is given about the usefulness or the proper
role, if any, for BCA.141
Third, it is unclear what is being criticized, that is, critics are unclear what they
mean when they speak of BCA. Practitioners and critics are divided on the meaning of
137
Some critics start from an apparent dislike of markets and simply extend this dislike to
benefit-cost as an approach that mimics markets. Economists on their part are often
reluctant to recognize the normative nature of their discipline when applied to policy.
138
See ZERBE, supra note 2, at 8–10.
139
See generally Henry S. Richardson, The Stupidity of the Cost-Benefit Standard, 29 J.
LEG. STUD. 971 (2000); MARK SAGOFF, THE ECONOMY OF THE EARTH (1988); William
Hildred & Fred Beauvais, An Instrumentalist Critique of Cost-Utility Analysis, 29 J.
ECON. ISSUES 1090 (1995).
140
One exception to this is Professor Calandrillo who notes figures for the “value of life”
used in benefit-cost analysis studies. Steve P. Calandrillo, Responsible Regulation: A
Sensible Cost-Benefit, Risk Versus Risk Approach to Federal Health and Safety
Regulation, 81 B. U. L. REV. 986–87 (2001). He then goes on to agree that it is
disturbing to put a value on life but finds that doing so produces better results than not.
Id. at 1029.
141
This is well illustrated in the exchange between Steven Kelman, Cost-Benefit
Analysis: An Ethical Critique, in REGULATION 5(1), at 3340 (1981) criticizing benefitcost analysis and several economists replying to the criticisms all in Defending CostBenefit Analysis: Replies to Steven Kelman, in REGULATION 5(1), at 39 (March/April,
1981).
42
BCA. It is difficult to criticize what does not wholly exist.
Even among the critics and
among the practitioners there is no uniformity of concept. The issue of the validity of
these criticisms is thus unresolved, and indeed irresolvable, within the existing
framework because there is no general agreement about what BCA either is, or should be.
Critics tend to see BCA as a sort of mechanical algorithm that claims to provide
the answer to the question: what do people want, and indeed this is undoubtedly the view
of some practitioners who, however, see such a claim as a virtue;
142
and others who
similarly believe that BCA can indeed provide the answer though its sufficient
refinement.143 Critics, however, see BCA as missing important values such as integrity
and equity, as rooted in a narrow utilitarianism, and as using private values where public
values are relevant.144 It is said further that BCA does not make the necessary exclusions
so that it includes bad values such as envy and malice.145 Critics see it as attempting to
combine incommensurables in a single metric so that the answer it provides is without
meaning.146
Others find that it loses legitimacy as it favors the preferences of the rich
142
See Richardson, supra note 14, at 984–85; SAGOFF, supra note 14, at 11. A notable
exception is McGarity who also examines actual studies of benefit-cost analysis. See
Thomas O. McGarity, The Expanded Debate over the Future of the Regulatory State,
63 U. CHI. L. REV. 1463, 1516 (1996).
143
See Cass R. Sunstein, Cost-Benefit Default Principles, 99 MICH. L. REV. 1651, 166366 (2001).
144
See generally ELIZABETH ANDERSON, VALUES IN ETHICS AND ECONOMICS (1993);
SAGOFF, supra, note 14; BERNARD WILLIAMS, UTILITARIANISM: FOR AND AGAINST
(1973).
145
See Martha Nussbaum, The Costs of Tragedy: Some Moral Limits of Cost-Benefit
Analysis, 29 J. LEG. STUD. 1005, 1032 (2000) (counseling against cost-benefit analysis on
the ground that the results reached may be subject to "serious moral wrongdoing");
Amartya Sen, The Discipline of Cost-Benefit Analysis, 29 J. LEG. STUD. 931, 945-46
(2000) (explaining that cost-benefit analysis is limited because of signaling issues, such
as distributional valuations and values of externalities and interdependencies). J. Quiggin,
Altruism and Benefit-Cost Analysis, in AUSTRALIAN ECONOMICS PAPERS 36, at 144–155
(1997) (suggesting that to include moral sentiments would unwisely require also
inclusion of immoral sentiments).
