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A Note On Cost-Benefit Analysis

No politely sized blog post is large enough to contain even a tenth of all that that there is to say about cost-benefit analysis.  So in this post – which I’ll keep polite – I’ll make only one point.  (Well, I’ll make one point plus a preface.)

I preface my point by saying that I’m all in favor of cost-benefit analyses.  Enthusiastically so!  Indeed, it would be stupid to go through life indifferent to whether the prospective benefits of the actions we take exceed or fall short of the costs of those actions.  Because we humans have survived, I’m confident in concluding both that our ancestors were pretty good at cost-benefit analyses and that we, inheritors of our ancestors’ genes and mores, are also pretty good at cost-benefit analyses.

The question is not whether or not cost-benefit analyses should be performed.  Of course they should be performed.  The question is who should perform these analyses.  Because each individual adult (1) knows far more, than does anyone else, about his or her tastes and preferences, (2) knows more, than does anyone else, about the details of the opportunities and constraints that he or she confronts at each moment in time, and (3) has stronger incentives, than does anyone else, to take actions that yield the greatest total net benefits for him or her, the presumptively best location, in space and time, for doing cost-benefit analyses is the individual adult at each moment in time.

Of course multiple examples of the contrary can be offered, some of which are even empirically relevant.  But the strong presumption should be that each individual adult is in the best position to do what is for him or her appropriate cost-benefit analyses of available alternative courses of action.  (Note that the claim is not that each individual adult will always make decisions that turn out to be best for him or her.  Rather, it’s that each individual adult will make decisions for himself or herself that, as judged by him or her, generally turn out to be better than are decisions made for him or her by other people.)

So, yes, I’m all in favor of having human actions guided by reliable cost-benefit analyses.  This fact is why I favor decentralized actions within an institution of private property and contract law.  Decentralized actors, spending their own resources and personally standing to gain or lose from the choices they make, have strong incentives to make wise choices (as judged, of course, by each choosing individual rather than by officious third-parties).  That is, such individuals have strong incentives to conduct appropriate (that is, cost-justified!) cost-benefit analyses of their prospective courses of action.

Policies that forcibly remove decision-making authority from individual adults and place that authority in the hands of third-parties (whose actions are ultimately backed by threats of physical violence) of course, in some trivial way, should pass a cost-benefit test.  But advocates of such policies should recognize at least three things:

  • First, the amount of information and knowledge that third parties have about the costs and benefits that alternative courses of action have on other people for whom those third parties are making decisions is typically worse – less voluminous and less accurate – than is the amount of information and knowledge that each individual on the spot has about the costs and benefits that alternative course of action have for him or her.
  • Second, the incentive is great for third parties to substitute their own preferences for those of the individuals over whom these third parties have seized the power to make decisions.
  • Third, aggregate, or government-level, cost-benefit analyses substitute for that of individual-level cost-benefit analyses, resulting in less and less-reliable cost-benefit analyses.

In short, precisely because I think very highly of cost-benefit analyses, I want as much of them as possible to be performed and to be performed accurately.  This sincere desire is one reason why I favor free markets.