Thursday, December 18, 2014

Cost-benefit analysis as "unacceptable nonsense"

Little, I.M.D.. Ethics, Economics, and Politics: Some Principles of Public Policy, 2002:
Cost-benefit analysis compares states of affairs with and without the project that is being analysed. It is applied welfare economics. Indeed it comprises almost all that is of interest in applying welfare economics. (p. 22)
Doubtless influenced to some extent by Robbins, economists gave up the idea of cardinal utility, claiming that all the propositions of positive demand theory could be derived from ordinal utility. They even tried to base normative economics on ordinal utility and the incommensurability of individual utilities. Thus one state of affairs was held to be better than another if those who gained could overcompensate those who lost. This was unacceptable nonsense, as was soon pointed out. However, the idea of compensation, and its possibility or otherwise, has remained important in applied welfare economics (that is, cost-benefit analysis...). (p. 11)
Little misinterpreted Robbins's 1938 article, which Robbins characterized as "a long story about the genesis of two or three pages in an essay that was written some time ago, and which was never expected to be the subject of much discussion." Robbins wasn't advocating the abandonment of interpersonal comparisons of utility. Rather he was arguing that it was not helpful "to speak as if interpersonal comparisons of utility rest upon scientific foundations..." The justification for making such comparisons, in Robbins's view, was ethical rather than scientific. He concluded his 1938 article affirming that "it is fitting that such assumptions should be made and their implications explored with the aid of the economist's technique."

In light of what Robbins wrote, the "unacceptable nonsense" of the compensation criterion is even more unacceptable and nonsensical. It was an attempt to concoct "scientific foundations" for avoiding the necessity of making ethical judgments. It is hard to say which is more reprehensible -- the pseudo-scientific pretension or the craven ethical evasion. Fortunately, it is not necessary to decide. The compensation criterion at the heart of standard cost-benefit analysis is functionally inept. Any semblance of conclusiveness derives from the arbitrary use of the "same yardstick" as both the standard of measurement and the thing being measured.

"Unacceptable nonsense" is an understatement. The Kaldor-Hicks compensation criterion is Duck Soup. "Now I ask you one: what is it has a trunk with no key, weighs 2000 pounds and lives in a circus?"

"Gentlemen, Chicolini here may talk like an idiot and look like an idiot but don't let that fool you. He really is an idiot."


Thornton Hall said...

If nothing else, S-man, you inspired me to watch "Duck Soup" this evening and in doing so made the world a slightly better place.

Thomas L. Hutcheson said...

What is the alternative to cost benefit analysis for deciding on public investment and regulation?