Eric A Posner University of Chicago Law School 1 Overview What is costbenefit analysis CBA The role of CBA in agency regulation Congress Executive branch Courts 2 Overview cont The Theory of CBA ID: 565416
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Cost-Benefit Analysis in U.S. Regulation
Eric A. PosnerUniversity of Chicago Law School
1Slide2
Overview
What is cost-benefit analysis (CBA)?
The role of CBA in agency regulation
Congress
Executive branchCourts
2Slide3
Overview, cont.
The Theory of CBA
Welfarism
Transparency
ControversiesHard valuations: life, culture
Uncertainty
Discounting
The Future of CBAIn the executive branchIn the courts
3Slide4
1. What is CBA?
Example: Regulator (Environmental Protection Agency) must decide whether power plants should install scrubbers in smokestacks.Costs: the cost of installing scrubbers x number of factories
Benefits: avoided medical costs (for example, less emphysema) x affected people
4
Regulation
Benefits
Costs
Net
Decision
Weak
$1 million
$10 million
- $9 million
Reject
Moderate
$16 million
$15 million
+$1 million
CB-justified
Strict
$22 million
$20 million
+$2 million
Optimal
Super-strict
$23 million
$30 million
-$7 million
RejectSlide5
What is CBA?, cont.
Issues and problemsInformal or rigorous?
Determining costs
Purchase price of scrubbers; maintenance costs; labor costs; etc.
Predicting technological change that may reduce costsDetermining benefits
Research on effect of pollution on people’s health
Research on medical costs
What about intangible quality of life?Determining costs and benefits can be expensive!Data analysis
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2. The Role of CBA in Agency Regulation
U.S. government structure (roughly)Congress has set up numerous regulatory agencies
Environmental Protection Agency (pollution)
Securities and Exchange Commission (corporate disclosure)
Office of the Comptroller of the Currency (bank safety and soundness)Occupational Safety and Health Administration (workplace safety)
Congress gives agencies (usually) vague instructions to promote the public interest
EPA: reduce “unreasonable risk to health and environment”
SEC: consider effects on “efficiency, competition, and capital formation”Courts must ensure that agency complies with statute but difficult to enforce vague standards
6Slide7
Role of CBA in Agency Regulation, cont.
Regulatory agencies are in executive branchPresidents have ordered regulators to use CBA since Reagan in 1981
When regulators issue regulations, they issue a Regulatory Impact Assessment (RIA) that contains the CBA
The regulatory agencies send the RIA to the White House for review. White House can block or delay regulations that fail CBA
In sum:
Agency performs CBA and chooses rule
If White House approves rule based on CBA, the rule is issued
Judicial review of rule based on statutory standard
7Slide8
3. The Theory of CBA
EfficiencyWelfarism
The government should maximize well-being of the public
Based on actual preferences as reflected in Willingness-to-Pay (WTP)
CBA aggregates preferences by using market valuesCriticisms
Government should not maximize well-being (vs. protect rights)
Actual preferences do not reflect well-being
Market values are distorted by wealth differences
8Slide9
Theory of CBA, cont.
TransparencyRegulators are agents in a bureaucracyPresident/Congress (or public) is the principal
Agents’ incentives are not aligned with public interest (“moral hazard”)
CBA forces regulators to reveal assumptions and expectations
This allows democratically elected principal to correct them
Criticisms
WTPs are inaccurate
CBA is manipulable
9Slide10
4. Controversies
Hard valuations
EPA’s regulation of cooling water intake structures in power plants
Stricter regulations save fish. How much is a fish worth?
Market valuation versus contingent valuation surveysOCC’s regulation of risk-taking by banks
Stricter regulations reduce the risk of a financial crisis. How much is an avoided financial crisis worth?
Justice Department’s regulation of prisons
How much is an avoided prison rape worth?OSHA’s regulation of the workplaceHow much is an avoided death worth?
