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Cost-Benefit Analysis

This problem is reinforced when we turn to the specific method of direct calculation favored by economic realists: standard economic cost-benefit analysis. Before assessing this, let us set aside a common confusion. The phrase “cost-benefit analysis” is used in different ways. First, it can refer to any kind of analysis that tries to pick out the positive and negative aspects of a given course of action or policy. Let us call this, “pros and cons analysis” (“PCA”). This usage seems deflationary. Arguably, all ethical analysis involves identifying “pros and cons” of some sort;

hence, endorsing “cost-benefit analysis” of this form merely amounts to endorsing analysis.

A second use of “cost-benefit analysis” refers to a method for choosing between policies based on which yields the highest net benefits. Call this “net benefit analysis” (NBA). NBA goes beyond PCA. It assumes “pros and cons” that are directly comparable in such a way that it makes sense to speak of a “net” benefit: that which is left over when the costs are subtracted from the benefits. Net benefit analysis is seriously controversial. For instance, many rights theorists would object to analyzing a situation involving a rights violation by counting the violation as a “cost” to the victim to be weighed against the “benefits” to the perpetrator. They do not, for example, analyze a lynching by weighing the cost to the victim against the benefits to the racists, and then producing an overall calculation of net benefit. Instead, they want to say that no “weighing” should be done: the rights of the victim are decisive, and whatever joy racists may get from lynching has no status.

The third form of CBA refers to a specific conception of net benefit analysis that relies on a set of distinctive techniques within contemporary economic theory: e.g., costs and benefits are to be understood in terms of “willingness to pay,” as expressed in standard market prices (or proxies for them), assessed in terms of their net present value, and mediated through a standard positive discount rate. Call this, “market cost-benefit analysis” (“market CBA”).

Market CBA is very far from “pros and cons” analysis. Consider a few standard criticisms. First, market CBA is very narrow, and so biased against some concerns. The focus on willingness to pay limits the benefits and costs that can be considered to those whose value can be expressed in economic terms. This skews the overall evaluation toward short-term consumption and individualistic values, rather than wider concerns, such as those bound up with communal, aesthetic, spiritual, environmental, and nonhuman values. For example, consider the outrage in the 90’s when economists evaluated lives lost due to climate change in terms of foregone income, with the predictable result that lives (and especially deaths) in poorer nations counted for much less in their market CBA than those in richer nations.40

Second, as Mark Sagoff argues, market CBA rests on a “category mistake”41: reducing all values to matters of preference as measured by market prices confuses mere preferences, whose significance might perhaps be measured in terms of the intensity with which they are held, with values, whose import should be assessed in terms of the reasons that support them. For example, just as we should not evaluate mathematical claims (such as 2 + 2 = 4) by asking how strongly mathematicians feel about them (or, more specifically, how much they would be willing to pay for the rest of us to accept them), so (Sagoff says) we should not evaluate ethical claims in these ways. To do so misunderstands the point of both ethics and mathematics.

Third, despite its initial appearance of impartiality, market CBA is an essentially undemocratic decision procedure. For one thing, each person’s influence is determined by how much they would be willing to pay for a given outcome. Yet this is profoundly influenced by the resources at their disposal. (For example, Bill Gates is willing to give more to almost any cause he is interested in than I am even to my favorite.) In addition, in practice CBAs are generated by “experts”: people who amass market, survey, and other information, and then distill and interpret it for their audience. Since an analyst must make a large number of decisions about the scope of a market CBA, the data relevant to it, and how the results are integrated, her preferences and values play a large role in shaping the outcome.

