A cost benefit framework as deus ex machina

Marian Borges of The Age recently wrote seeking comment on an article on fire prevention which was subsequently written up by her and Peter Martin here. I didn’t have time to really check out the article but sent her a response in which I expressed a kind of generalised scepticism of economists habitual tendency to imagine that in their own cost/benefit framework they have discovered some general key which unlocks the mysteries of the world. Of course it’s a good point to make that the benefits of one’s actions should exceed the costs, but then it’s also obvious and so pretty trivial. It’s true that practitioners of various practical disciplines sometimes forget that basic idea, so it’s good to point it out. But often economists give the impression that they’re the ones with the secret keys. I think a little more modesty is in order and said as much in my reply to Marion, which I reproduce below FWIW.

I’ve had a bit of a look at this and I’m not very impressed by the paper. The abstract is quite hard to understand. Further, as I understand it, one of the central assumptions in the paper is that imposing costs on an economy costs lives directly because wealthier people have lower mortality than poorer ones. Viz:

Keeney (1990) attempted to quantify this opportunity cost further in terms of statistical or regulatory fatalities. He did this by drawing upon the evidence given above that poorer people have poorer health outcomes, and combining this with the notion that government intervention reduces people’s purchasing power and a statistical relationship between mortality and income. In this way, Keeney found that the cost of direct intervention — regulation — in the economy may induce more fatalities than had been previously recognised.

I think this is a pretty suspect assumption – which – at least on my very quick reading (which may be wrong) seems to discount the possibility that it’s the differences in income that are asssociated with different mortality, not absolute levels of income. If so I think the article is definitely overreaching.

A few more points – it would take quite some effort to really satisfy oneself as to the methodology employed – there’s a fair bit to it, and given that the article is poorly expressed, that adds to the burden of getting to the bottom of the methodology.

I have a further concern which is that the article is quite narrow in its conception of the issues. It is of course entirely appropriate to ask the question about the cost effectiveness of fire safety measures. And of course to do so one needs to value human life – which is a controversial thing, but whether we acknowledge it or not, we are making choices on the value of life all the time – by default or design. So far so good.

However there is much more to it than that. Safety is a practice. Safety practitioners, including policy practitioners should have some eye to cost/benefits, but there is also a sense in which safety practitioners are practicing a value based craft which takes as its object not just the minimisation of harm, but its elimination. It’s like the Hippocratic Oath of doctors to “do no harm”.

Of course we can say that logically speaking this is impossible – clever us! But if you ask the safety practitioners of most large private sector companies what their objectives are, it is that any deaths is unacceptable – their target and their intended result is none at all. And if there are any deaths, they go to the board with full reports. This is not ‘cost/benefit’ management. It is a ‘do no harm’ philosophy – and it seems like the most competitive companies have that philosophy. So we should be careful thinking that our (relatively trivial) cost/benefit idea is such a deep insight.

So while it can’t be appropriate to really imagine that we should have public policies to reduce fire deaths to zero, I’m not so quick to imagine that, as an economist, I know how we should manage fire safety or even that we have got it wrong (though if there were some more concrete examples, perhaps I could understand the texture of this over-regulation and over-protection a little more.

Ultimately the observation that we should have a cost/benefit perspective is a pretty trivial one when all’s said and done. It should be part of the consideration of the issues (and perhaps it’s a fault of the fire safety practitioners and regulators that they don’t give sufficient consideration to it) but beyond that, I’m not sure that economists have a lot to add.

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Richard Tsukamasa Green

A month or so ago a colleague and I described cost-benefit analysis as being ill suited to ex-post evaluation. Another (prominent) economist had an objection to this. We had said “cost benefit analysis” meaning only the practice that people do that they call “cost benefit analysis”. In his view however this was hard on CBA because CBA referred to all situations where benefits were compared to costs.

In my mind this was too broad a definition to be useful. I asked if I had performed a CBA 2 hours earlier when I had obviously compared the $7.50 I’d spent on a sandwich with the subjective utility I would receive from eating it.

He said yes.

My colleague intervened at this point.

It does highlight a problem with the way economists, and policy types, use CBAs (or BCAs as convention now demands). It’s either specific enough that it can be a useful tool, but too limited to be the keys to the universe), or so broad it covers most, or all of human decision making. The economist I describe would presumably deem a “do no harm” approach as the result of a CBA that presumes a extremely high value of human life. Kinda renders the concept moot.