146
See Lynn E. Blais, Beyond Cost/Benefit: The Maturation of Economic Analysis of the
Law and Its Consequences For Environmental Policymaking, 2000 U. ILL. L. REV. 237,
249-50 (2000) (arguing against overreliance on quantifying costs, benefits and risks
43
and is defective and not deserving of our approbation, as it does not consider issues of
income distribution or fairness.147 Economic welfare theory in general is seen as flawed
in ignoring transactions costs.148 A few critics, e.g. Jules Coleman, incorrectly see the
Scitovsky reversal paradox as rendering useless BCA.149
A common view is thus that
BCA is a “flawed science that deprives citizens of the opportunity to participate in
democratic processes that bear on resource allocation ….” 150
because the value of environmental protection cannot be measured in economic terms);
see also Robert H. Frank, Why is Cost Benefit Analysis So Controversial, 29 J. LEG.
STUD. 913, 914 (2000).
147
See Richardson, supra note 14, at 987–990. See also CHARLES FRIED, RIGHT AND
WRONG 15 (1978); Kelman, supra note 16, at 33.
148
This is not at all to imply that Coase is against the use of benefit-cost analysis. The
contrary is the case. See generally RONALD H. COASE, THE FIRM, THE MARKET, AND
THE LAW (1988).
149
See Jules L. Coleman, Efficiency, Utility and Wealth Maximization, in MARKETS,
MORALS AND THE LAW 95, 95-132 (1988); see also Richard S. Markovits, A Constructive
Critique of the Traditional Definition and Use of the Concept of "The Effect of a Choice
on Allocative (Economic) Efficiency": Why the Kaldor-Hicks Test, The Coase Theorem,
and Virtually all Law-and-Economics Welfare Arguments are Wrong, 1993 U. ILL. L.
REV. 485, 512–515 (1993). In 1941, Scitovsky introduced a slightly different criterion
from KH that states that a project is desirable if the losers are unable in the original state
of the world to bribe the potential winners not to undertake the project.149 The Scitovsky
criterion assumes that the value to winners from a change is the value they would have
were they to have ownership of their winnings; the value to losers is the value where
losers to have no right to be compensated for their losses. KH assumes winners have no
such right and that the value of winnings is determined by what the potential winners
would pay for them; losers value losses at what they would accept to bear them. Both of
these criteria are referred to as potential compensation tests. Scitovsky suggested that
both compensation tests, that is a dual test, be used as otherwise it is possible to use KH
to recommend a move from a state of the world A to a new one B and then, having
arrived at B, to recommend a move back from B to A. The dual tests would avoid this
possibility known as the Scitovsky reversal, though at the expense of some indeterminacy
when a project passes one test but not the other.
150
Hildred & Beauvais, supra note 14, at 1092. See also Mark Sagoff, Economic Theory
and Environmental Law, 79 MICH. L. REV. 1393, 1419 (1981).
44
VI. KHM OBVIATES MOST CRITICISMS OF BCA: THE ROLE OF BCA
KHM assumes that BCA is to be used to inform policy, not to make the decision
or to provide the answer. This view is also consistent with that adopted generally by
many policy economists.151
Yet many critics (e.g., Richardson, etc.) identify BCA with a sort of mechanical
approach that purports to deliver the answer to public policy questions.152 We associate
this view with what we have called the mainstream view, although there are practitioners
who do not subscribe to it. This view suggests that the results of BCA come as close as is
possible to identifying the best decision subject to constraints of data and data costs. This
view imposes no constraints on the sort of questions that BCA is suited to address.
Posner probably best exemplifies this view, which is also held by a number of
economists.153 The logic of this view is that BCA attempts to mimic the market and to
create a result similar to what market forces would create were transactions costs zero.
