Cost-Benefit Analysis as a Tool for Policy Alan Krupnick, PhD Senior Fellow and Division Director Resources for the Future March 2, 2007.

Cost-Benefit Analysis as a Tool for Policy

Alan Krupnick, PhD

Senior Fellow and Division Director

Resources for the Future

March 2, 2007

Policy Context

Environmental and health regulations are often very costly to society, and deliver benefits of very different types and quantities

So need to identify those that deliver the greatest benefit for the resources expended, i.e., are efficient

Requires estimating the benefits and costs of regulatory intervention.

Other factors matter at least as much: equity, legality

Two Types of Policy Analyses

Cost-Benefit Analysis (CBA) = Monetary benefits minus costs

Cost-Effectiveness Analysis (CEA) = Cost/Effectiveness

Effectiveness measures Physical units, e.g., emissions, lives saved Quality adjusted life years

Uses of CBA

Accounting framework Prioritization Normative Decision: Is it worth it to take

any action? Policy Choice: Which policy is better (on

efficiency grounds)? How can policy design be improved?

Limitations

Only addresses efficiency under a utilitarian model

Discounting; growth and change Hard to monetize everything

Example of cost-effectiveness analysis

Many major applications of cost-benefit analysis (CBA)

Social cost of Electricity (e.g., U.S., Europe (EXTERNE))

EXTERNE: Social cost of Transportation, CAFÉ

U.S.: BENMAP IPCC: Ancillary Benefits of climate change

Many of above are “integrated assessments.”

Experience with CBA at U.S.EPA (Morgenstern, 1997)

All CBA’s studied “ended up improving the rules” Guiding development of rules Adding/eliminating/adjusting alternatives Supporting decisions

Broad educational value

Example for Mexican Brick Kilns

The Benefits and Costs of Informal Sector Pollution Control: Mexican Brick Kilns, Allen Blackman*, Jhih-Shyang Shih, David Evans, and Michael Batz, Stephen Newbold, Joseph Cook, April 2006

Figure 1. Brickyards, formal industrial facilities, and population in Ciudad Juárez

Annual net benefits of pollution control strategies for brick kilns and formal industrial facilities ($millions)

Brick kilns Iron foundry Chemical plant

Scenario

Natural gas

NMSU kilns

Relocation

No-burn days

Baseline

= no controlsa

Baseline = 50% U.S.

controlsb

Baseline

= no controlsa

Baseline = 50% U.S.

controlsb High 232.22 231.01 132.05 4.59 16.23 8.12 90.27 45.13 Mean 75.46 75.02 43.10 1.49 6.63 3.31 33.42 16.71 Low 9.12 9.08 5.20 0.17 1.42 0.71 5.94 2.97

Effect on Policy

Wanted to try natural gas approach: Pipeline costs (fixed) were too high

NMSU kilns: Introduced from cross-border emissions trading in El Paso; 60 of 350 kilns converted

Some center city kilns were relocated outside city

Example of CBA for Shanghai

“Quantifying the Human Health Benefits of Curbing Air Pollution in Shanghai” Li, Guttikunda et al., Journal of Environmental Management, 70 (2004), 49-62.

Overview of the Case Study Examines 2 options to control pollution from stationary

sources in Shanghai Integrated Gasification Combined Cycle for power plants Relocation and reduction in coal use by the industrial sector

Analysis conducted for the year 2020, assuming baseline emissions fall

RAINS-Asia model used to predict future energy use and emissions; UrBAT used to calculate ground-level concentrations of SO2 and PM

