Cost-Benefit Analysis April 13 2017 MSSM Program Columbia

Cost-Benefit Analysis April 13, 2017 MSSM Program Columbia University Satyajit Bose

Announcements • Today: Critique of CBA. • Next Week: – Multifamily Solar – Vertical Forests – Fairtrade Coffee

Rationale for CBA 1. Measure aggregate costs & benefits, using individual choice as foundation 2. Prioritize across alternative projects 3. Force decision-makers to engage with objective data 4. Clarify and rationalize social choices 5. Build consensus

To Monetize or Not? 2010 DOJ rule requires that a wheelchair bound person be able to use single-user toilets in state and local government buildings without assistance from anyone else. RIA notes that “although monetized costs of the rule substantially exceed the monetized benefits, the benefits that have not been monetized (avoiding stigma and humiliation, protecting safety, and enhancing independence) are expected to be quite high. ”

Question Should speeding fines be means-tested as they are in many European countries? August 2010…A speeding Swedish driver is facing the world‘s biggest ever motoring fine of € 650, 000 euros after being clocked at 180 mph while driving through Switzerland.

Day-Fines • Finnish method: – Compute disposable income per day – Impose fine that equals 0. 5 to 120 days of disposable income, depending on severity – Example: 65 mph in 50 zone. Fine € 54, 000 for offender with declared income of € 6. 5 mm p. a. • Montesquieu: “Cannot pecuniary penalties be proportionate to fortunes? ” • Mulligan: changed incentives for enforcement hurts the poor victims of crime

Question • If a kidney donor is willing to sell one kidney to a wealthy recipient, should that be allowed? • Are Tradable Pollution Permits a good idea? • What about Tradable Procreation Permits?

Fundamental Assumptions of CBA 1. Choices made in real or constructed markets should be interpreted as indicators of value 2. Such interpretations should direct decisionmaking

Kelman Critique of Monetization 1. Price of bad things is overstated because market is driven by consumers with constraints 2. WTP vs WTA 3. Private choices are not the same as public choices 4. Encourages indecent proposals to put a price on sacred things

Kelman Critique of CBA 1. Many important actions fail CBA tests (“The Bill of Rights was not RARGed”) 2. Good reasons to oppose efforts to monetize non-marketed benefits and costs Therefore, significant resources should not be devoted to CBA.

Executive Order 13563 Improving Regulation and Regulatory Review dated January 18, 2011

Other Foundational Critiques – Free Market Environmentalist or Austrian Environmentalist Critique: preferences are not fixed, they are constantly in flux and market exchange shapes them, occurs with limited information and creates new opportunities. – Psychological or Behavioralist Critique: The choice presented affects the WTP. – Institutionalist Critique: Underlying preferences should be questioned. Exchange context vs. Moral context.

Rana Plaza On April 24, 2013, Rana Plaza building complex housing at least 5 garment manufacturers collapsed. 1, 123 deaths. 2, 500 injured. Worst ever accident in garment industry. (7. 3 deaths per mn of population) (1911 Triangle Shirtwaist Fire. 146 deaths. 1. 6 deaths per mn of population)

Rana Plaza Mean GDP per capita $800 per year. Workers primarily women. Alternative occupation: domestic service Wages $37 per month. Factory cost of a $22 pair of jeans: 90 cents. Estimated cost to upgrade factories: $600, 000 per factory, for 5, 000 factories = $3 bn.

Back-of-the-Envelope CBA Value of a statistical life: US VSL times ratio of Bangladeshi GDP per capita to US GDP per capita: $6 million times $1, 000 over $50, 000 = $120, 000 Caveat: implies that 50 Bangladeshi lives are equivalent to 1 US life. 1700 minimum deaths over 9 years (190 deaths per year)

Back-of-the-Envelope CBA $3 bn capital cost amortized over a life of 5 yrs = $600 mn per year, to prevent 190 deaths. Spend $600 mn per year to save $23 mn per year. (little higher than ILO recommendation) DOES NOT WORK. 7 billion garments sold annually by Bangladesh to Western brands. Spend 10 cents per garment to fund capital expenditure. Easily funds the cost. DOES WORK.