To attribute this view to KH is perhaps somewhat unfair to its originator, Kaldor, who
clearly did not see the role of BCA as providing the answer because he explicitly
expected that decision makers would consider distributional effects. Leading textbooks
and articles on BCA explicitly treat BCA as a means of providing information to the
decision process, not as proving the decision.154
This understanding of the KHM view of BCA immediately obviates most of the
criticisms of it. Richardson, for example, sees BCA as foreclosing deliberate and
intelligent deliberation.155
But if the BCA is seen simply as providing relevant
information then it does not foreclose deliberation. In my experience, it encourages
151
See Mark A. Wolfson, Earnouts: The Effects of Adverse Selection and Agency Costs
on Acquisition Techniques, JOURNAL OF LAW, ECONOMICS & ORGANIZATION (2001);
Richard O. Zerbe, Jr., An Integration of Equity and Efficiency, 73 WASH. L. REV. 349,
361 (1998); RICHARD O. ZERBE, JR. & D. DIVELY, BENEFIT-COST ANALYSIS IN THEORY
AND PRACTICE (1994).
152
See Richardson, supra note 14, at 984–90.
153
See RICHARD A. POSNER, ECONOMIC ANALYSIS OF LAW 15 (2d ed. 1977); Harberger,
supra note 5, at 785.
154
See ANTHONY BOARDMAN ET AL, COST-BENEFIT ANALYSIS: CONCEPTS AND PRACTICE
(1996); RICHARD O. ZERBE, JR. & D. DIVELY, BENEFIT-COST ANALYSIS IN THEORY AND
PRACTICE (1994); Adam Wolfson, The Costs and Benefits of Cost-Benefit Analysis, in
THE PUBLIC INTEREST, at 93–99 (2001).
155
See Richardson, supra note 14, at 971.
45
deliberation. It does this by proving a framework for discussion that allows data to be
challenged, allows new data to be provided, and increases the transparency of the
process.
A very great advantage of BCA is that it is a framework for questioning and
refutation. Instances of agency bias in preparing BCA are widespread.156 But these
biases will be expressed in other probably more opaque ways in the absence of BCA.
The advantage of BCA is that the biases can be more easily questioned, challenged and
changed. For example, criticisms by Haveman of BCA of the Corp of Engineers have
changed their practices.157 Work by the Department of the Interior ETC showed that the
BCA underlying the proposal by Tennessee Valley Authority to build the Tellico Dam
was so seriously flawed that the benefit-cost conclusion was incorrect.
158
The existence
of even a flawed BCA allowed discussion and revision that produced a different opinion.
A realistic criticism noted by a number of commentators is that BCA tends to
bring undue focus on values that are quantified and thus on those that are most easily
quantified.159 That is, in using BCA, hard numbers tend to drive out soft values.160
Certainly this problem justifies efforts to ameliorate it through the presentation of BCA
results to give due weight to difficult or costly-to-quantify information, as Weisbrod and
McDaniels have done.161 Indeed the McDaniel's work is a model, tested in practice, of
156
See McGarity, supra note 17, at 1515; see also THOMAS O. MCGARITY, REINVENTING
RATIONALITY: THE ROLE OF REGULATORY ANALYSIS IN THE FEDERAL BUREAUCRACY
(1991).
157
See ROBERT H. HAVEMAN & JULIUS MARGOLIS, PUBLIC EXPENDITURE AND POLICY
ANALYSIS (2d ed. 1977).
158
See, e.g., Gov. Edward M. Gramlich, The Methodology of Cost-Benefit Analysis,
WERNER SICHEL ECONOMICS LECTURE-SEMINAR SERIES, WESTERN MICHIGAN
UNIVERSITY (Oct. 16, 2002), available at
http://www.federalreserve.gov/boarddocs/speeches/2002/200210163/default.htm
159
See McGarity, supra note 17; Sunstein, supra note 18.
160
See Calandrillo, supra note 15.
161
See Tim McDaniels & C. Roessler, Multiattribute Elicitation of Wilderness
Preservation Benefits: A Constructive Approach, in ECOLOGICAL ECON. 27(3), at 299–
312 (1998); Burton Weisbrod, Collective Consumption Services of Individual
Consumption Goods, in QUARTERLY J. ECON. 78(3), at 471–477 (1964); see also Tim
McDaniels & Daryl Fields, Decision Aiding, Not Dispute Resolution: Creating
Insights through Structured Environmental Decisions, in J. POL. ANALYSIS & MGMT.