202

0

202

0

BA

UB

AU

Units:Gg/year

Economic SectorEconomic Sector PMPM1010

(C )(C )PMPM1010

(M)(M)PMPM2.52.5

( C)( C)PMPM2.52.5

(M)(M)SOSO22 NONOxx

Power 11.2 5.1 394.3 112.7

Industry 52.1 18.6 19.6 5.3 214.2 73.2

Domestic 5.2 3.6 16.8 5.4

Transport 31.1 16.7 32.0 276.6

Other 0.0 36.4 0.0 9.3 0.0 0.0

Total 99.699.6 55.055.0 45.045.0 14.614.6 657.2657.2 468.0468.0

Economic SectorEconomic Sector PMPM1010

(C )(C )PMPM1010

(M)(M)PMPM2.52.5

( C)( C)PMPM2.52.5

(M)(M)SOSO22 NONOxx

Power 40.6 18.1 214.1 80.4

Industry 49.2 31.5 18.3 9.0 199.9 71.1

Domestic 10.4 6.8 31.9 5.9

Transport 10.1 6.0 11.6 125.8

Other 7.0 18.0 5.9 4.6 1.0 2.5

Total 117.2117.2 49.549.5 55.155.1 13.713.7 458.4458.4 285.8285.8

199

51

995

Shanghai Urban Air Quality Management

Emission Estimates

in 1995in 1995 2020 BAU2020 BAU

120.8 121 121.2 121.4 121.6 121.8 122

30.8

31

31.2

31.4

31.6

31.8

32

5102030405060708090100110120

Units: g/m3 PM10

120.8 121 121.2 121.4 121.6 121.8 122

30.8

31

31.2

31.4

31.6

31.8

32

Shanghai Urban Air Quality Management

Annual Average PM10 Concentrations

Shanghai Urban Air Quality Management

2020 Control Scenarios

Power Power Sector Control Integrated Gasification Combined Cycle (IGCC) for coal

combustion

IndustrialIndustrial Sector Control 75% coal consumption reduction

Remaining 25% relocated to neighboring provinces

Scenario ==> C1 C2% Emission Reduction Industrial Power SectorSulfur 14 41NOx 6 13TSP 9 3PM10 12 4PM2.5 13 4

2020 Power Control2020 Power Control 2020 Industrial Control2020 Industrial Control

5102030405060708090100110120

Units: g/m3 PM10

120.8 121 121.2 121.4 121.6 121.8 122

30.8

31

31.2

31.4

31.6

31.8

32

120.8 121 121.2 121.4 121.6 121.8 122

30.8

31

31.2

31.4

31.6

31.8

32

Shanghai Urban Air Quality Management

Annual Average PM10 Concentrations

2020 Power Control2020 Power Control 2020 Industrial Control2020 Industrial ControlUnits: g/m3 PM10

120.8 121 121.2 121.4 121.6 121.8 122

30.8

31

31.2

31.4

31.6

31.8

32

0

5

10

15

20

25

30

120.8 121 121.2 121.4 121.6 121.8 122

30.8

31

31.2

31.4

31.6

31.8

32

Shanghai Urban Air Quality Management

Annual Average Reduction in 2020

Shanghai Urban Air Quality Management

Health Benefit Analysis

No. of cases avoidedNo. of cases avoided

Health EndpointHealth Endpoint Power Scenario Power Scenario

(no. of cases)(no. of cases)

Industrial ScenarioIndustrial Scenario

(no. of cases)(no. of cases)

Mortality 2,808 1,790

Hospital Visits 96,293 61,379

Emergency Rm Visits

48,506 30,918

Hospital Admissions

43,482 27,716

Chronic Bronchitis

1,753 1,117

Conclusion on Case Study

Both scenarios are welfare improving CBA can help show whether it is desirable to take action

Industrial scenario is the more efficient in spite of having lower health benefits: $417-$395 = $23 vs $266-$94 = $172

CBA can help choose the best policy

Embedding a CBA Process into the government

Location of process An OMB-like agency Centralized within SEPA De-centralized Provincially

Commit resources Issue Guidance Document Develop appropriate regulatory process: early analyses,

broad set of options CBA/CEA AS TOOLS NOT A JUSTIFICATION

Development of analytical tools E.g., ECM

STOP

Benefit Categories and Estimation Approaches

BENEFIT CATEGORY ESTIMATION APPROACHa

To Individuals Property Value (hedonic price)

