Critique of cost-benefit analysis

Here is Lisa Heinzerling’s and Frank Ackerman’s critique of cost-benefit analysis, Pricing the Pricelesss: Cost-Benefit Analysis of Environmental Protection (they also discuss Larry Summers’ toxic waste memo). They write,

In recent years the use of “cost-benefit” analysis to set environmental standards has attracted a large and high-profile group of supporters. According to its advocates, cost-benefit analysis offers a way of achieving superior environmental results at a lower overall cost to society than other available approaches.

This view is mistaken. Cost-benefit analysis is a deeply flawed method that repeatedly leads to biased and misleading results. Far from providing a panacea, cost-benefit analysis offers no clear advantages in making regulatory policy decisions and often produces inferior results, in terms of both environmental protection and overall social welfare, compared to other approaches.

The paper is here (pdf).

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FEASIBLE Environmental Finance

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Click on graph for larger image.


FEASIBLE is a software decision support tool that provides a systematic, quantitative framework for analysing alternative targets related to environmental performance of infrastructure or to the level of its services.

Wouldn’t it be good to have decision support tool like this for protected areas? At present FEASIBLE can be used on water, wastewater and solid waste services projects.

It was developed by COWI in collaboration with OECD and the Danish Environmental Protection Agency.

The basic approach underlying FEASIBLE is to take public policy targets in areas like water supply and sanitation, determine the costs and timetables of achieving them and compare the schedule of these expenditure needs with available sources of finance.

This analysis generally reveals “finance gaps” during planned implementation. FEASIBLE can then develop various scenarios to determine how these gaps could be closed. This could be by: identifying policy reforms that could help achieve the targets at lower cost; identifying ways of mobilising additional finance; adjusting the ambition level of the targets; or extending the time period for achieving the targets.

An important feature of FEASIBLE is the emphasis on realism and affordability. The model can assess the levels of finance (public, private, domestic, foreign) that might be available under different macro-economic conditions. In this way, it provides a check on what public budgets might realistically be expected to contribute. It can also help to assess the potential social implications of increasing tariffs by determining the impacts of such price increases on household income.

By focussing on these issues, the application of FEASIBLE is more than a technical exercise: it also supports a process of dialogue and consensus building among the key stakeholders involved in financing environmentally-related infrastructure. In this way, it can build a bridge between policy development and implementation.

One of the key features of FEASIBLE is the use of generic expenditure functions. Generic expenditure functions are used to estimate the cost of a given type of infrastructure. The expenditure functions are based on international prices and on a standard set of assumptions. The model then modifies the cost results to reflect local prices. If local conditions vary from standard assumptions, the user can apply correction factors to some of the most important assumptions.

You can download FEASIBLE, it is available free of charge. However, it asks you for a lot of detailed information related to local costs of land, fuel, labor, building materials, equipment, building materials, etc.

Links: OECD FEASIBLE page, COWI (with program download and documentation files).

About Business Ideas

The best book about business models (they talk about “profit models”) is Adrian Slywotzky, David J. Morrison, and Bob Andelman, The Profit Zone: How Strategic Business Design Will Lead You to Tomorrow’s Profits.

The best way of thinking through a business model is not by developing a set of Power Point slides, it is by drawing a diagram. The best guide for doing this can be found in Scenarios: The Art of Strategic Conversation by Kees van der Heijden.

A Business Idea Diagram should be specific enough so that if anybody asks you, “what is the idea?”, you can answer, “wait, let me draw you a diagram”. You should then draw a diagram that is simple enough so you can draw it from memory, but specific enough so that it is unique to your business.

Business Idea

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If you looked at this remarkable graph from Richard Hatfield’s very interesting paper (also mentioned in this post), it was clear that the local population in Africa was the loser, and the international community, the winner, in terms of benefits. So, how can a large consumer surplus be converted into a producer surplus?

One solution would be to increase visitors’ fees or park fees, but by how much? In these particular forests, visits to observe the gorillas are strictly limited. Price discovery is difficult. Some weekdays may be more popular than others, and the dry season more popular than the rainy season. A visitor may be a local high school student, a backpacker, or a tourist arriving in a private jet. They have very different have different price-sensitive characteristics.

One solution could be a dynamic pricing system using an on-line auction model. This is how prices are set, e.g. by Google AdWords. Airlines and hotels use yield management systems that are more or less based on auctions.

How could an NGO or a company use this business idea to generate more money for conservation? The traditional thing to do would have been to get one client to pay for the development of the software application while retaining the intellectual property rights, and then resell the application to other clients. Given the worldwide interest in the environment, an open source software development model could work. The difficult part of this project is not just software development, the problem is sales, implementation, and support in remote areas. An organization that could do that in a professional manner could occupy an interesting market niche.

The market is probably extremely limited right now, but as the ever increasing number of tourists cause more damage to more protected areas, rationing will become more common. There are already limits to the numbers of visitors on the Galapagos Islands and in the Ngorongoro Crater.

Of course, maximizing income from park fees is not the same as maximizing income for the local population, but that is another story.

Data visualization

This is nice. Go to Gapminder.org, scroll down to Has the world become a better place?, and listen and watch the animated graph.

I don’t know if Gapminder.org means to imply that the world has become a better place because women have fewer children. Lower infant mortality is a good thing, but it is not obviously true that fewer children are better than more children. Fewer children and negative population growth in Russia, Ukraine and Bulgaria are not signs of progress.

Unfortunately, apart from a few nice samples, Gapminder.org doesn’t seem to be doing much. There is not much data available. Too bad.

A much richer data set can be found on NationMaster. What we need is a (more stable) Gapminder interface for NationMaster’s data.

Useful Tool: DEA

Reading the paper by J.S. Brooks et al. (see my previous post) made me wonder why there isn’t more use of data envelopment analysis (DEA) in conservation. DEA is well suited to the analysis of problems with multiple inputs and multiple outcomes.

DEA is widely applied to problems in which answers about optimum input levels, their characteristics, and output levels are needed. It is a linear programming technique for measuring the relative performance of organisational units where the presence of multiple inputs and outputs makes comparisons difficult.

All units under comparison are assumed to operate homogeneously: they receive the same inputs and produce the same outputs (in differing quantities, of course) and these inputs and outputs are representative of the whole population. The figure below shows a model of a bank branch.

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The example and the picture above is from Prodtools.com, a company that produces a DEA add-in for Excel, xlDEA. There is a free demo version available, try it out. You might think “protected areas” instead of “bank branches”; one output could be “population of endangered species X”, and, if you are dealing with Integrated Conservation and Development Projects, another could be “median income of local population”.