20(3), at 415–432 (2001).
46
how to use BCA in a deliberative process. It seems doubtful that the hard-number bias is
sufficient to discontinue the use of BCA though no definitive evidence on this matter
exists.
Criticisms of KHM are implicit in certain criticisms of KH, namely the weight
given to the Scitovsky reversal paradox and the criticisms that preferences are incomeweighted. These have mainly come from non-economists.
The Scitovsky paradox is
unimportant as a criticism as it requires inferior goods and a strong inferior effect at that
(See Appendix). The criticism of ownership is at base a criticism of law and society and
BCA is merely instrumental to the status quo and is therefore a poor object to
fundamental criticism of this sort. There remain technical criticisms offered by
economists. These are that including moral sentiments may result in acceptance of a
project that fails the potential compensation test or that inclusion of moral sentiments can
result in double counting. The conditions for failure of the potential compensation test,
however, ensure that failure will occur only when moral sentiments are trivial in intensity
and extent as I have shown elsewhere. More to the point, as I have also shown
elsewhere, there is no reason for either technical or moral reasons to continue to require
the potential compensation test. The test does no work for us. The double counting
argument rests on a misinterpretation of results that give a positive value to existence
value it situations in which it has none, as I have shown elsewhere. All of this does not
mean, though, that KHM is without limitations.
VII. LIMITATIONS OF BENEFIT-COST ANALYSIS FOR THE CHOICE OF
FUNDAMENTAL RIGHTS AND DUTIES
Precisely because proper BCA is grounded in existing law and rights, it is not
suitable to provide meta answers to questions about fundamental rights, whether in the
form of KH or KHM.
BCA is meant to reflect preferences and these preferences are
part of the existing pattern of rights. As Heyne carefully pointed out, BCA builds on
47
existing rights to affect changes in rights at the margin.162 Critics that find fault with it on
these grounds are missing the point.163 Consider the examples of abortion and slavery.
1. Slavery
Dworkin finds fault with BCA in the form of wealth maximization because he is
unable to condemn slavery with it.164
Posner responds as a defense that wealth
maximization probably would find it inefficient.165 Posner focuses on whether one would
be more productive as a slave or as a free person and suggests in the latter state a person
would be more productive.166 Fogel and Engerman, however, undercut this speculation
by finding empirically that slavery was efficient at least in a sense in which Posner often
uses the term.167
Fogel and Engerman ask and answer in the negative the question, if
slavery had been eliminated would the U.S. gross national product have been greater?
But this whole debate, including the finding of Fogel and Engerman, is wrongheaded. The wrong questions are asked and answered. The right question for BCA,
162
See Heyne, supra note 138.
See Ronald Dworkin, Is Wealth a Value?, 9 J. LEGAL STUD. 191 (1980); Thomas J.
Meeks, The Economics, Efficiency, and Equity of Abortion, in ECONOMICS AND
PHILOSOPHY 6, at 95 (1990).
164
See Dworkin, supra note 153.
165
See Richard A. Posner, Ethical and Political Basis of Efficiency, 8 HOFSTRA L. REV.
501 (1980).
166
Posner attempts to answer that wealth maximization condemns slavery, as wealth
would be greater without it. There is no evidence that this was the case. Moreover,
greater wealth is insuffient to pass a benefit-cost test of greater net benefits or even a
potential compensation test. A slave owner with a taste for slavery might refuse the
greater monetary wealth offered to give up his slaves, and in this case one could not say
that slavery was inefficient. To answer this question one would need to ask, starting
from a position in which slavery was legal, whether the WTP for the illegality of those
opposed to it is greater than the WTA of slaveholders to give up their right to own
slaves. Or starting from a position in which slavery was illegal, one would ask whether
the WTP of potential slaveholders was greater than the WTA of those opposed to
slavery. Little evidence is available on either of these questions. If the answer to the
questions was no in both cases, as one could easily imagine, the benefit-cost approach
is indeterminate. If the right is not clear, the benefit-cost analysis approach in this case
suggests giving the right to whichever group had the greatest WTP. Nevertheless,
introducing benefit-cost analysis does point to relevant policy information. If the WTP
to end slavery was greater than the WTA to eliminate it, a financial transactions would
have had the potential to eliminate slavery without the Civil War.
