Some limits of CBA

David Smith calls for the government to use more cost-benefit analysis. Such is the irrational way policy is made, there’s a case for doing so. However, CBA has some limitations:
1. It requires enormous computational power to get it right. Take NICE’s decision not to offer Velcade on the NHS. I suppose this was a correct decision, in a sense that Velcade is not cost-effective relative to other cancer drugs. But this is not the relevant comparison. The important question is: is Velcade cost-effective relative to the least cost-effective government spending anywhere else? The answer to this is almost certainly “yes.” But to apply this question to every single spending decision – every civil servant, every purchase – is just impossible.
2. Some long-run benefits and costs are unknowable. For example, in the years before anyone had heard of global warming, coal-fired power stations might have seemed a good idea.
What’s especially unknowable is the impact institutions have upon our preferences and character. For example, a strong argument for a freer market economy is that it encourages self-reliance and independence. But this benefit – if it accrues at all – takes decades to become evident.
3. Costs and benefits accrue to different people. Take a rise in the minimum wage. With the price-elasticity of demand for labour low, this benefits tax-payers, who gain from lower tax credit and benefit payments. But it hurts the least employable workers – those with mental illness or low intelligence – who can barely hold a job. How should we weight their costs against our benefits? It’s a cliché – because it’s true – that CBA can be blind to justice.
4. Who decides what policy options get considered? David gives the example of comparing three ways of reducing property crime. But a fourth possibility – corporal punishment – isn’t considered. Why not?
5. CBA is vulnerable to rent-seeking. Powerful bureaucrats can overstate the benefits of their departments – that’s how they became powerful in the first place. 
These are, of course, only a handful of the practical problems with CBA; more philosophical ones are discussed here and here.
CBA’s advocates, of course, say these quibbles only show that CBA must be used carefully. But isn’t it just idealistic to suppose this will be done? Rationalists can be impractical too.   

Comments

[Andrew Zalotocky]

Surely a CBA has to be "blind to justice" because its purpose is to tell us what the consequences of a given policy would be, not to make value judgements about whether the balance of costs and benefits is acceptable?

Another practical problem is that ministers can bias the CBA towards their own preferred conclusion, by how they set its terms of reference or who they appoint to do it. Instead of an impartial analysis of the available options it can be turned into a rationalisation for what they've already decided to do.

[Bob B]

There are wobbles with CBA:
http://www-pam.usc.edu/volume4/v4i1a3s1.html

There will always be scope for arguing over prospective benefits of, and detraction from, environmental amenities and a thorough CBA exercise - as with the economic assessment of options for a Third London Airport under the auspices of the Roskill Committee - can be very costly.

There is certainly cause to consider who will enjoy the project benefits and who will bear the costs. But in my experience, the brunt of the opposition to CBA usually comes from those who don't want to see a close, analytical examination of the issues and much prefer to hype up popular concerns. That is where we need to focus on the costs of rent-seeking behaviour.

[Mrs Trellis]

I wouldn't be too negative about CBA. It is more an issue about freedom of information - an obligation to do CBA ought to be a useful weapon to establish facts and to delineate these from opinions; it ought to be a useful mechanism for outsiders through which to dispute and debate policy options. Too often it isn't because (i) it appears too late in the debate as an ex post add on to justify a decision already taken, (ii) it ignores uncertainty - the FSA are classic in putting in zeros when the number is unknown and (iii) the information required to challenge the CBA is often not made available, conspiracy theorists might think deliberately.