Cost-Benefit Analysis Is Poor Guide to Government Action

Tuesday, August 29, 2017

Many Americans think of themselves as pragmatists. Pundits often brag they are non-ideological independents. Forget theory; let’s just figure out what works. Their preferred method for assessing public policy is cost-benefit analysis. If the benefits of a proposal exceed the costs, we should adopt it. If not, let’s look for something else.

This approach is not actually non-ideological. To say public policies ought to be enacted when putative benefits outweigh costs is an ideology. Everyone has a set of principles to guide political-economic choices. No one looks at each situation as though it were unrelated to any that has come before. Those who eschew explicit ideology simply leave their ideology implicit — that is, unexamined.

Underlying cost-benefit analysis are a large number of premises and assumptions, which in themselves constitute an ideology. We can say one thing in favor of cost-benefit analysis: it brings attention to the issue of costs. For too long, proponents of policies discussed only the putative benefits. An industry’s gains from tariff protection were well-publicized while the unseen costs to consumers and other domestic industries were ignored or unintended. Every choice entails costs, which don’t disappear because they are unacknowledged.

But this does not mean cost-benefit analysis is the best approach to public policy. One reason it may have intuitive appeal is that individuals consider costs and benefits when making choices in their own lives. Whether we are deciding between going to the movies or bowling Saturday night, between becoming an auto mechanic or a computer programmer, or between marrying or not, we think about expected advantages and disadvantages. Every choice has a trade-off; every action expresses a preference for A over B. The forgone alternative is the true cost of any choice: its opportunity cost. Note the subjectivity in choosing: B is rejected but never realized. In assessing costs and benefits, we envision different futures under available alternatives.

Economists traditionally saw decision making as a purely economizing activity. As Austrian-school economist Israel Kirzner puts it, when economizing, “ends and means are viewed as given and known, the act of decision-making being seen as essentially calculative, as though the resulting action were already implicit in the relationship between given ends and means.” Kirzner parodies this constrained view of decision making by positing an impersonal bureau that makes important decisions for people after gathering all the relevant “data,” including resource constraints.

The shortcomings of this approach are obvious. As Kirzner writes,

Attention must also be paid to an element in decision-making which cannot be formalized in the allocative, calculative terms. Purposefulness in human decision-making manifests itself along a dimension which is ignored in the analysis of “economizing” decision-making. In addition to the exploitation of perceived opportunities, purposive human action involves a posture of alertness towards the discovery of as yet unperceived opportunities [my emphasis] and of their exploitation. This element in human action — the alertness towards new valuations with respect to ends, new availability of means, — may be termed the entrepreneurial element in the individual decision. Awareness of this element in human action leads to the recognition that knowledge by the outside observer of the “data” surrounding a decision-making situation is not sufficient to yield a prediction of the decision that will be made.

Thus subjective individual decision making among incommensurable, irreducible alternatives is more complex than cost-benefit analysis suggests. There is no quantifiable homogeneous substance called utility to be maximized. Individuals and firms often use money costs and income to make decisions, but money is not an end in itself. Money costs represent opportunity costs.

At the social level, things are even more complex. Each individual has a value scale — though, as Kirzner indicates, value scales emerge through action and are not fixed. If Smith shops for breakfast cereal, he knows he prefers Cheerios to Wheaties. So when he buys Cheerios and forgoes Wheaties, we can say he has ascended his value scale. Jones’s value scale may differ, but in a free society, Smith and Jones may make their own choices without imposing costs on others.

In contrast, society has no single value scale because it is a collection of unique individuals. When Smith in effect trades Wheaties for Cheerios, he is better off. But if the government forces him to forgo Wheaties so that Jones may have Cheerios, collectively they are not better off, worse off, or unchanged. Instead, Jones is perhaps better off and Smith worse off. Nor can we say that Jones’s gain is greater than Smith’s loss, or vice versa, because interpersonal comparisons of “utility” cannot be performed.

We can see the point clearly when a government policy would limit some people’s freedom to provide benefits to others. How can the loss of freedom to some be compared to the other people’s gains?

Public policy should be judged not by putative costs and benefits, but by whether they liberate or constrain our peaceful pursuits.

Sheldon Richman

Sheldon Richman is the executive editor of The Libertarian Institute, senior fellow and chair of the trustees of the Center for a Stateless Society, and a contributing editor at Antiwar.com. He is the former senior editor at the Cato Institute and Institute for Humane Studies, former editor of The Freeman, published by the Foundation for Economic Education, and former vice president at the Future of Freedom Foundation. His latest book is America's Counter-Revolution: The Constitution Revisited.