167
See ROBERT FOGEL & S. ENGERMAN, TIME ON THE CROSS: THE ECONOMICS OF
AMERICAN NEGRO SLAVERY (1974).
163
48
under either KH or KHM, is, starting from a position in which slavery exists, would the
WTP to eliminate slavery exceed the WTA to give it up? Starting from a position in
which it is illegal, the BCA question is, would the WTP to allow slavery exceed the WTA
to allow it? The answer to both questions is almost certainly negative, so that the legal
starting point determines the BCA answer. This is not a question of tragic choice
(Nussbaum);168 to choose against slavery is not tragic, to decide whether to fight the Civil
War is a tragic choice. Fogel and Engerman do not answer the question of whether
slavery was efficient because they incorrectly define efficiency. What they show instead
is simply that the system was economically productive, which does not mean it is KH-,
let alone KHM-efficient. Efficiency is not the same as changes in GNP.169 To show that
slavery was efficient, Fogel and Engerman need to calculate the relevant willingness to
pay or accept. They do not. Where disagreement exists about fundamental rights, who
would expect BCA to provide the answer?
2. Abortion: An Example When Rights are Uncertain
One could as well ask whether abortion meets a benefit-cost test, and sure enough
the question has been asked. Meeks uses an econometric benefit-cost approach to
persuade us that “banning abortion of human beings would in general be efficient.”170
Meeks compares the consumer surplus that women derive from access to abortion with
the expected loss of earning that would have accrued to the aborted fetuses. The
consumer surplus is estimated from a demand equation for abortion. Meeks finds that the
present value of the expected loss of earnings of the fetuses would be greater than the
women’s loss of consumer surplus, and that this result is “robust” to different
specifications, and that, therefore, a ban is efficient. There are a number of technical and
conceptual difficulties with Meeks’ work, which have been ably pointed out by Julianne
Nelson.171 Posner, in a more sophisticated discussion than Meeks, also attempts to use
168
See Nussbaum, supra note 21.
See Harberger, supra note 105.
170
See Meeks, supra note 152, at 126.
171
See Julianne Nelson, Persuasion and Economic Efficiency, in ECONOMICS AND
PHILOSOPHY 9, at 229 (1993).
169
49
economic efficiency to favor a ban.172 He makes, however, the same two conceptual
errors as Meeks.
The dominant conceptual error by the participants in this debate is that efficiency
is not correctly defined. Two errors are made. One is that the relevant parties are
incompletely defined; that is, the sentiments of others not subject to or participating in
abortion are ignored. The second is that WTP measures alone are used, when WTA
measures are relevant as well, even under KH.
Suppose we start with a situation in which abortion is clearly legal. Let us say that
the persons designated by the letter A are in favor of a ban, and that the letter B
represents parties who are opposed. For a change to a situation in which abortion is
illegal, a BCA test requires that the willingness to pay for a change exceeds the
willingness to accept the change, or WTPb > WTAa. Because some of those that favor
abortion rights would accept no sum for a change in the law, such a change cannot be
efficient.
When we start with a situation in which abortion is clearly illegal, a similar result
is obtained. For those who believe abortion to be wrong, there is no sum large enough
for them to allow it, so that, starting from a position of illegality, no change is efficient.
As with slavery, the legal starting point determines the outcome.
Suppose we start from a position in which the legal starting point is ambiguous.
If parties on both sides of the issue are seen without rights, the gains from moving to a
clear set of rights would be determined by the relative willingness to pay of both parties
so that an auction would determine the outcome. Clearly this is no way to decide the
issue.
Instead let us start from a position in which both parties have psychological
ownership of their position, in the sense that they would have a sense of loss from any
change in the position they hold. In this case the BCA would involve a comparison of the
respective WTA of both parties. But because these are both likely to be infinite no
answer, let along a solution, is available here. Yet this result is not without meaning.
