Cost-Benefit Analysis as Operationalized Neoclassical Economics: From Evidence to Folklore

By Argyrous, George | Journal of Australian Political Economy, Summer 2017 | Go to article overview

Cost-Benefit Analysis as Operationalized Neoclassical Economics: From Evidence to Folklore


Argyrous, George, Journal of Australian Political Economy


Neoclassical economics is an imposing theoretical edifice. But at another level it provides detailed operational guidance for public policy. At this operational level it is a technocratic tool that gives the appearance of scientific precision and evidence-based policy to underpin the day-to-day work that public servants do. This 'deep embeddedness' within the routine operation of government makes it difficult to dislodge the influence of neoclassical economics, even when it has been subjected to sustained theoretical critique, and even when there is a generalized sense that its impact on policy has been harmful. By providing tools that public officials use to resolve the workaday choices they confront, it becomes part of 'business as usual'; a set of 'engineering' instructions that are followed without much critical assessment.

One of the principal means by which neoclassical economics has achieved this embeddedness is through cost-benefit analysis (CBA). Governments across Australia now have guidelines that mandate the use of CBA for decision-making (see for example Commonwealth of Australia, 2006; NSW Treasury, 2017).

As a general principle, it is hard to argue with CBA: weigh up the costs and benefits of different options for achieving a particular objective, and choose the option for which the benefits most outweigh the costs. At this level, it imposes a discipline on public sector activity that appears largely beneficial, in that CBA:

* requires decision-makers to acknowledge that the same problem can be tackled through different means--there are options;

* recognises that all the costs and benefits of these choices should be taken into account--options should be evaluated in terms of their social impact rather than just on the immediate 'business case' for each.

From a political economic perspective, however, issues arise with CBA in so far as it adopts marginal utility theory as the principle upon which the costs and benefits are valued (usually in current dollar terms). (1) For example, whether to proceed with a road fatality reduction program by installing traffic lights or by building a roundabout will be judged in terms of the marginal consumer and producer surpluses that are gained or lost by each option relative to the other.

Previous criticism of CBA has focused on the conceptual difficulties of making social welfare judgments on the basis of aggregating individual utilities (Sen, 2000). The choice of the appropriate discount rate for 'telescoping' future costs and benefits into their 'current value equivalent is also contentious. So too is the question of how costs and benefits are distributed among different sections of the population. It is not only the aggregate value of costs and benefits that matters in what are inherently political decisions (see Stilwell 1999; Frank, 2000; and Argyrous, 2013, for an extensive discussion of these issues).

This article focuses on two further aspects of CBA that have a major bearing on its practical application. They are fundamental to the claim of neoclassical economics to act as an operational tool for public sector decision-making by providing dollar values enabling comparison of program options for public spending. The two issues are the so-called 'marginal excess burden of taxation' (MEBT) and the 'value of a statistical life' (VSL). It is argued that, in both instances, the default values that have been adopted in Australian CBA exercises are based on outdated data and methods. They serve a useful pragmatic function for policymakers, relieving public sector employees from doing the hard empirical work of constantly recalculating these values, while providing a superficial appearance of evidence-based decision-making. But the evidence is in fact folklore. Consequently, the decisions are unsound.

The value of a statistical life

Within the framework of neoclassical economics, everything has a price, including life itself, in so far as people will incur other economic costs to preserve it, or alternatively, accept an economic reward to put it at risk. …

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