Cost-Benefit Analysis

Cost-benefit analysis (CBA) is a decision-making support tool widely used to evaluate public sector interventions from a social perspective and in monetary terms. CBA is used to assess projects (e.g., roadway construction) as well as policies (e.g., environmental regulation). On the premise that decision making should include a comprehensive account of costs and benefits, CBA aims to provide a balance sheet of these costs and benefits.

To take the long-term impacts of a given intervention (e.g., a project) into consideration, CBA contrasts the costs and benefits of the project over its anticipated lifespan by discounting the future value of money. Essentially, the aim of CBA is to provide a net present value of the benefit-cost ratio. If this value is positive for any given project under consideration, the project is deemed to be feasible. Conversely, a negative value suggests that the project should be rejected, as society would be worse off with the project. This idea can be expressed mathematically as

where NPVp is the net present value of the project, Bt are the benefits generated at time t, Ct are the costs of the project at time t, and r is the discount rate.

While most often used ex ante to determine the feasibility of an intervention, CBA is also used ex post to evaluate the impacts of past decisions or in medias res to evaluate a project (or policy) during its lifespan. Additionally, CBA can be employed in a comparative manner to identify one intervention of any number of alternatives that is most beneficial to society. To arrive at a recommendation, CBA generally includes the following steps:

• 1.
  Define intervention and identify alternatives
• 2.
  Identify stakeholders and objectives
• 3.
  Catalog costs and benefits
• 4.
  Predict and quantify changes
• 5.
  Monetize the costs and benefits
• 6.
  Discount costs over the anticipated lifespan
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• 7.
  Compute the net present value
• 8.
  Perform a sensitivity analysis

There are three criticisms regarding CBA. The first focuses on the fact that CBA considers the impacts on society as a whole rather than the impacts on individuals. While a given intervention may generate a positive net present value for all of society, the impact for individuals or a portion of society could well be negative (CBA does not take redistribution of benefits into consideration). The second criticism relates to difficulties of assigning a monetary value to certain impacts (e.g., environmental degradation) or even determining if a specific impact is considered a cost or a benefit. The third criticism is that CBA has been lacking a spatial perspective. Recently however, there have been advancements in linking CBA analysis and geographic information systems to increase the spatial sensitivity of the method.