Although the willingness to pay is not determinative, there might be a difference in the
willingness to fight for the right and the benefit-cost rule would suggest that the right
172
See RICHARD A. POSNER, SEX AND REASON 15 (1992).
50
should then go to the party most willing to fight. This can be seen more clearly by
imagining that both parties posses some psychological ownership of a right.173
To do a proper economic analysis, parties A and B must include not only the
women who demand abortion and the fetuses that might be born but all of those whose
feelings about abortion are sufficiently strong that they are willing to pay or to accept to
have abortion legal on the one hand, or banned on the other. In this case, there are
indisputably a number of people on both sides of the abortion dispute with some degree
of psychological ownership and whose WTAs would be infinite. Some people would not
allow a woman to be forced to give birth, no matter how much they were “bribed” to vote
for an anti-abortion law, and other people would not allow a fetus to be destroyed, no
matter how much they were “bribed” to allow the abortion to occur. Indeed, many if not
all people with a strong stance on abortion would find the question of what sort of “bribe”
would convince them to change sides highly offensive. Whether the fetus' WTP or WTA
should be included is, in the terms of the KH perspective, a matter of standing, and one
which clearly has not been decided. Thus, we cannot say that either a ban on abortion or
the legality of abortion is efficient. We can say, however, that this is an issue in which the
language of economic efficiency is not the best suited to the discussion, though I am not
173
Let the status quo is clearly one of conflicting expectations. In this case we regard this
matter as one in which both sides to the debate have some sense of psychological
ownership. Let P represent the extent to which the party has psychological ownership
and let a and b represent the two parties. We want to compare the willingness to pay and
accept of both parties weighted by their sense of ownership. The relevant equation would
then be
WTPa(1-Pa) + WTPa(Pa) > WTPb(1-Pb) + WTAb(Pb)
This can be expressed as
WTPa + Pa(WTAa - WTPa) > WTPb + Pb(WTAb - WTPb)
This is interesting because it says that the divergence between the willingness to accept
and the willingness to pay is relevant. Not just income determines the efficient outcome
but also the willingness to fight for thegood. For example, one party, a timber company
say, might value an environmental right to timber at only the commercial value of the
timber so in the company’s valuation there was no divergence between its WTP and
WTA. An environmental group, however, might be able to pay little to preserve the
timber but have a very large WTA. The total value to the environmental group might
then be greater in the situation where each party had an equal right to the timber so that
the benefit-cost analysis would favor ownership by the environmental group.
51
sure it does worse than other attempts using different language. What is clear is that
neither Meeks or Nelson nor Posner is able to say that either abortion rights or the lack
thereof is efficient.
Nussbaum correctly comes to the point by stating that “we badly need an
independent ethical theory of basic entitlements….”174 BCA builds on such basic
entitlements. But if its critics cannot furnish such an independent foundation, it seems
churlish to argue against the use of BCA on the grounds that it also does not do this job, a
job for which it was never intended. Such criticism should be directed at the legal or
political system, which must underlie any acceptable normative analysis concerned with
less than revolutionary changes. The source of the objection implicitly lies in a concept
of BCA that incorrectly holds it separate from the legal environment in which it operates.
The concept of any coherent BCA and explicitly so under KHM is, however, tied to the
legal system. It is tied to the legal system at the most basic level, the measurement of
benefits and costs as we have seen.
VIII CONCLUSION
I have presented two archetypes of BCA. Both are consistent with existing
literature. The KH version closely represents what a majority of economists have in
mind when they refer to BCA. The KHM version represents an emerging version that
combines elements of BCA that have long existed and that are associated with
recognition of its grounding in rights and in an inclusive adoption of values.
This paper has demonstrated first that the legal and philosophically based
criticisms of BCA are in the main obviated when applied to the KHM version of BCA. It
also demonstrates that there is value added in substituting a KHM version of BCA for the
traditional version of KH. I have shown that KHM provides better answers than KH to
the critics of BCA. The superiority of KHM lies in the fact that it better reflects
preferences and is thus a better measure judged by the benefit-cost standard itself. We
have seen these better answers in our examinations of abortion, slavery, the municipal
incinerator, the thief, and other examples. That is, the simple argument for KHM over
174
See Nussbaum, supra note 21, at 14.
