6.4 Evaluating projects and policies

Learning objectives

After reading this module, students should be able to

• know five important features of how economists think about costs
• understand why discounting is both important and controversial, and be able to calculate the net present value of a project or policy
• know what cost-benefit analysis is, and be aware of some of its limitations
• think about four criteria for evaluating a project that are not captured in a basic cost-benefit analysis

Introduction

Environmental valuation methods help analysts to evaluate the benefits society would gain from policies or cleanup and restoration projects that improve environmental quality or better steward our natural resources. Another set of tools can yield information about the costs of such actions (a brief description is below). But even if we have plausible estimates of the costs and benefits of something, more work needs to be done to put all that information together and make some rational choices about public policy and investments. This module discusses the challenges of policy evaluation when costs and benefits accrue over time, outlines the main features of cost-benefit analysis, and presents several other criteria for policy evaluation.

Net present value, discounting, and cost-benefit analysis

Cost estimation has not generated the same amount of scholarly research as benefit valuation because the process of estimating the costs of environmental improvement is usually more straightforward than the process of estimating the benefits. Economists do think differently about costs than engineers or other physical scientists, and several key insights about the economics of cost evaluation are important for policy analysis. Viewed through an inverse lens, all these ideas are important for benefit estimation as well.

Opportunity cost

Not all costs involve actual outlays of money. An opportunity cost is the foregone benefit of something that we choose (or are forced) not to do. The opportunity cost    of a year of graduate school is the money you could have made if you had instead gotten a full-time job right after college. Endangered species protection has many opportunity costs: timber in old-growth forests can’t be cut and sold; critical habitat in urban areas can’t be developed into housing and sold to people who want to live in the area. Opportunity costs do not appear on firms’ or governments’ accounting sheets and are thus often overlooked in estimates of the costs of a policy. Studies of U.S. expenditures on endangered species’ recoveries have used only information about costs like direct government expenditures because opportunity costs are so challenging to measure (e.g. Dawson and Shogren, 2001 ).