Climate change and the re-evaluation of cost-benefit analysis

Climatic Change DOI 10.1007/s10584-017-2047-4 Climate change and the re-evaluation of cost-benefit analysis Francis Dennig1 Received: 5 August 2015 / Accepted: 24 July 2017 © The Author(s) 2017. This article is an open access publication Abstract The evaluation of climate policy has emerged as an important application of cost-benefit analysis (CBA). But the tool, as it had been most widely used previously, was not suited for this problem. Spatially, the effects of climate change transcend national boundaries and, temporally, they transcend generational time scales. CBA, in its standard form, relies on assumptions that are not fully appropriate in this context. In this essay, I discuss the shortcomings of CBA framed by its historical development and argue that its relatively recent application to climate change has contributed to growth in the literature re-evaluating its normative foundations. In relation to discounting, recent innovations emphasise aspects such as the aggregation of a multiplicity of time preferences and the distinction between inter- and intra-generational time preferences, which lead to discounting approaches that differ from the standard approach with the Ramsey equation. In relation to spatial equity, much of the recent literature argues for the use of equity weights to account for impacts on different income groups. These are significant changes relative to the orthodoxy in the field before the emergence of climate change. 1 Introduction At the turn of the century, the eminent economist Tony Atkinson lamented the “strange disappearance of welfare economics”—Atkinson (2001). He was referring to the fact that the study of normative foundations of economics was no longer regarded as an essential part of the economics curriculum and that, consequently, there was little ongoing critical analysis of the normative aspects of economic analysis. He documents this through a sweeping case This article is part of a Special Issue on “Historicizing Climate Change” edited by Melissa Lane, John R. McNeill, Robert H. Socolow, Sverker Sörlin  Francis Dennig 1 Yale-NUS College, Singapore, Singapore Climatic Change study of macroeconomics from the 1970s through to the 1990s, but would have observed the same phenomenon had he considered the subject of cost-benefit analysis. In this essay, I will argue that climate change may be causing a “reappearance” of normative analysis, as the application of cost-benefit analysis to climate policy has led to renewed interest in normative foundations. This process is generating interesting new alternatives to the standard approach of cost-benefit analysis (CBA). In due time, the economics curriculum might also catch up and the process of disappearance identified by Professor Atkinson may be reversed. As with all questions involving consequential value judgements, the standard approach to cost-benefit analysis up to the beginning of the 1990s was a compromise between different views. There were interpretational differences amongst practitioners, and some cracks in the foundations, but there was a broad consensus that this particular approach to cost-benefit analysis was appropriate for a range of policy questions. This compromise resulted in CBA becoming a very successful tool for policy evaluation. In the USA, for example, Executive order 12291 mandates its use in the federal regulatory process. Especially for environmental regulation, it is used ubiquitously and entrenched in the evaluation process of international organisations such as the UNO, the World Bank Group, and the OECD.1 But since the first applications of CBA to climate change in the 1990s the long held consensus has begun to fade.2 Two aspects in particular have been the target of the emerging critical analysis in relation to climate change. The practice of valuing (contemporary) dollar impacts equally, regardless of the economic status of the affected, and the discounting of future impacts at observed market interest rates. Climate policy was a natural breaking point for those two practices in particular. Its spatial and temporal scopes are greater than those of any previous policy question, and it was the limited scope along these dimensions that provided much of the rationale for the compromise underpinning the previously existing consensus. The application of CBA to climate change laid these issues bare, prompting new as well as recycled critical analysis. This process is resulting in better understanding of the normative foundations of policy evaluation and even some revision of the existing orthodoxy. I illustrate this process by tracing the historical development of cost-benefit analysis.3 In doing so, I will highlight the previous debates on normative issues, describe their (tentative) resolutions, and explain why those didn’t survive intact the contact with climate change. 2 New welfare economics and interpersonal comparisons The basic normative question in economics is how to weigh costs and benefits against each other when alternative policies impose these on different individuals. There is widespread agreement in the profession that any contending method must take individual preferences as the basic source of value.4 As different individuals (or groups) value things differently, 1 These organisations contributed to the development and establishment of cost-benefit analysis as sponsors of the early manuals, Little and Mirrlees (1974) and Marglin et al. (1972). 2 William Nordhaus’ earliest contributions to climate change economics date from 1990 – Nordhaus (1990a, b). 3A more complete account of the historical development is given in Gowdy (2004). 4 This view is known as consumer sovereignty—see Lerner (1972) for a defence and Scitovsky (1962) for a critique of this approach. This anthropocentric view leaves no room for valuation of the welfare of nonhuman animals over and above the value humans put on them. As we shall see later, the standard approach to cost-benefit analysis treats currently unborn humans similarly, in that the only way their welfare enters the valuation is through the value this generation places on its own future consumption. Climatic Change there is a source of conflict in the establishment of what is valuable. The resolution of this conflict is the main task of normative analysis. Classical (nineteenth century) economists were in broad agreement that it was legitimate to resolve this conflict by comparing utility across individuals—Mill (1901). If it were possible to agree on the utility scale to be used, it could be said that policies which generate a greater sum of utilities are preferred to policies that generate a smaller sum. With the development of positive economics in the early twentieth century came the realisation that such judgements were based on quantities that are not measurable according to an agreed-upon scale. It could therefore not properly be the subject of economic science, as the field bega (...truncated)