Criticizing the Cost-Benefit Analysis: Strength, Weakness, and Political Interest

The cost-benefit analysis (CBA) in my opinion is a powerful tool in assisting a decision making process. However, it may not be the best tool available in assessing several environmental protection programmes. In this paper, I discussed about the strength and weakness of CBA. There are two strength points of CBA that is it increases efficiency and it provides an objective and transparent decision making process. The weaknesses are the problems of quantification, overstating costs, broadening inequality, and discounting practice. In the end of the paper, I include my reflection on empirical decision making practices in my country –Indonesia- where political interest often neglects the CBA results, and thus I think that in the country such as Indonesia, it is not the question of what is the best strategy for public welfare but which strategy is yielding greatest benefit for power holder (i.e. political party, president, ethnic group, etc).

The cost-benefit analysis follows economic principles that resources are scarce and they should be utilised wisely to increase net welfare. The cost-benefit analysis increases efficiency –at least theoretically- through better allocation of scarce resources –that is mostly concerning public funds- into projects that yield greater benefit among other various project opportunities. How is it happening? The basic idea is to value all projects by the same measurement that is in monetary term. In each project, the CBA quantify and monetize costs and benefits of the project and calculated the net worth / (loss) of the project. The CBA compares every project afterwards. The project that gives greatest net worth is usually selected and financed. By bringing the project’s effects into one measurement, the CBA makes it possible to compare projects social costs and social benefits.

It also provides a theoretically objective comparison among projects as it use the same standards. The CBA also requires analyst to reveal all the assumptions used in the analysis and thus making it a transparent process. As it makes decision making process more objective and transparent, then the CBA improves the accountability of decision making process.

The quantification of costs and benefits besides being CBA’s strength, it also in the same time becomes its’ weakness. In my opinion, there are two issues regarding the quantification problems that are the assumptions used in quantification and the unquantifiable of several benefits and costs.

In quantifying social aspects –no matter as costs or benefits- assumption is used in two ways, which are when we weighted the aspects and when we valued the aspects. The weighing is judged on preferences and these preferences can differ among groups in society, analysts, regions, and time frames. Thus, I think that judging something based on preference is not fully trustable. In valuing the social aspects, analysts may use several ways such as “willingness to pay” (WTP) or “willingness to accept” (WTA). However, I think not every social aspect can be valued correctly for example the life. This brings me to the second issue in quantification that is the unquantifiable of several benefits and costs. It is unquantifiable due to its natures (i.e. uncertainty and lack of information) and ethical considerations.

The second weakness is costs overstatement. It can come from the way the costs are estimated, the size of the projects or action needed, and the cost factors (i.e to include costs that are irrelevant to the project). Empirically, the costs and benefits can be overstated [1]. As it can be overstated, it means that inaccuracies happened and thus CBA’s result should be treated with caution.

Like the neoclassical concern that is optimization, the CBA deals only with optimal allocation of scarce resources, yet it does not taking into account the distribution problems. For example consider two projects that are to provide drinking water to poor people and to clean a park in rich people dwellings; both projects give the same net worth. If government makes decision based only on CBA, then it may select the cleaning project instead of drinking water project. CBA calculates the benefits and costs aggregately, so that it does not matter who bear the costs and who enjoy the benefit. Another example, suppose government has a plan to build a new railway passing through poor neighbourhood where the beneficiaries of the new railway are rich people. It can be that the project creates benefits for the rich at the costs of the poor neighbourhood –such as moving out their house or noise pollution-. Thus, CBA, in this case, is broadening the existing inequality. Meanwhile, any public policy should ideally take equality as an important aspect. The problem also occurs in calculating WTP or WTA as the rich may have higher WTP –they have more money- than of the poor to get rid disadvantaging projects from them.

The last CBA’s weakness that I discussed here is regarding the discounting practice. The idea is developed from an economic perspective that money value changed as time changed taking into consideration the inflation, economic growth, and opportunity costs. I agree that we should use discounting to evaluate investment opportunities. However, I think that environment projects should not be treated as investment projects in term of profit seeking motive. Environmental problems are delicate as they are mostly irreversible and need a long-term recovery process. Furthermore, by discounting future benefits and costs, it is as if we regard future generation as less important than of present generation. For example, the value of providing health services is 100 babies –I do not use monetary value for the sake of intensifying my reason- in the next year, with “r” is 10% the present value of health services is 91 babies only. It means that we value 100 babies in the next year equal to 91 babies in this year and thus 9 babies are discarded. Then the ethical and rhetorical question is “are future beings less valuable compare to present beings?”

For the last argument, I want to relate CBA and real life conditions such as in Indonesia. Indonesia in brief has ill-defined property rights and corruption is eminent. Although CBA try to internalise externalities (i.e. pricing the “non-marketable goods”), it usually collides with corruption practices such as bribery and favouritism. Projects had usually been agreed / selected without even having run any CBA. Furthermore, CBA result is often neglected in decision making process especially when the CBA’s suggestion is in contrary to political/power-holder interest. For example, a project to build a bridge may be selected because the area where the bridge is build is the region that supports him/her to be in power, not because the bridge provides net worth to the greater society. In Indonesia, the common practice of “repaying support” is by building infrastructure such as asphalting the roads and erecting a mosque/church/temple. It is hoped that by doing so, the inhabitant will be loyal to him/her and choose him/her again in the next election. In my personal reflection, CBA is defeated by political/individual interests in my country. The CBA itself is not trustable as the analyst can be “bought” (i.e. ordered to write in favour of the client instead of society) by anyone.

The cost-benefit analysis is indeed a powerful tool, yet it is not a panacea or one-solution-fit-all for environmental problems. It has to be treated with caution. Especially in developing country, CBA is only a formality and thus CBA’s result is not trustable.

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[1] Bent Flyvbjerg, Mette K. Skamris Holm, and Søren L. Buhl, "Underestimating Costs in Public Works Projects: Error or Lie?" Journal of the American Planning Association, vol. 68, no. 3, Summer 2002, pp. 279-295. And: Bent Flyvbjerg, Mette K. Skamris Holm, and Søren L. Buhl, "How (In)accurate Are Demand Forecasts in Public Works Projects? The Case of Transportation." Journal of the American Planning Association, vol. 71, no. 2, Spring 2005, pp. 131-146. Both were taken from Wikipedia. Cost-Benefit Analysis, http://en.wikipedia.org/wiki/Cost-benefit_analysis.