Cost–Benefit Analysis, 5th edition
Preface to the fifth edition ix
Scope and method 1
1 Introductory remarks 3
2 Cost-effective analysis 8
3 Proposals for weighting money valuations 11
Basic concepts of benefits and costs 21
4 Measurements of consumer surplus 23
5 Consumer surplus when several prices change 32
6 Consumer surplus when other things change 39
7 Introduction to the compensating variation 45
8 Measurements of rent 49
9 Is producer surplus a rent? 55
Shadow prices and transfer payments 59
10 Introductory remarks 61
11 Opportunity cost of labour 64
12 Opportunity cost of unemployed labour 69
13 The additional benefits of using unemployed labour 72
14 The opportunity costs of imports 76
15 Transfer payments and double counting 81
External effects 85
16 Introduction to external effects 87
17 Adverse spillovers: the complacent view 94
18 Internalizing externalities 99
19 Evaluating spillovers 104
20 Compensating for environmental damage 111
Investment criteria 119
21 Introduction to investment criteria 121
22 Crude investment criteria 125
23 The discounted present value criterion 129
24 The internal rate of return 135
25 The alleged superiority of the discounted present value
criterion compared with the internal rate of return criterion 139
26 Investment criteria in an ideal capital market 147
27 Calculation of rates of returnan d of time preference 149
28 Critique of the discounted present value criterion (I) 153
29 Critique of the discounted present value criterion (II) 158
30 The normalized compounded terminal value criterion (I) 162
31 The normalized compounded terminal value criterion (II) 167
32 The Pareto criterion and generational time 171
Notes on particular goods 177
33 The value of time saved 179
34 Measuring the benefits of recreational areas (I) 183
35 Measuring the benefits of recreational areas (II) 189
36 The value of life 194
37 Risk and certainty equivalence 205
38 Game theory and decision rules (I) 208
39 Game theory and decision rules (II) 212
40 How practical are game theory decision techniques? 218
41 Simple probability indecision making 221
42 Mixed strategies indecision making 224
43 Four additional strategems for coping with uncertainty 228
Further notes 237
44 A summing up 239
Appendix 1: Brief historical background to CBA 243
Appendix 2: The normative interpretation of a CBA 245
Appendix 3: The alleged contradiction of the Kaldor–Hicks criterion 247
Appendix 4: The problem of second-best 251
Appendix 5: Origins of the Hicksian measures of consumer surplus 255
Appendix 6: Marginal curve measures of consumer surplus 260
Appendix 7: The concept and measure of rent 267
Appendix 8: Marginal curve measure of rent 272
Appendix 9: The limited applicability of property rights 277
Appendix 10: The rate of time preference 279
Appendix 11: Selecting a set of investment projects for given political objectives 282
Appendix 12: The value of human life 286
Appendix 13: Deadweight loss or love’s labour lost 288
Appendix 14: CBA and the problem of locating
environmentally noxious facilities – an informal discussion 292
Bibliography and further reading 302
Preface to the fifth edition:
Following precedent, this fifth edition of Cost–Benefit Analysis addresses itself primarily to the ‘mature student’, at least to the conscientious student, who is primarily concerned with understanding the rationale and the limitations of basic methods. The exposition, however, continues to remain informal, proceeding in the main through numerical illustrations and with only occasional recourse to simple notation.
Economists familiar with the fourth edition will at once notice that the several simplified examples of cost–benefit calculations, presented in its introductory Part I, have now been removed. At the time when the first edition was being prepared (1970), cost–benefit analysis was not so familiar a subject, and few economics departments included it in their list of courses. It seemed then advisable to prepare the students’ minds for the need of the various techniques that were to follow. With the passage of time, we must recognize that initial presentations of simplified cost–benefit examples are no longer necessary.
In this new edition, therefore, we have reverted to the more traditional practice of beginning a textbook with an introductory Part I on Scope and method; in our case, a decision that has required, inter alia, the removal of some chapters of the fourth edition, and parts of some other chapters, to this introductory Part I, where they are now more comfortably lodged, for it is incumbent in this Part I that the authors make clear just how the economist’s conceptions of costs and benefits differ from those employed in the business world. To the layman and the politician, the notion of gains and losses may seem evident enough for transactions between a limited number of people. It is far from evident, however, when calculations of gains and losses have to be made for whole communities, whether or not the individuals are directly engaged in some project or programme.