10Slide11
“The Value of a Statistical Life”
Suppose a regulation would eliminate 100 statistical deaths but it would cost $1 billion. Does it pass CBA?Government normally uses $7 million value of a statistical life
100 x $7 million = $700 million < $1 billion
Fails CBA.
Where does $7 million figure come from?
Based on studies of wage premiums for dangerous jobs
Example: safe job (0 risk of death) pays $40,000
Dangerous job (1/10,000 risk of death) pays $40,700Then VSL = $700 / (1/10,000) = $7 million
11Slide12
Uncertainty
Climate regulationWhat effect does the reduction of greenhouse-gas emissions have on the risk that the global temperatures will increase by more than 2 degrees Celsius?
Endangered species regulation
How does one determine whether flat-tailed horned lizards are endangered?
Nuclear waste regulation
What risk does the storage of spent nuclear fuels pose to people living 10,000 years in the future?
Bank regulation
How much does increased capital requirements for bank reduce the risk of a financial crisis?
12Slide13
Discounting
Regulations frequently create costs today and benefits in the futureClimate regulation
Nuclear waste regulation
The usual method for comparing benefits and costs at different times is through discounting
A future benefit of 100 is worth less than 100 today because of time preferences and interest
A discount factor,
δ
< 1, is multiplied by future benefits; δ2 for Year 2, and so on.E.g.: If the benefit is 100 in Year 2 and the cost is 80 today, then the regulation passes a CBA if 80 <
δ
2
100
A great deal of controversy over what
δ
should be. Depends on rate of future economic growth, which is unknown.
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5. The Future of CBA
In the executive branchCBA is entrenched for many types of regulations, including environmental, and health and safety.
OIRA (an agency in the White House) demands that regulators use standard valuations for life, discounting, etc.
Controversy as to whether these rules have improved regulation
Enforcement problems
Unquantified benefits
14Slide15
Future of CBA, cont.
CBA of financial regulation?Currently, financial regulators do not use CBA
Some academics think they should. But difficulties:
What are the benefits of financial regulation?
Avoided financial crises. How to estimate risk and value?Avoided “speculation”/gambling
Avoided high-speed trading and related activity
Worries about evasion: from banks to “shadow banks”
15Slide16
Future of CBA, cont.
CBA and Judicial ReviewShould courts enforce CBA? Or do they lack capacity to do so?
Business Roundtable
(2011)
The SEC issued the “proxy access rule,” which required public corporations to place candidates nominated by large shareholders on the proxy statement sent around before board electionsThe purpose of the rule was to loosen management’s grip on the board, and hence to improve oversight of management
16Slide17
Future of CBA, cont.
SEC conducted CBABenefitsShareholders spend less money on printing and mailing
Shareholders gain from better-managed firm
Query: or will shareholders elect bad directors, hurting the firm?
Costs
Firms’ printing and mailing costs increase (est. $2-7 million per company)
Firms may be distracted by election contests
May distort choices between firms covered by rule and firms not covered by ruleSEC claims benefits > costs, but also acknowledges that most benefits (and many costs) are not quantifiable
17Slide18
Court struck down proxy access rule
SEC did not estimate cost of election contests when in fact it is likely that Board will oppose nomineesSEC did not rely on sufficient empirical data showing that proxy access will improve board performance
Academic studies were in conflict
Court was heavily criticized for this decision
Frequently not much data; hard to know whether regulator should gather more data or do the best it can with existing data
Regulator is in better position than court to adjudicate among academic studies
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Conclusion: CBA versus Democracy
To what extent can public policy be based on empirical data and rigorous analysis?Normative questions: does CBA reflect what we care about?
Data limitations
To what extent should courts or expert agencies play a role in doing rigorous analysis?
Courts derive authority from Congress (democracy?)
Regulators are controlled by President (expertise?)
CBA as a way to enhance democratic control over agencies while
taking advantage of their expertise
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