The use of cost benefit analysis (CBA) in most governments as an environmental policy has gone through several stages and is becoming very important in decision making. The analysis provides information to aid public and the private managers who are considering any of the number of policies with social and consequences. CBA can enable these decision makers to understand, interpret and critique a particular analysis and thereby make informed decisions.
The CBA does not displace political decision making nor dictate the final decision. This is because it is designed to provide information and hence aid the public decision maker when choosing between policies. Rather it is one input in the decision making process, at the end, it is the decision makers responsibility to wrestle with difficult issues, weighing competing objectives and apply informed judgment to reach a final decision (Fuggiut & Wilcox). CBA offers a reasoned framework to help asses and priorities alternative policies according to their relative efficiency. It further measures individual preferences concerning the desirability which can be regarded as benefits and burdens (costs) of a given policy alternative. Furthermore, an important objective of economic policy is to improve the living standards which can imply increased level of consumption of good and services. This results in the scarcity of economic resources leading to a competition between the current consumption and future consumption. Freeman (2003) has shown this by indicating that naturally it is politically difficult to persuade the public to defer consumption because it is normally associated with unpopular policy measures such as higher taxes.
Many types of environmental impact are multidimensional in character. Hence an environmental asset that is affected by a proposed project or policy often will give rise to changes in component attributes each of which command distinct valuations. For every country that has development projects, they need to make good decisions on whether the projects will have costs and benefits, thus it is necessary to supplement such cost-effectiveness analysis with CBA tool to assist in policy making decisions. As defined by Pearce, Atkinson & Mourato (2006), CBA is a tool that economists use to determine whether a particular policy or policy proposal promotes economic efficiency. They further explain it as an aggregator of all impacts, to all affected parties, at all points in time. The impacts, both positive and negative, are converted into a common monetary unit, and the cost-benefit criterion is simply a test of whether the benefits exceed the costs. If the net benefits are positive, the policy promotes economic efficiency (Kotchen 2007).
Economic appraisal is undertaken to ensure that the best option to meet an objective is selected, taking account of both costs and benefits, including risk and uncertainty, as well as other policy objectives and constraints. A fundamental aspect of economic appraisal and why it differs from other appraisal methodologies such as Environmental Impact Assessment (but should not necessarily give rise to any incompatibility) is the definition of the impacts. By impacts we mean the impacts on the welfare of affected parties � as reflected in their preferences concerning these impacts. Economic appraisal is anthropocentric � as of course are decision-makers.
The environmental impacts may affect the welfare of many individuals who care about the environment, irrespective of their proximity to the river. This applies whether or not the impacts manifest themselves on marketed goods and services. Furthermore, welfare can be affected without any use being made of a particular environmental asset that might be affected. That is, impact on a cherished or important resource might have a deleterious effect on an individual's welfare simply by them being aware of the impact. This more accurate definition of welfare gives rise to two important conclusions for the role of economics in environmental decision-making:
Economics should not be seen in any way to be biased against the environment. Pollution matters and it is not something that proper economics treats as trivial or which is beyond economic reasoning or analysis. It follows that economic appraisal and decision-making should adopt this wider definition of welfare.
Projects and policies should not be judged solely or even primarily by their impact on GDP or market values. In relation to environmental regulation there will typically be an array of options confronting the decision-maker. Selection will entail comparison and trade off concerning the environmental, economic and social impacts. The key challenge is how these market and non-market factors should be integrated in the appraisal. Whether or not they are included on the same terms as conventional 'economic' aspects and reflected in monetary values, or considered in some other way, trade-offs will inevitably have to be made.
The environment and economics are inextricably intertwined since environmental decisions entail choices concerning the use of scarce resources and economics is essentially concerned with analysis of such choices. Demand for environmental protection or improvement entails use of scarce resources. Economic appraisal supports allocation of these resources in the most beneficial way.
Economic appraisal is rooted in conventional neo-classical welfare economics. Underpinning this are three key tenets, which in turn define the standard framework for economic appraisal, namely cost-benefit analysis (CBA). First, the preferences of individuals are what matter. Second, it is necessary to bring together or aggregate the (diverse) preferences of individuals to indicate the overall preferences of society. Third, that individual preferences are reflected in individual willingness to pay (or willingness to accept compensation) for goods and services.
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CBA has its roots in the middle of the nineteenth century, when economists started to link the theory of consumers' sur with the net gain of communities from government spending projects. The link between the sur theory and the indirect third-party losses and gains from capital projects was again revived in the 1930's in the United States with the United States Flood Control Act of 1936. That CBA should start in the USA in practice is not surprising, because academic economists secured links with the US government at an earlier stage than in any other country. The earliest application of CBA in the United Kingdom was only in 1960 in respect of the M1 motorway. In 1967, the British Government officially directed its nationalised industries to adopt CBA.
The increasing interest and application of CBA in recent times can be based on two distinct
factors: Firstly, public expenditure in the developed economies has risen substantially since World War II. Furthermore, in developing countries the need for infrastructure expenditures has
increased substantially, often financed by governments of developed countries and international aid agencies � requiring some "standardised" framework and method to evaluate these huge capital projects and minimise, as far as possible, the risk of failure. Secondly, such appraisal techniques were already fairly well developed in the private sector in the form of discounted cash flows (DCFs) and also allowing for identified risks and causal sensitivities. These two factors, have given impetus to the prevailing notion that the principle of efficiency should be extended to drastically increased government expenditures.
No technique for analyzing public policy is immune to criticism, and CBA is no exception. Nevertheless, CBA is perhaps the most widely applied and influential method of policy analysis. Many countries have specific guidelines for the conduct of regulatory impact analysis, and CBA typically plays a prominent role. In the United States, for example, CBA has been required since 1981 of all new regulations that impose significant costs or economic impacts. The existing statutory requirement is not that policies necessarily pass the cost-benefit test, but that CBA be used as a general accounting framework to highlight the range of impacts of proposed policies. Since 1993, the specific provision has been that the "benefits justify costs." In this capacity, CBA plays an important role in decision-making about environmental quality and public heath at the U.S. Environmental Protection Agency, along with other regulatory agencies.
The economic and political experiences in South Africa over the past three decades or so do not differ materially from the international one discussed above. The main difference between South Africa and other developing countries is to be found in the added pressures that the apartheid policy placed on scarce national resources. Since the 1970s, government expenditure as percentage of the gross domestic product (GDP) rose constantly, reaching high levels of 30 percent. Due to direct and indirect international economic sanctions, over time, the need for economic self-sufficiency and security, forced government to channel a disproportionate amount of resources for government use. This led to large budget deficits, high inflation and declining GDP growth.
The need for some kind of framework and method to evaluate spending priorities on a more rational and systematic basis arose. With the help of the then Office of the Prime Minister's Economic Advisor, the concept and practice of CBA was steadily promoted for use in state departments with the backing of the Finance department. In order to facilitate consistency and comparability it was decided in the mid-eighties to compile a manual for CBA.
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Cost Benefit Analysis: Concepts and Practice (3rd Edition). Prentice Hall.
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3. Matthew J. Kotchen, Cost Benefit Analysis
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Pearce, D. (2000). Controversies in environmental valuation. In McMahon, P. and Moran, D. (eds), Economic Valuation of Water Resources: Policy and Practice. London: Chartered Institution of Water and Environmental Management.
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