ABSTRACT
Cost–benefit analysis can be used to evaluate proposed projects and government actions. Environmental factors are often involved in cost–benefit analysis and can be 183some of the most controversial to value. One important issue is the valuation of future costs and benefits. Economists use the technique of discounting to balance the needs of the present and future. Selection of an appropriate discount rate is important and can significantly affect the results of cost–benefit studies. The socially appropriate discount rate may be different from the commercial discount rate used to evaluate financial investment returns.
Another important and controversial issue is the valuation of human lives. While we must somehow evaluate trade-offs between environmental protection expenditures and mortality risks, the VSL methodology seeks to estimate society’s willingness to pay to avoid a death due to environmental contaminants in terms of economic value.
Cost–benefit analysis also requires the assessment of risk. When risks are known with a reasonable degree of certainty, it is possible to estimate the expected value of various outcomes using known probabilities, and to include this expected value in cost–benefit analysis. When outcomes are uncertain, and probabilities are not known or not easy to estimate, alternative approaches may be needed to take into account risk aversion and the need for precaution.
Using these techniques for discounting, valuation, and risk assessment, it may be possible to construct a reasonably complete cost-benefit analysis for a particular project or proposal. The results can be used to guide policy decisions, but it is important to keep in mind the possible sensitivity of results to assumptions made, and the limitations of valuation techniques in capturing all relevant environmental and social factors.