52
KH is simply that KHM reveals more information about actual preferences and is thus
more informative.
The greater value of the KHM version is being recognized, however slowly and
controversially, by a change in the understanding in what is meant by BCA from the
mainstream view to something similar to KHM.175 Many, if not most, economists, for
example, now recognize the importance of defining gains and losses from a status quo
position. Recently the importance of moral sentiments in determining charitable giving
has been recognized. The concept of standing as one used to make the proper exclusions
that reflect broad public sentiment, has found its way into textbooks.176 Increasingly the
role of BCA is seen as that of providing information to a decision process rather than one
of providing the answer. Market failure as a prescription has been challenged and shown
to be wanting.177 Those doing practical BCA realize they cannot ignore transactions
costs. In making the choice between KH and KHM more formal, I hope to speed it and
provide justification for it.
This article has not considered issues of measurement. In any applied empirical
analysis there are always issues of measurement. Yet, in performing practical analysis it
is always desirable to have the better theoretical template in mind so that decisions about
practice can be well considered and not ad hoc. My purpose has been to contribute to this
template.
This approach was given a boast by Kahneman’s receipt of the Nobel Prize in
economics in part for his work showing the asymmetry of gains and losses, the
importance of the status quo position and the economic relevance of fairness.
176
See ALLEN S. BELLAS & RICHARD O. ZERBE, JR., A BENEFIT-COST PRIMER
(forthcoming Edward Elgar Publishing) (2004).
177
See Zerbe & McCurdy, supra note 234.
175
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Appendix A
III. CHARACTERISTICS OF THE KALDOR-HICKS CRITERION
A. The Willingness to Pay and the Willingness to Accept
In 1943 Hicks derived the compensating and equivalent variations and showed
their relationships to the willingness to pay (WTP), and the willingness to accept (WTA).
The compensating variation measures the value of a change in states of the world by
using prices before the change to measure the welfare change. The equivalent variation
measures the change using the prices after the change. The compensating gain for a
move from position A to B gives the same value, but with opposite sign, for the
equivalent variation test for a move from B to A. Either of these variations are exact
utility indicators in the sense that for a single individual they rank preferences correctly.
The compensating variation was shown to correspond to the KH test and the equivalent
variation to the Scitovsky test. The compensating variation was shown to measure gains
by the WTP for the gain and losses by the WTA payment for a loss. The compensating
variation test, or KH, has come to be the standard for BCA.178
B. Potential Compensation Tests
These two criteria, KH and Scitovsky, are each known as potential compensation
tests. The idea is that the winners could hypothetically compensate the losers, in the new
state of the world for KH and in the original state of the world for the Scitovsky test.179
For Kaldor and for many subsequent economists the ability to pass a potential
compensation test seems to have furnished a moral justification for the use of the
criterion.180 The political process could, if desired, produce compensation for the losers
and thereby turn a project that was KH-efficient into one that was Pareto-efficient. These
compensation tests then represent what economists and lawyers generally mean, or think
they mean, when they speak of economic efficiency.181
178
The equivalent variation uses the WTA for gains and the WTP for losses.
The Scitovsky criterion is dual using both the KH and the Scitovsky test.
180
See Nicholas Kaldor, Welfare Propositions in Economics and Interpersonal
Comparisons of Utility, 49 ECON J. 549, 550 (1939).
181
The other concept, of course, is that of Pareto optimality, but this is a concept ill suited
to discussion of economic changes and is, therefore, of limited practical application.
179
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Appendix B
Scitovsky Reversals and Inferiority
C. Scitovsky Reversals: A Technical Critique
A problem for the compensation tests is the possibility of Scitovsky reversals.
