Equity through a cost-benefit lens
CBA can provide insights on equity. But CBA isn't a substitute for a more comprehensive analysis of equity-related issues.
Cost-benefit analysis (CBA), as taught and used in economics, law and public policy, evaluates the Kaldor-Hicks efficiency of policies and programs. That is, do those policies and programs result in a bigger pie for society overall, regardless of how shares in the pie are distributed?1
Distributive fairness can be acknowledged or discussed in a CBA, but isn’t explicitly evaluated within the core analysis. Indeed, where the primary goal of a policy is redistribution, through transfers such as progressive income taxes or welfare benefits, it is widely understood that CBA is not a relevant method to use. That’s because it evaluates net benefits and not distributive impacts.
CBA can be adapted to look at equity in useful (but limited) ways. Economists have developed ways of exploring equity in CBA, including:
Subgroup analysis: Conducting the analysis from two or more perspectives to understand how costs and benefits affect different groups (e.g. land owners and tenants)
Wealth adjustment weights: Weighting costs and benefits to adjust for wealth-based differences in the marginal value of money (the first dollar you receive is extremely valuable because it’s all the money you have in the world; as your wealth increases, the value of adding one more dollar diminishes)
Normative weights: Adding extra weights to include normative distributional objectives (e.g. to up-weight benefits that reach intended recipients and down-weight benefits received by people outside of the intended target groups).
Subgroup analysis
Like oil and water, some values don’t mix. When using CBA we need to take care not to lose sight of differing perspectives (e.g. millennials vs. boomers, urban vs. rural, powerful majority vs. marginalised minority, etc). This is especially important where different groups might have different values that conflict with each other - like this example in an earlier post.
A series of CBAs can be conducted to look at costs and benefits from the perspectives of different subgroups in society (sometimes called multiple-account CBA), to understand who bears the costs and who enjoys the benefits. By estimating different Net Present Values for different subgroups, our analysis can contribute important evidence for decision-makers - e.g., by clarifying tensions between different sets of interests. Subgroup analysis of costs and benefits can give us insights that we would otherwise miss.
Equity weights
Theorists have also argued that CBA should be modified to incorporate equity weights. Just as costs and benefits are weighted to adjust for differential timing, and sometimes for probability or risk, further weights can be applied to adjust values for equity-related reasons.
We can conceptualise two different layers of distributional adjustment: wealth adjustment weights, and normative weights.
a) Wealth adjustment weights
The first layer of distributional adjustment is concerned with improving the accuracy of CBA in valuing costs and benefits to different socio-economic groups, by adjusting for differences in the marginal value of money. At the margin, one extra dollar is more valuable to a poor person than a wealthy one, because of its relative scarcity. As an alternative to valuing all dollars equally (the default practice in CBA), valuations can be re-weighted to adjust for differences in wealth (this is only an issue because CBA uses money as a proxy for wellbeing).
This kind of adjustment turns out to be methodologically challenging. According to some theorists, “there does not seem to be a reliable way of determining people’s marginal utility of money” and consequently, “welfare economists have not proposed a practical way of determining the appropriate method of weighting”.
Nonetheless, from a pragmatic standpoint, we can observe that wealth adjustment weights are produced and used (e.g., see Annex 3 in the UK Treasury’s Green Book). Indeed in the US right now, the Office of Regulatory Affairs is revising its guidance to weight costs and benefits depending on the income of the person affected. Check out this excellent article on the topic by Jerry Cayford, which explains the rationale, issues and challenges in greater depth.
b) Normative weights
A second layer of distributional adjustment could involve weighting valuations to incorporate normative goals. For example, a policy or program might be justified on equity grounds, even if it doesn’t increase aggregate welfare. By valuing benefits and costs according to their incidence (that is, who they affect), policies that benefit intended target groups could be assigned proportionately greater value than policies that benefit others. Similarly, the discount rate could be modified to adjust for intergenerational equity.
These adjustments would need a sound empirical basis for setting and justifying the weights used.
Conceptually, distributional weights could be derived by measuring and monetising the value people place on equity – a departure from the standard CBA approach. But how should we measure this? People’s altruistic preferences, given their beliefs and life circumstances? The impact of altruism on their life satisfaction? Their hypothetical values under a Rawlsian ‘veil of ignorance’? A communitarian approach? Or something else? Depending which approach we use, we might well end up with different results.
And there’s a deeper question: Is the aggregative ‘voting’ system inherent in CBA the way we should evaluate equity, or is a different process more appropriate, such as public dialogue and debate?
Although distributional weighting may not be an exact science, I do see value (in some circumstances) in subjecting weights to sensitivity, scenario and break-even analysis to determine to what extent equity weighting might alter our conclusion in a CBA, or how far we have to skew weights toward benefits for priority groups in order to produce a favourable result. This approach can’t provide a “right” answer but could provide useful intel to inform decision-making.
So… can CBA evaluate equity?
Subgroup analysis, wealth adjustment, and normative weighting can all be valid, informative and worthwhile analytical options. They offer ways of thinking about distributive impacts that can bring a fresh perspective and inform sound decisions.
However, in my view, they supplement and can’t replace more comprehensive analysis of equity-related issues such as power, privilege, inclusion, diversity, decolonisation, self-determination, social and distributive justice.
The principal criterion that CBA focuses on is a goal of maximising total welfare, with equity being a peripheral concern. Moreover, contemporary evaluations of CBA by leading theorists have argued that this is precisely what CBA should do: stick to its knitting and provide a sound estimate of total welfare while leaving wider considerations to other methods.
This is not by any means an objection to the use of CBA, though it may be a reason not to rely on CBA alone.
If you’re looking for an approach to help you provide rigorous answers to value for money questions, taking equity and efficiency (and other criteria) into account, harnessing the strengths of CBA without limiting the analysis to economic methods and metrics, guided by a practical reasoning process that helps you reach clear evaluative conclusions without getting lost in the weeds, check out the Value for Investment system and subscribe below to stay up to date.
Thanks to Charles Sullivan for peer review of this post. Errors or omissions are mine.
Adapted from King, J. (2019). Evaluation and Value for Money: Development of an approach using explicit evaluative reasoning. (Doctoral dissertation). Melbourne, Australia: University of Melbourne.
Kaldor-Hicks efficiency is an elaboration on Pareto efficiency. An allocation of resources is said to be Pareto-efficient if there is no alternative allocation in which one person can be made better off without making somebody else worse off. The Pareto criterion is too restrictive to be practical for evaluating real-world policy proposals, which usually produce winners and losers. Kaldor (1939) modified the Pareto criterion by arguing that for an action to be in the public interest, those who gain from it should be able (in principle) to compensate those who lose from it, and still find the action worthwhile. However, the compensation does not actually have to take place. Hicks (1939) added that the losers must not be able to bribe the winners to forego the action. For a lucid explanation of how Kaldor-Hicks efficiency came about, see this.