For economists, a policy/program/project is justifiable in terms of public interest, and contributes to social welfare if the benefits, to whomever they accrue, outweigh the estimated costs. This approach is in line with the Kaldor-Hicks potential compensation principle, which is a very widely accepted variation of the Pareto criterion (Pareto efficiency is achieved when it is not possible to make some people better off without making others worse off). The Kaldor-Hicks principle only requires that the net gains from an action are positive. If society as a whole gains with the action, and if it is, at least in theory, possible to transfer some of the winners’ gains to the losers, then the project is considered in the interest of the public. CBA is intended to help decision-makers to identify projects/programs/policies with potential net gains by evaluating in monetary term all relevant costs and benefits.
There are several important steps in a CBA:
• Perspective: deciding on the perspective from which the study is to be done (e.g. societal, governmental, provider, payer, etc.);
• Project definition: specification of the main elements of the project and implications in terms of resource allocation (e.g. location, timing, groups involved, affected population and connections with other projects);
• Classification of impacts: determining the full range of consequences of the project, including a physical and quantitative description of the inputs and outputs (e.g. consumption of materials, emissions, effects on local employment levels, land occupation, etc.). This can be very difficult for policies;
• Conversion into monetary terms: placing monetary values, estimating the social costs and benefits of these inputs and outputs (including adjustments for inflation and shadow prices, meaning prices of items which are not in the market);
• Comparison of benefits and costs: the various costs and benefits over time are made commensurate through a process known as ‘discounting’, which converts them into what they would be worth today. The fundamental assumption is that future costs and benefits count for less than present ones. To calculate the present values of costs and benefits, it is important to select the appropriate discount rate, which is a difficult and sometimes controversial task (e.g. Field and Field, 2009);
• Project assessment: several indicators can be adopted to make judgements about the overall value of the action under study (e.g. net present value, benefit/cost ratio, distribution of costs and benefits). The relation between total benefits and total costs is not only a question of economic efficiency but also a political issue related to who reaps the benefits and who bears the costs.
The status and potential role of CBA in ecological economics is controversial, featuring several objections and criticisms (e.g. Baer and Spash, 2008; Spash, 2007; Vatn, 2000; Hanley and Spash, 1993). Historically, CBA was developed to evaluate well-defined small-scale projects, but even at the project level, there is often scepticism related to the necessary simplifications and assumptions. Scepticism increases when CBA is used for global-scale problems, where uncertainties about environmental problems, potential impacts and valuation raise additional challenges.
Objections to CBA are mainly related to the ethical choices and practical application involved. CBAs have been criticised on the basis of: (1) their inability to acknowledge value incommensurability; (2) distributional aspects (e.g. CBA treats gains and losses equally and is unconcerned with who gains and who loses), even assuming the possibility of appropriate compensation; (3) problems with discounting and accounting for future generations and non-human species; (4) their approach to dealing with risk, uncertainty, ignorance and ecosystem complexity, including non linear and stochastic (random) relations; (5) treatment of irreversibility; (6) lack of a strong sustainability criteria; and (7) their reliance on consumer values which are a limited subset of all values in society (e.g. citizen values).
Baer, P., Spash, C. (2008) Cost-Benefit Analysis of Climate Change: Stern revisited. Socio-Economics and the Environment Discussion CSIRO Working Paper Series 2008-07. May 2008. CSIRO, Australia.
Field, B., Field, M., (2009) Environmental Economics: an introduction, 5th edition, McGraw-Hill, New York.
Hanley, N., Spash, C. (1993) Cost-Benefit Analysis. Edward Elgar Publishers, Aldershot.
Spash, C. (2007) The Economics of Climate Change: The Stern Review. Environmental Values 16 (4): 532-535.
Vatn, A. (2000) The environment as commodity. Environmental Values 9 (4) 493- 509.
For further reading:
Common, M., Stagl, S., (2005) Ecological Economics – an introduction, Cambridge University Press, Cambridge.
Dixon, J.A., Scura, L.F., Carpenter, R.A., Sherman, P.B. (1998) Economic Analysis of Environmental Impacts. Earthscan Publications Ltd, London.
Martinez-Alier, J., Munda, G., O‘Neill, J. (1998) Weak comparability of values as a foundation for ecological economics. Ecological Economics, 26, 277–286.
Munasinghe; M.C., (1993) Environmental Economics and Sustainable Development. World Bank Environment Paper No.3. The World Bank, Washington DC.
Tietenberg, T., Lewis, L., (2009) Environmental and Natural Resource Economics, 8th edition, Pearson International Edition, Addison Wesley, Boston.
The environmental valuation and cost-benefit website [http://www.costbenefitanalysis.org]
Beneficial use values database [http://buvd.ucdavis.edu/]
Environmental valuation reference inventory [https://www.evri.ca/Global/Splash.aspx]
This glossary entry is based on a contribution by Rui Santos
EJOLT glossary editors: Hali Healy, Sylvia Lorek and Beatriz Rodríguez-Labajos