Practitioners pay little attention to them. Coleman, on the other hand, sees the possibility
of Scitovsky reversals as reason to reject KH.182 It is not. Though it is not generally
recognized, Scitovsky reversals can only occur when one of the choices of a state of the
world is economically inferior. Choices are inferior when higher incomes lead one to
desire smaller rather than larger amount of the goods.183 Since inferior goods are rare and
choices in which one choice is inferior even rarer, the possibility of reversals warrants
little attention. Because inferiority is rare and unimportant, Coleman’s rejection of BCA
on this ground fails.184
Choices are inferior when higher incomes lead one to desire smaller rather than
larger amount of the goods. This requires that the WTP for a good is greater than the
WTA to give up the same good for the same group of people. 185 Suppose all relevant
goods are normal (not inferior) and that there are two persons A and B. This situation is
shown in Table 1.
Table One*
Scitovsky Reversals
Value of a Move
WTP
WTA
From A to B
182
See Jules Coleman, Efficiency, Utility, and Wealth Maximization, 8 HOFSTRA LAW
REVIEW 509, 551 (1980).
183
See EDGAR K. BROWNING & J.M. BROWNING, MICROECONOMIC THEORY AND
APPLICATIONS 15 (4th ed. 1992).
184
Coleman appears to believe that the mere existence of reversibility is sufficient for
rejection. A more useful criterion is the usefulness of KH and this is not destroyed per
so by the possibility of reversals.
185
See Richard O. Zerbe, Jr., What is Economic Efficiency? A New Paradigm, Working
Paper, University of Washington Evans School of Public Policy (2001) (copy on file
with author).
55
Person 1
$100
$150
Person 2
($90)
($95)
* The brackets indicate losses.
In Table one person 1 is the winner for a move from A to B and person 2 is the loser. For
a move back from B to A, person 2 would be the winner and person 1 the loser. For a
normal good for a single individual the absolute value of the WTA exceeds the WTP by
definition of a normal good.186 This is reflected in Table 3 by the fact that the WTA of
$150 for person 1 exceeds his WTP of $100, and by the fact that the absolute value of the
WTA for person 2 of $95 exceeds the absolute value of her WTP of $90. The value of a
move from A to B will be the WTP for person one plus the WTA of person 2, or $100 $95 or 5. So this move satisfies KH and KHM. To find the value of a move back it is
useful to know that the WTP for person 2 for a move back is equal to the negative of the
value of her WTA for the original move from A to B. And, that the WTA for person 2
for the move back is equal to the negative of the WTP value for the move from A to B.
Thus the value for a move back will be $90 minus $150 or -$60. As long as persons 1 and
2 have a WTP for a gain that is less than the WTA to forego that gain, no reversal can
occur.
Slightly more formally represent the values in Table 3 as abstract values a, b, c,
and d as follows:
Table 2
Scitovsky Reversals are Not Possible for Normal Goods
Value of a Move
WTP
WTA
Person 1
a
b
Person 2
c
d
From A to B
KH is passed in a move from A to B if a>d. The reverse move is passed if c>b.
Normality requires that b>a and d>c. If a>d, then a>c, because by normality d>c. But
186
See MISHAN, supra note 32, at 121.
56
c>b and b>a, which is a contradiction. To avoid the contradiction we must abandon
normally as shown in Table 3.
In order for a reversal to occur, the situation would need to be as shown in Figure
4. In this case person has a WTP less than his WTA, so the move is inferior for him.
Table 4
Scitovsky Reversals with Inferior Goods
Value of a Move
WTP
WTA
Person 1
$100
$80
Person 2
-$90
-$95
From A to B
The value of a move from B to A will be the WTP for person 1, who would win, and the
WTA for person 2, who would lose. This would be $100 - $95 or $5. For a move back
from B to A the signs get reversed, as do the winners and losers. The KH or KHM value
of a move back from B to A would be WTP for person 2 which is $90 minus the WTA
for person 1 which is $80 or $10. Thus if the move is inferior for one person (here person
1) this is necessary (but not sufficient) for reversal. This establishes that inferiority is a
necessary condition for a Scitovsky reversal. In a similar manner, it is possible to also
show that inferiority is not a sufficient condition for reversal.
57