Ken Parish
11 years ago

Applying a cost/benefit approach to bushfire casualties seems intuitively right to me, but closer analysis compels a different conclusion. Actuaries put the median value of a prime aged worker at $7 million per year. When you realise that amount would buy a free Big Mac for 1.4 million Australians, you’d probably agree that one or two additional rural residents burnt to a crisp is a fairly modest price to pay.

But the attraction of this logic is only superficial. Most residents of fire-prone areas like the Dandenongs are probably retirees with a reduced life expectancy of decreasing utility. That’s certainly what Peter Singer reckons and he’s an intelligent sort of chap. Say 10 years or so with the last few severely devalued by creeping dementia. Probably no more than a few thousand cheeseburgers. Hardly adequate compensation for exposing millions to distressing images on A Current Affair.
The phenomenon isn’t just confined to bushfires either. Watching that bloody Four Corners program showing Indonesians painfully butchering Aussie live cattle turned our daughter Jess into a vegetarian, and it isn’t easy to find greasy takeaway food without meat in it. I blame Peter Singer for that too. It’s just not bloody right. Kant knew what he was talking about.

Update – Actually on closer perusal I see that the actuarial calculation of the value of human life is $7 million in total not per year. It’s between $50K and $129K per year, a paltry amount in Big Mac Index terms. So why not save some of the $4.5 billion dollars spent annually on fire fighting and prevention, and let a few more than the current 14 or so people burn to death each year? But how many additional people would be burned for each $100 million or so saved? And how much additional property would be destroyed (given that even moderate bushfires destroy hundreds of millions of dollars worth of property? And how could we meaningfully assess what the money saved by reducing the fire prevention and fighting effort would or should actually be spent on instead, or how many lives that expenditure would save or enrich?

Come to think of it, if we want to have fun with this cost/benefit stuff, we could deploy it in aid of Richard Florida’s thesis that compact, densely populated, trendy cities attract the “creative class” and thereby boost productivity and wealth. Moreover it costs less than providing services and infrastructure to people living in an ever-expanding urban sprawl. What could be better for persuading those flaccid outer urban bogans and retirees that they should be cramming themselves into inner city high rises than the televisual images of some of them dying horrible bushfire deaths in the Dandies?

11 years ago
Reply to  Ken Parish

It wasn’t the $4.4B per annum spent on fire response that interested me so much as the $11.9B spent on fire “prevention” that manifestly fails to prevent fires.

So, maybe we could just spent $1 or 2B more on response and a whole lot less on so-called “prevention” – which mostly seems to be off-season clearance burnings – and spend a large amount of the saving on, say, preventing road traffic deaths, or on cancer research or some such thing. In short, on attempted death prevention in areas where a whole lot more people die per year than are burnt to death in bushfires.

11 years ago

This reminds of the almost identical debate about airline safety that occurred with Dick Smith, and has occurred without much debate in terms of all the new safety measures (which arn’t too bad in Aus — try going through a US airport). Safety clearly won out on that one.

11 years ago

The virtue of BCA for public policy items like firefighting, Darwin-Alice Springs railways, NBNs is that they give us an idea of the degree to which such thing might be economical or not.

At first this sounds trivial – like the sandwich example cited. However, let’s say we have a framework that says: If something has a financial BCA of >1, then let the free market take it up – Government need not be involved as an operator or financier. However, if something has a financial BCA of <1 initially based on tangible costs and tangible benefits, then let the political process value the intangibles. I would suggest that the political processes for determining intangible costs and benefits is much better than some central planning manual method for determining intangible costs/benefits. After all, any 'methodology' for determining intangibles is just likely to reflect the thoughts and values of those who determine the intangibles, so why not the broader community, rather than some less representative sw..,er I mean subset. If through the political and social processes, we are prepared to value the project or institution (such as firefighting) enough to stump up the money, then the intangibles have been addressed sufficient to bring the BCA to at least =1.

Put another way, in the public sphere, economists and accountants can value the tangibles that comprise the components of the BCA, and we the taxpayers through the various social/political processes can value the intangibles to complete it.

Looked at this way, the 'deus ex machina' is actually the social political process and the willingness to pay that completes the analysis. Sort of like the degree of stomach emptiness and pocket full of change (or not) completes the analysis of the sandwich decision.

Were economists to adopt this approach, they might get less heartburn about such issues as NBN or Darwin Railway projects. Do the BCA. If it comes up <1 put it up as a plank in an election platform and let us punters decide.