Foreshocks – 2 building collapses and 4 fires in 2005 -06. 200 deaths. – November 24, 2012 Tazreen Fashions fire killed 117 and injured 200. – 600 worker deaths in factory fires between 2005 -2012. Source: Asl & Etula 2012

Systemic Issues Codes of conduct: Voluntary. Audits: Two manufacturers in the complex had recently passed audits. With one exception, all buildings collapsed or in fires since 2010 had passed multiple inspections. (Structural integrity and fire safety not part of inspections). Plausible Deniability “We did not know that there was sub-contracting. ” Just-in-time Inventory Practice: Brands wait till last possible moment to place order. Flexible Supply Chain: No incentive for long-term investments.

Prior Knowledge? “In the case of the Rana Plaza building collapse in Bangladesh, one of the notable findings is the prior awareness of the issues in doing business in Bangladesh among major global brands such as Benetton, Gap, Walmart, H&M, Matalan and Primark, among others. Poor local working conditions were understood, and similar health and safety incidents had occurred in the past as a result of the rapid expansion of the industry, unreliable energy supplies mandating backup generators, and geographical constraints on factory expansion, along with a reportedly light regulatory approach to planning permission and control. The April tragedy followed a similar incident in November 2012. It was also understood among brands that it was common practice that production and storage moved around through sub-contracting. ” Lee Glendon, Business Continuity Institute, May 2013

Due Diligence Sources: Beyond the experts 1. Civil society/NGOs 2. Third party audits ($4 -$7 k per factory) 3. Mobile phone crowdsourcing (Labor. Voices, Labor. Link)

Bebbington Critique of CBA 1. Overreliance on monetization 2. Subjectivity of calculations 3. Opposition between democratic processes and CBA 4. Distributional issues

Bebbington Critique of CBA 1. CBA is not suited to measuring the multiple contested goals of sustainability or the participatory nature of SD. 2. CBA is expert-driven. While it purports to aggregate societal preferences, the process is managed by technocrats. 3. Full cost accounting, multi-criteria decisionmaking and LCA offered as alternatives

Alternatives to CBA • Cost-effectiveness analysis (CEA): – When monetization of benefits is difficult or undesirable (e. g. in healthcare) – When outputs are intermediate goods with an unclear link to final benefits • Cost-utility analysis (CUA): – Use a proxy metric other than $ (e. g. QALYs)

Alternatives to CBA • Distributionally-weighted CBA: – Pure CBA ignores distribution – Many programs that help low income groups would not pass the pure CBA • Arguments for Distributional weighting: – Diminishing marginal utility of income – Preference for equity at the expense of some inefficiency – One person-one vote rule

Alternatives to CBA • Sustainability Assessment Modeling (SAMs) are heterogeneous accountings of: – Economic impact – Environmental impact – Resource impact – Social impact • “Triple Entry Bookkeeping” • Makes a qualified commitment to monetization, but does not force a single Net Benefit number.

ESG Impact Source: Eccles, Serafeim & Krzus

Bloomberg ESG Screen

ESG Impact 1. Increasing interest in Bloomberg ESG screen 2. Carbon data most requested 3. Disclosure viewed as proxy for mgmt quality 4. “E” and “G” more requested than “S” 5. Equity investors: broad interest in “ESG” 6. Fixed income investors: primarily interested in “G” 7. Sell-side: interest in carbon data 8. Buy-side: interest in “ESG” Source: Eccles, Serafeim & Krzus

ESG Impacts on: 1. Sales growth 2. Customer loyalty 3. Cost of capital 4. Employee turnover and productivity 5. Reduced accident rates 6. Avoided litigation

ESG Impact

Example ESG Report