As for the remaining parts in this fifth edition, apart from correcting some minor errors in the fourth edition, some rearrangement of the chapters has taken place and, occasionally, what appeared there as two consecutive chapters has been combined here to form a single chapter: all this, and more, in the endeavour to make the expositioninthis new editionmore lucid and concise.
It may be noted, in particular, that Part IV (on ‘External effects’) now ends with anexten ded chapter in which the possibly quite different outcomes from using a calculation based on the CV21 measure, instead of the CV12 measure, are elaborated and illustrated. Again, in our Part V (on ‘Investment criteria’), a searching comparison of the implications and the limitations of the various criteria in common use cannot be undertaken without taking up far more space than any of the other parts. In this connection, the two chapters devoted to explaining the proposed normalization procedure (in compounding net benefits forward to a terminal date), regarded as a technique superior to any of the popular discounted-present-value criteria for evaluating a stream of net benefits, have been entirely re-written to make it more comprehensible.
After much reflection, it seemed to us that some of the chapters in the fourth edition, inparticular that on the Scitovsky Paradox and that onSecon d-Best, would be better relegated to expanded Appendices. There they are included with a number of other Appendices that, although not central to a proper exposition of cost–benefit analysis, touch on sources of misunderstanding or of common error insome popular treatments of the subject.
It may be unnecessary to remark that no significant theoretical novelty is to be found in this edition, or indeed in earlier editions. Inasmuch as cost–benefit analysis is, in fact, no more than an assembly of concepts and techniques culled from mainstream economic theory, in particular from that branch known as Welfare Economics, it is not surprising that the subject itself cannot boast of theoretical innovation.
Apart from proposals for the gathering and refinement of data, the development of cost–benefit analysis over the years has centred, in the main, on controversies over the propriety of concepts, over proxies for their measurement and over the appropriateness of the techniques employed to determine the ranking of alternative public projects. With regard to all such issues, our overriding concern remains that of examining the validity of the key concepts in use, of making explicit the limitations of the usual proxies adopted for their measurement and of checking for consistency the various techniques employed in any cost–benefit calculation. We are aware, of course, that although purporting to be both a guide to, and a critique of, cost–benefit methods, this resulting volume is somewhat slimmer than other popular cost–benefit manuals. There are several reasons for this. One is that we are studiously economical in our choice of tables, diagrams and other such schema that seem to exert a fascination on some writers. Another is that we do not undertake to test the reader’s understanding of the material in each chapter by including pages of questions (and answers). Although we do not deny that repeated elaboration of such features can be helpful in impressing on the more plastic minds of beginners who are eager to be inducted into ‘the mysteries of the craft’, there is always the danger that the sheer mass of material and formulae in these bulkier manuals may also act to intimidate or to bewilder hapless students so that, in the end, they ‘cannot see the woods for the trees’.
We also note that, in some of the more ambitious textbooks, there are extended reports of cost–benefit studies already undertaken for existing programmes or projects. Their value, however, is limited unless the methods used in such studies are also subjected to fastidious examination. Since this, in fact, is not the case, the reader might like to know that a companion volume to this fifth edition is currently being prepared, one that, indeed, subjects the selected case studies to critical assessment.
The co-author of this fifth edition, Professor Euston Quah, needs no introduction to economists who keep abreast of the growing literature in Environmental Economics. He is currently editor of The Singapore Economic Review and, in the past few years, has been active in arranging cost–benefit courses for the cohorts of economics students at the National University of Singapore: courses that have been based on the material now contained in the present edition, which has, incidentally, benefited from students’ ‘feedback’. We should like to acknowledge Dr Lim Boon Tiong from the National University of Singapore for his invaluable advice, as well as Mr Lim Sze How for all the fieldwork and multitude of tasks that he has undertaken in the course of writing and organizing the material used in this book, and it is indeed to his credit that things got organized.We should also like to thank Ms Khatini binte Anuar for much of the secretarial work that accompanied this project and, last but not least, we must thank Robert Langham and colleagues at Routledge for their suggestions and support throughout.