Efficiency Benefit-Cost Analysis
In Chapter 1 it was suggested that the word [social] in [social benefit-cost analysis] has a rather restricted interpretation: it refers to the group whose costs and benefits are to be calculated and compared by means of the analysis. Often the referent group consists of all the residents of a country or State, but sometimes the definition is a narrower one. We have used the term [efficiency] cost-benefit analysis to refer to a study which calculates all the benefits and costs of a proposed project, irrespective of who gains or loses. A benefit-cost analysis from an efficiency perspective tells us whether the project is an efficient use of resources in the sense that the gainers from the project could, in principle, compensate the losers.
As noted in Chapter 1, a project makes a difference and the purpose of the benefit-cost analysis is to identify and measure that difference using the [with and without] approach. Each person who benefits from the project could, potentially, give up a sum of money so that she remains at the same level of economic welfare as she would have had without the project; these sums are money measures of the project benefits. Similarly, each person who bears a net cost as a result of the project could, potentially, be paid a sufficient sum to keep her at the same level of well-being as she would have had without the project; these sums are money measures of the project costs. If the sum of the monies which could notionally be collected from beneficiaries exceeds that required to compensate those who are affected adversely by the project then the project is an efficient allocation of resources according to an economic welfare criterion known as the Kaldor–Hicks criterion, as discussed in Chapter 1. We will return to this concept in Chapter 7, but for the moment we simply note that a project which has a positive NPV in an efficiency benefit-cost analysis is an efficient use of resources according to this welfare criterion.
Before we consider how to appraise a project from an efficiency perspective we need to remind ourselves that, while the efficiency analysis will ignore the distributional consequences of the project, these are important in the decision-making process. First, the fact that the decision-maker has specified a particular subset of the economy as the referent group tells us that some groups [matter] more than others in the comparison of benefits and costs. Secondly, even if a project is inefficient from an overall perspective it may still be undertaken because of its positive aggregate net benefits to the referent group; as noted in Chapter 1, we will find it convenient to calculate net benefits to the referent group indirectly – by subtracting nonreferent group net benefits from efficiency net benefits – as well as directly. Thirdly, even if the social benefit-cost analysis indicates that the aggregate net benefits to the referent group are