Modernizing Regulatory Review Beyond Cost-Benefit Analysis

This post was originally published on LPE Blog and is part of a symposium on the future of cost-benefit analysis. Reprinted with permission.

Cost-benefit analysis (CBA) is inherently classist, racist, and ableist. Since these are foundational problems with CBA, and are not simply issues with its implementation, they can never be fixed by mere methodological improvements. Instead, the ongoing modernization of centralized regulatory analyses must focus on "moving beyond" CBA, and not on fixing it or improving it. Thus, in implementing President Biden's memorandum on Modernizing Regulatory Review (the Biden Memorandum), the Office of Management and Budget (OMB) should make explicit that regulatory review no longer requires CBA, even—as will be true in the typical case—when regulatory review does demand economic analysis as part of a holistic, multi-factor regulatory impact analysis.

The Biden memorandum endorses a series of goals that are not premised in the narrow pursuit of Kaldor-Hicks "efficiency," the warped type of efficiency promoted by CBA. Such goals include using the regulatory review process to promote "racial justice, environmental stewardship, human dignity, equity, and the interests of future generations." However, the Biden Memorandum also reaffirms the "basic principles" expressed in executive orders 12,866 and 13,563, orders that do require evaluation of regulatory costs and benefits. Does or does not the Biden Memorandum endorse, or even require, the continued use of CBA in regulatory review?

Our thesis is that it does not. We contend that OMB can—and should—explicitly reject the use of cost-benefit analysis, a neoliberal tool that secured its recent, outsized role via the savvy intervention of industry-sponsored lobbying groups, and which has been used for decades to undermine the entire enterprise of public health and environmental risk regulation.

Moving Regulatory Review Beyond a Questionable Pursuit of "Efficiency"

In the context of regulatory review, CBA does not refer to just any thoughtful weighing of pros and cons. It is, rather, a specific tool for the pursuit of strictly utilitarian ends. This is illustrated by the following, typical definition: "Cost–benefit analysis is an applied economic technique that attempts to assess a government program or project by determining whether societal welfare has or will increase (in the aggregate more people are better off) because of the program or project."

In theory, regulatory CBA is intended to promote Kaldor-Hicks efficiency, a state where—after a regulatory change—net welfare is improved sufficiently that the winners could hypothetically compensate the losers. For a regulation to be Kaldor-Hicks efficient, however, the transfer is not necessary. Thus, many "efficient" regulations tend to make rich people richer and healthier while making poor people poorer and more disenfranchised.

Many decades before it became the centerpiece of regulatory review, CBA was used to assess individual development projects. For example, the Army Corps of Engineers used CBA to justify, on a case-by case basis, numerous water management projects. To determine whether a new hydroelectric project was Kaldor-Hicks efficient, assessors calculated whether total combined changes in projected "consumer surplus" and "producer surplus" would be positive. Eventually, under some conceptions of Kaldor-Hicks efficiency, the singular project alternative that maximized these combined values was the only efficient one (this definition evolved into the modern notion that CBA should be used to identify the option that maximizes social welfare). As applied in this context, producer and consumer surpluses often related to fungible commodities that defensibly could be monetized and converted to present value. In addition, it was said that all factors not under immediate consideration should be assumed to remain in stasis, an assumption of "partial equilibrium" that made sense for such projects. Given this history as a project evaluation tool, CBA continues to be considered a type of "microeconomic" analysis, even in the context of federal regulatory review, where the focus is on evaluating the largest regulations that are expected to have impacts that reverberate throughout the economy.

A partial equilibrium analysis might make sense for, e.g., a firm evaluating its activity in a single market. However, it obviously cannot be applied to broad regulatory schemes like President Obama's Clean Power Plan, schemes likely to impact foreign policy and a plethora of domestic industries. The absence of partial equilibrium obliterates a fundamental premise of the "applied economic technique" of CBA. For the large, real-world regulations that are actually subjected to centralized review, CBA cannot be used to maximize welfare; as a tool, it simply breaks down because the required premise of a partial equilibrium is absent. Moreover, consumer surplus cannot be calculated. Time after time, poorly monetized benefits are used as a proxy for priceless goods in real-world Regulatory Impact Analysis (RIA). So too with producer surplus, which is equally incalculable for such complex regulatory schemes that will persist over decades; industry compliance costs are used as substitutes, but no serious economist would claim that the analyses that purport to be CBAs can reliably point to the most Kaldor-Hicks efficient level of regulatory stringency.

