Friday, June 13, 2014

Should U.S. Government Cost-Benefit Analysis Look Outside the U.S.?

When Americans consider the costs and benefits of policy actions, should we also be counting costs and benefits for people  in other countries? Ted Gayer and W. Kip Viscusi point out in "Determining the Proper Scope of Climate Change Benefits," (June 3, 2014) that U.S. environmental regulators seem to have started counting global benefits when looking at costs and benefits of U.S. policies with regard to climate change.

Of course, any benefits from reducing climate change have global effect. Gayer and Viscusi refer to one which estimated that for a global reduction in the effects of climate change, the United States would receive 7-10% of the benefits. They point out that if the U.S. benefited relative to it share of world GDP, it would receive 23% of the benefits from reducing effects of climate change. Here's a recent example comparing global benefits to domestic costs (footnotes omitted):
More recently, the EPA proposed regulations to limit CO2 from existing power plants.
For this rule, EPA estimated climate benefits amounting to $30 billion in 2030 using a 3 percent discount rate. However, assessing these benefits in a manner that is consistent with the methodology developed by the Working Group, only 7 to 23 percent of these benefits would be domestic benefits. As a result, the domestic benefits amount is only $2.1 billion-$6.9 billion, which is less than the estimated compliance costs for the rule of $7.3 billion. (Note, however, that EPA also claims substantial air-pollution co-benefits for this rule, associated with reductions in particulate matter and ozone.)
In other words, the estimates are that the global benefits of the rule exceed the costs, but the U.S. benefits are much smaller, and may possibly (depending on how other factors are counted) not exceed the costs.

This concept of counting global benefits of U.S. regulatory actions is a clear departure from established practice. U.S. environmental laws and guidance for regulations are quite careful to specify that the cost-benefit calculations should be done for Americans. Explicit guidance for regulatory authorities from President Obama, as from previous presidents, has emphasized that they are to consider costs and benefits for "the American people."As once example, Gayer and Viscusi write:
Subsequently, the U.S. Office of Management and Budget (OMB) developed a guidance document (known as Circular A-4) for regulatory impact analyses that maintained an emphasis on domestic benefits but permitted the reporting of foreign benefits if reported separately: “Your analysis should focus on benefits and costs that accrue to citizens and residents of the United States. Where you choose to evaluate a regulation that is likely to have effects beyond the borders of the United States, these effects should be reported separately.”
But even if this practice of counting global benefits in the cost-benefit calculation is a departure from the norm, should it become standard practice? Or is it the kind of practice that will only be followed when convenient? The practice of counting global effects in U.S. government cost-benefit decisions raises some tricky issues. As Gayer and Viscusi point out, if U.S. government actions are to take benefits to foreign citizens into account on a regular basis, the policy implications could be striking.
It is important to note that granting the GHG [greenhouse gas] benefits to non-citizens equally to the benefits to citizens represents a dramatic shift in policy, and if applied broadly to all policies, would substantially shift the allocation of societal resources. The global perspective would likely shift immigration policy to one of entirely open borders, as the benefits to granting citizenship to poor immigrants from around the world would dominate any costs to current U.S. citizens. It would suggest a shift away from transfers to low-income U.S. citizens towards transfers to much lower-income non-U.S. citizens, elevating policy challenges such as eradicating famine and disease in Africa to the most pressing concerns for U.S. policymakers, trumping most domestic efforts in terms of their impact on social welfare. And a shift in policy towards fully counting the costs and benefits towards citizens of all other countries would suggest a drastic change in defense policy. A shift in policies to foster such efforts, while in many cases worthwhile, would not be consistent with the preferences of the U.S. citizens who are bearing the cost of such programs and whose political support is required to maintain such efforts.

It's easy to imagine other difficult situations that would arise. Imagine that U.S. environmental standards are tightened, and that as a result some U.S. companies decide to locate their manufacturing elsewhere. In this case, the economic gains received in other countries would be counted as a plus for the policy, which would presumably could be used to offset any economic costs the policy created in the U.S. economy.

Even if one takes the reasonable position that the U.S should give weight to benefits and costs incurred in other countries, there is a question of who determines how much weight will be given. Imagine a U.S. law which requires that U.S. companies abroad operate in a way that has certain standards for lower pollution, worker safety, not bribing public officials, and the like. Now also imagine that the other country would prefer not to have such laws, or to have lower standards. If the government of another country does not favor such laws, does the U.S. claim that people of that country gain anyway?

Economists often work with models that assume a diminishing marginal utility of of income: that is, gains or losses to people with low levels of income should have more social value than same-sized gains or losses to those which higher levels of income. (For example, this is the standard justification why society should favor a degree of redistribution, because the social cost of transferring a certain amount of income from those with higher incomes is less than the social benefit received by the recipients who have lower incomes.) But if this kind of cost-benefit analysis is to be applied to the world as a whole, costs and benefits in low-income countries will receive a greater weight than costs and benefits of the same size in high-income countries.

It seems to me that as a practical matter, the current federal rules about evaluating costs and benefits of government regulatory policies are correct: that is, evaluate them first in terms of effects on U.S. citizens, and if there are also effects on the rest of the world, by all means list them--but list the non-U.S. effects separately.

Bayer and Viscusi write: "The question of whose preferences are to be counted in the calculation of net benefits is known as standing. There has been limited academic discussion about economic standing, with the more recent studies suggesting that standing cannot be resolved based on principles of benefit-cost analysis but instead depends on the ethical consensus of society ..." Of course, this is both true and a way for economists to make sure that the buck does not stop with them, but instead is handed off to "the ethical consensus of society."

Epilogue: When thinking about how people regard their own well-being, in comparison to how they regard the well-being of people who live in faraway places, I always remember the comment by Adam Smith in his first book, The Moral Sentiments (Chapter III, Part III), where he points out
that for most people, losing your little finger would feel like a much larger calamity than the death of hundreds of millions of people in a faraway place like China. (Here, I quote from the ever-useful version of the book at the Library of Economics and Liberty website.)

Let us suppose that the great empire of China, with all its myriads of inhabitants, was suddenly swallowed up by an earthquake, and let us consider how a man of humanity in Europe, who had no sort of connexion with that part of the world, would be affected upon receiving intelligence of this dreadful calamity. He would, I imagine, first of all, express very strongly his sorrow for the misfortune of that unhappy people, he would make many melancholy reflections upon the precariousness of human life, and the vanity of all the labours of man, which could thus be annihilated in a moment. He would too, perhaps, if he was a man of speculation, enter into many reasonings concerning the effects which this disaster might produce upon the commerce of Europe, and the trade and business of the world in general. And when all this fine philosophy was over, when all these humane sentiments had been once fairly expressed, he would pursue his business or his pleasure, take his repose or his diversion, with the same ease and tranquillity, as if no such accident had happened. The most frivolous disaster which could befal himself would occasion a more real disturbance. If he was to lose his little finger to-morrow, he would not sleep to-night; but, provided he never saw them, he will snore with the most profound security over the ruin of a hundred millions of his brethren, and the destruction of that immense multitude seems plainly an object less interesting to him, than this paltry misfortune of his own.
Smith goes on to argue that people should and in fact do care about those who live elsewhere. I would add that governments should care about those in other places, too. But whether it's the case of climate change, or some other issue, it's important first to be clear on whether U.S. policies have benefits that exceed costs for the U.S. population, and then to look at the global dimensions.