Cost–benefit analysis
It is used to determine options which provide the best approach to achieving benefits while preserving savings in, for example, transactions, activities, and functional business requirements.
[1] A CBA may be used to compare completed or potential courses of action, and to estimate or evaluate the value against the cost of a decision, project, or policy.
Assuming an accurate CBA, changing the status quo by implementing the alternative with the lowest cost–benefit ratio can improve Pareto efficiency.
[8] The concept of CBA dates back to an 1848 article by Jules Dupuit, and was formalized in subsequent works by Alfred Marshall.
By taking the sum of each user's willingness to pay, Dupuit illustrated that the social benefit of the thing (bridge or road or canal) could be measured.
The Corps of Engineers initiated the use of CBA in the US, after the Federal Navigation Act of 1936 mandated cost–benefit analysis for proposed federal-waterway infrastructure.
[11] The Flood Control Act of 1939 was instrumental in establishing CBA as federal policy, requiring that "the benefits to whomever they accrue [be] in excess of the estimated costs.
[18] CBA was expanded to address the intangible and tangible benefits of public policies relating to mental illness,[19] substance abuse,[20] college education,[21] and chemical waste.
[22] In the US, the National Environmental Policy Act of 1969 required CBA for regulatory programs; since then, other governments have enacted similar rules.
The European Union's Developing Harmonised European Approaches for Transport Costing and Project Assessment (HEATCO) project, part of the EU's Sixth Framework Programme, reviewed transport appraisal guidance of EU member states and found significant national differences.
[30] US federal and state transport departments commonly apply CBA with a variety of software tools, including HERS, BCA.Net, StatBenCost, Cal-BC, and TREDIS.
[36] In health economics, CBA may be an inadequate measure because willingness-to-pay methods of determining the value of human life can be influenced by income level.
[39] It has been argued that if modern cost–benefit analyses had been applied to decisions such as whether to mandate the removal of lead from gasoline, block the construction of two proposed dams just above and below the Grand Canyon on the Colorado River, and regulate workers' exposure to vinyl chloride, the measures would not have been implemented (although all are considered highly successful).
The guiding principle of evaluating benefits is to list all parties affected by an intervention and add the positive or negative value (usually monetary) that they ascribe to its effect on their welfare.
[42] Survey respondents often misreport their true preferences, however, and market behavior does not provide information about important non-market welfare impacts.
Controversy can sometimes be avoided by using the related technique of cost–utility analysis, in which benefits are expressed in non-monetary units such as quality-adjusted life years.
In the 1980s, to ensure workers' safety, the US Supreme Court made an important decision to abandon the consideration of return on investment and instead seek the lowest cost-benefit to meet specific standards.
[45] Monetary values may also be assigned to other intangible effects such as business reputation, market penetration, or long-term enterprise strategy alignment.
CBA generally attempts to put all relevant costs and benefits on a common temporal footing, using time value of money calculations.
A generalization of these methods can be found in arbitrage pricing theory, which allows for an arbitrary number of risk premiums in the calculation of the required return.
Although CBA in US policy-making dates back several decades, Reagan's Executive Order 12291 mandated its use in the regulatory process.
Criticisms of CBA (including uncertainty valuations, discounting future values, and the calculation of risk) were used to argue that it should play no part in the regulatory process.
[52] The use of CBA in the regulatory process continued under the Obama administration, along with the debate about its practical and objective value.
As a concept in economics, cost-benefit analysis has provided a valuable reference for many public construction and governmental decisions, but its application has gradually revealed a number of drawbacks and limitations.
[53][54][55][56] in addition, relying solely on cost-benefit analysis may lead to neglecting the multifaceted value factors of a project.
This means, that positive net-benefits are decisive, independent of who benefits and who loses when a certain policy or project is put into place.
As a result, CBA can overlook concerns of equity and fairness, potentially favoring policies that disproportionately benefit certain groups while imposing burdens on others.
Phaneuf and Requate phrased it as follows "CBA today relies on the Kaldor-Hicks criteria to make statements about efficiency without addressing issues of income distribution.
This has allowed economists to stay silent on issues of equity, while focusing on the more familiar task of measuring costs and benefits".
[55][61][62] Some scholars argue that the use of discounting makes CBA biased against future generations, and understates the potential harmful impacts of climate change.