The role of the analyst is especially important in the climate case. For one thing, most of the relevant cost-benefit information is unavailable. For example, we lack realistic market prices for events that will play out over the next several centuries, since the historical uncertainties are so large. Consequently, the role for personal judgment and values to intervene becomes very large. In light of this, John Broome, a defender of CBA in normal contexts, goes so far as to say that for climate: “Cost-benefit analysis ... would simply be self-deception.”42 For another thing, Broome complains that Nordhaus’s CBA is based on the assumption that “everything will be much as it is now, but a bit hotter,” which he finds complacent: “I think we must expect global warming to have a profound effect on history, rather than a negligible effect on national income.”43

A fourth concern brings us to arguably the most contentious issue between mainstream climate ethics and climate economics: that of how to treat future generations. Market CBA employs a substantial positive “social discount rate” (SDR). Discounting is “a method used by economists to determine the dollar value today of costs and benefits in the future. Future monetary values are weighted by a value <1, or “discounted” .” The SDR is the rate of discounting: “Typically, any benefit (or cost), B (or C), accruing in T years’ time is recorded as having a ‘present’ value, PV of: PV(B) = BT/(1 + r)T.” In public policy in general, the rates used vary, typically between 2%-10%. For climate change, traditional models employ rates of around 5% (for example, Nordhaus uses 5.5%44 ; similarly Posner and Weisbach advocate discounting at the market rate of return).45

Social discount rates reduce the weight of future costs and benefits relative to current costs and benefits. Given the effects of compounding, this has profound effects in the evaluation of very long-term issues, such as climate change. For instance, at 1%, 1 benefit is equal to 2.7 in 100 years; at 5% it is 131.5; at 10%, 13,780.6. Clearly, the choice of SDR matters. For example, suppose we were trying to decide whether to pursue a project with costs of $10 million this year, and benefits of $100 million in one hundred years. With a discount rate of 5%, this project is not justified; with a rate of 1%, it is.

Discounting is the most controversial issue in climate economics. One reason is indeterminacy. Harvard economist Martin Weitzman tells us “no consensus now exists, or for that matter has ever existed, about what actual rate of interest to use,” and the results of CBA on long-term projects are “notoriously hypersensitive” to the rate chosen.46

A second reason is dominance. For all their sophistication in other respects, economic models of climate change are largely driven by the single number they use to assess the future. For instance, critics of Nordhaus often claim that his choice of SDR effectively swamps the contribution of the other components of his model (e.g., the damage function), rendering them irrelevant.47 Similarly, Nordhaus complains that the very different conclusions reached by his rival, Nicholas Stern, arise “because of an extreme assumption about discounting ... a social discount rate that is essentially zero.”48 Dominance is a deep problem from the point of view of intergenerational ethics. Given the theoretical storm, the idea that future people could be dealt with by a single number in a relatively simple economic equation is ethically astounding.

The third reason for the controversy is, however, the deepest: the SDR lacks a clear, overarching rationale, and the underlying issues are often ethical. In my view, discounting is primarily a practice: it is what economists do to costs and benefits that occur to the future in order to assign them a current value. Different rationales are offered for this practice under different circumstances. These include appeals to economic growth, pure time preference, democracy, probability, opportunity costs, excessive sacrifice, special relations, and the idea that our successors will be better off. It would be worth addressing each of these rationales independently. However, here I will merely emphasize that they often pull in different directions, and all are vulnerable to serious objections in at least some contexts, especially when assessing the long-term future.49 Most importantly, many of the rationales, and especially the most influential, involve ethical claims, such as that the future should pay for climate action because it will be richer, or that not discounting at a positive rate demands an excessive sacrifice of current generations, or that respect for democracy requires accepting that the current generation is allowed to discriminate against future generations.50 Consequently, an analyst’s choice of discount rate usually rests on a variety of ethical decisions about these issues. Market CBA is far from an “ethics-free zone.”

To sum up, Chicago “welfarism” is a complex and controversial ethical doctrine. Not only does it reflect philosophical utilitarianism, which many reject, but in policy settings it typically embodies a form of utilitarianism (market CBA), which many utilitarians reject. Consequently, economic realists who embrace “welfarism” cannot escape engagement with moral and political philosophy.

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