A Practical Guide to Cost Benefit Analysis

Abstract

Versatile and comprehensive, cost–benefit analysis (CBA) can be applied to any number of policy issues. Construction of a dam or a road are relatively straightforward candidates for cost–benefit analysis and are often used as examples in textbooks. But cost– benefit analysis has also been used to assess the net social benefits of an almost endless range of regulatory and policy issues. A small, illustrative selection could include: the benefits of health warnings on cigarette packets (Abelson 2003a), the social cost of compulsive gambling (Productivity Commission 1999), provision of government services in Rural Transaction Centres (Dobes 2007), the economic costs of regulating optometry services in the United States (Haas-Wilson 1986), climate change (Nordhaus 1991), and a switch to insensitive munitions in defence (White & Parker 1999). Although the term cost–benefit analysis is increasingly used by financial analysts to refer to the (solely financial) implications of a project or activity, its more accurate meaning is in its use by governments. Government projects and policies often have no market equivalent, or are intended to rectify some form of market failure – ultimately the justification for the government’s intervention in the area – so cost–benefit analysis is used to assess the value of a project or policy to society as a whole. When economists refer to cost–benefit analysis, they mean social cost–benefit analysis: reflecting the fact that the analysis is not limited to the standpoint of a government budget, a firm’s profits, or an individual’s interests. This has important methodological implications. A social perspective will encompass more than purely financial considerations, and the often-conflicting interests of many individuals will need to be taken into account.