How well suited is cost-benefit analysis to transformative change?

Cost-benefit analysis (CBA) is used to appraise policy options in terms of their efficiency impacts. Impacts are measured by individuals’ willingness-to-pay for a benefit and willingness-to-accept a cost. Benefits and costs are generally revealed through markets with money being used as the main metric. If benefits exceed costs, the policy is potentially worthwhile.

CBAx tool

In New Zealand, CBA is used for budgetary purposes, in major regulatory changes and elsewhere. However, the use of CBA is patchy and compliance is low. Some New Zealand agencies have undertaken CBA for many years, for example, in the transport sector. But in other agencies the use of CBA is more limited and/or more variable. Discussions with New Zealand agencies revealed wide-ranging perspectives, and deeply-held views, on CBA and other analytical tools.

To help New Zealand agencies conduct CBAs, Treasury has developed the bespoke CBAx tool including guidance on how to undertake a ‘social’ cost-benefit analysis.

CBAx is a spreadsheet model with a database of values to monetise impacts, including environmental values and subjective wellbeing values (WELLBYs). The guidance includes some material relevant to transformative change, including the use of sensitivity analysis and ranges to help deal with risk and uncertainty.

However, the default discount rate in CBAx guidance is 5% which is at the high end of the spectrum, and, unlike many countries, New Zealand does not have a separate (lower) discount rate for long-term investments.  This works against policies with long-term benefits.

General strengths of CBA

CBA has a number of strengths, including that it is a well proven and systematic tool, uses a common metric (money), and takes account of unintended consequences.

CBA can be applied in many contexts and is generally seen as the dominant analytical tool in the policy toolkit. 

Specific limitations of CBA in the context of transformative change

Despite its general applicability, CBA has major limitations in the context of transformative change:

  • a status quo bias, for a number of reasons including through the use of discounting 
  • a tendency to underplay environmental and other non-market (non-monetary) impacts which may be the very goal of transformative change
  • a narrow focus in general, which may fail to identify the potential of a sum of multiple projects to collectively achieve transformative change.

Some New Zealand and overseas studies have identified CBA’s limitations in the context of climate change policy. Discounting may distort the appraisal of climate policies whose benefits tend to accrue over long timeframes. The benefits from emerging clean technologies and other innovations may be particularly hard to estimate.

Environmental benefits and costs are also hard to aggregate; a wide range of biophysical, monetary and socio-cultural indicators are available, but these indicators are challenging to combine. While a CBA may include non-monetised and qualitative information, this information may not be seen by decision-makers on a level footing to ‘hard’ monetary or quantitative data.

Some techniques are available to make CBA more suited to transformative change. However, these techniques tend not to be used much in practice, and some question the extent to which these techniques overcome CBA’s core limitations in the context of transformative change. CBA seems ill-suited to situations where fundamental relationships in the economy might be changing. CBA is more concerned with static efficiency (the efficient allocation of resources at a point in time), whereas transformative change is more concerned with dynamic effectiveness (achieving a goal over time). 

Overall, we conclude that analysts might want to question whether CBA is the most suitable tool in the toolkit when the goal is transformative change.