Health

Mortality Wage Compensation, Stated Preference Averting Behavior, Human Capital (foregone earnings)

Morbidity (acute,

Chronic)

Stated Preference, Cost of Illness (medical, earnings, pain and suffering, avoidance), Averting Behavior

To Production/consumption

Crops/Forests/Fisheries Consumer plus producer surplus

Water-using industry Same

Municipal Water Supply Authorities

Opportunity Cost (alternative aquifer) Service Replacement (Municipal treatment, bottled water)

To Economic Assets

Materials (corrosion, soiling)

Replacement Cost, Service Values, household production function

Property Values Hedonic Price Models

To Environmental Assets

Use

Recreation Unit Day, Stated Preference , Property Value, Travel Cost, Random Utility, Hedonic Travel Cost

Other (visibility) Service Replacement Stated Preference Property Value

Passive Use (Nonuse)

Stated Preference Models

Key Unquantified BenefitsSOURCE: The Benefits and Costs of the Clean Air Act, 1990 to 2010, Tables 5-1 and 7-5 (p.53, 88)

Ozone Acidic Deposition

Mortality Commercial forest effects

Pulmonary effects Commercial freshwater fishing effects

Non-asthma emergency room visits Watershed damage (filtration, flood control)

Effects on recreation in terrestrial

Particulate Matter Reduced existence and options values

Neo-natal mortality

Pulmonary effects Nitrogen Deposition

Non-asthma emergency room visits Commercial forest effects

Commercial freshwater fishing effects

Carbon Monoxide Agriculture effects

Behavioral effects Watershed damage (filtration, flood control)

Other hospital admiss ions Effects on recreation in estuar ine ecosystems

Other cardiovascular effects Reduced existence and options values

Developmental effects

Tropospheric Ozone Exposure

Nitrogen Oxides Effects on recreation in terrestrial

Pulmonary effects Reduced existence and options values

Non-asthma emergency room visits

Sulfur Dioxide Hazardous Air Pollutants

Respiratory symptoms in non- All health effects

Pulmonary effects All ecological effects

Non-asthma emergency room visits

Table II-1: A sample of externalities assessed in studies of electricity generation. Health Forests

Mortality Morbidity

Materials

Crops Timber Other

Amenity 2/

Eco- Systems

PM10 Y Y Y n.e. n.e. n.e. Y n.e. SO2 1/ Y Y Y Y Y Y Y Y NOx 1/ Y Y Y Y Y NA n.e. Y Ozone Y Y Y Y Y NA n.e. n.e.

Mercury and other

heavy metals

NA NA n.e. n.e. n.e. n.e. n.e. ?

Water

pollutants4/

n.e. n.e. n.e. n.e. n.e. n.e. Y

Noise n.e. NA n.e. n.e. n.e. n.e. AM n.e.

Defining and Measuring Cost

On a conceptual level, the definition of cost is the same as benefits, i.e., the opportunities given up by a choice.

Agencies often measure costs in terms of expenditures. Too narrow.

Compliance cost — the cost of all the actions necessary to comply with a particular regulation is better, but still a poor measure.

Proper Cost Accounting: Opportunities Forgone

Example: Ban on ozone depleting substances

The diverted resources necessary to develop the substitute products

The value of services of specialized capital and technology necessary to manufacture the banned products

Increased costs of production for the replacement product vis-à-vis the banned product/Differences in the retail price of the replacement product

Decline in the quality of the replacement product

Other Critiques

Preference satisfaction is not important/not important enough

Economic value doesn’t measure preferences

Social well-being is not the aggregate of individual well-being

Some things should not/cannot be priced

Other Issues in CBA

Equity integration Tax interaction effects

E.g., CBA and the Clean Air Act

Valuation of natural resources