Even assuming that it were possible to monetize the intangible benefits of risk regulation, CBA fails to achieve its stated purpose of pointing to the welfare-maximizing option. When considered solely as a utilitarian exercise, other objections—such as the difference in marginal utilities experienced by regulatory winners and losers—cause CBA to fail. It is nonsense to argue that the CBAs found in real-world RIAs point to the most efficient regulation, even if one were to accept that Kaldor-Hicks efficiency is a meaningful type of efficiency.

CBA Arbitrarily Ignores the Distributional Consequences of Regulatory Alternatives

There is intuitive appeal to the contention that CBA promotes a better world for most to the extent it succeeds in its aim of improving overall "net welfare." However, the question of who benefits and who is burdened by regulatory alternatives matters in risk regulation. Uncompensated Kaldor-Hicks "losers," individuals who disproportionately experience excess pollution, diminished health, riskier workplaces, and other inequities, are often the very people who were intended to be protected by the statutory schemes that CBA has been weakening for decades.

CBA in regulatory review can be justified from neither an economic nor a justice perspective. By ignoring distributive factors, OMB would reaffirm CBA's assumptions that all stakeholders have the same economic footing and that risk regulations are distributionally neutral. This, in turn, contradicts the consensus among economists that there exists "decreasing marginal utility for higher levels of income" and wealth. In other words, a hundred dollars in "regulatory relief" that accrues to, say, Jeff Bezos does not offer the same utility as a hundred dollars to a family facing food insecurity. As philosopher Mark Sagoff has convincingly explained, empirical work demonstrates that once basic needs are met, happiness or utility derived from additional wealth decreases, thus people do not become happier or more satisfied as they become richer. Analyses that omit the differences in marginal utility among stakeholders—as the current CBA framework does—present a woefully incomplete economic picture, thereby misleading policy-makers.

Further, insensitivity to distributional concerns has worrisome environmental justice implications. In the context of environmental standard-setting, ignoring equity-based granularities among stakeholders omits burdensome costs that vulnerable people—disproportionately low-income and people of color—continue to disproportionately bear in terms of mortality and morbidity risks from pollution.

As the Biden memorandum makes clear, when assessing the costs of regulatory alternatives, OIRA must "take into account the distributional consequences of regulations … to ensure that regulatory initiatives appropriately benefit and do not inappropriately burden disadvantaged, vulnerable, or marginalized communities." To this end, OMB should encourage consideration of distribution and disparities in economic analyses. Such consideration may take the form of distributional weights (without falling into another reductionist utilitarian framework that subjugates deontological values) and/or narrative descriptions of how regulations will affect groups differently. In this way, regulatory review would confront the systemic issue of inequality and distribution in risk regulation.

Instituting a Post CBA Regulatory Review that Appreciates Priceless Values

As explained above, the monetization requirements of CBA are impossible to realize in a complex economy, yet the framework gives the questionable economic data produced by this requirement exclusive weight. Deviating from a myopic approach to regulation requires broadening the horizons of regulatory review to weigh in deontological considerations—such as justice, rights, duties, and equity—as contemplated the Biden memorandum.

A comprehensive and just approach to regulation that properly balances economic considerations with deontological factors is possible in a post-CBA world. In the context of risk regulation, the regulatory review process should prioritize deontological interests, particularly when controlling statutes don't provide for a welfarist blueprint, and are, instead, more concerned with protecting rights or promoting equity—as most of them are.

Implementing this post CBA-approach to regulation requires OIRA to diversify its portfolio of career staffers beyond economists, thus avoiding falling into methodological labyrinths that threaten to derail regulatory action with no apparent coherence. By incorporating more areas of disciplinary expertise in the review process, important non-quantifiable considerations like climate resilience, environmental justice, and intergenerational equity would be given predominant weight despite the difficulties associated with assigning a monetary value to the benefits that might accrue from centering them. Moreover, a post-CBA regulatory review that appreciates deontological values should be wary of falling into other reductionist utilitarian frameworks that democratically-enacted statutes do not call for. Recall that the Clinton and Obama administrations both made gestures toward retaining CBA while softening its anti-regulatory effects; these half-measures were ineffective then, as they will be again if CBA is merely "reformed" instead of rejected.