Cost-Benefit Analysis and Individual’s Willingness to Pay

Economic methods such as Cost-Benefit Analysis (CBA) are used to aid decisions, many of which encompass natural resources and environmental problems. Approaches including Contingent Valuation (CV) may be used to provide a monetary value to these cost/benefits. In the context of the question, the lack of accuracy associated with contingent valuation alongside the implications to the future generations of discounting within a CBA raise ethical arguments against the use of these techniques. 

Where both economic methods and monetary valuation are involved in decision making, that has such great societal impact, the existence of strong ethical foundations is necessary. Firstly, this essay will identify the ethical aspects surrounding both techniques then consider the implications of these aspects in determining whether these techniques should be used. Finally, I will provide a judgement on the importance of the ethical arguments discussed.

The CV approach is used in order to provide a value to an environmental good that has no observed market price. The method uses stated preference, where the individual’s willingness to pay (WTP) is elicited using a questionnaire. McFadden and Leonard state that a CV should be “psychometrically robust” and “statistically reliable”. There is, however, uncertainty surrounding the validity of the values this method estimates.

In theory, it is expected that as the levels of the environmental good changes the respondents WTP will change accordingly yet in practice this is not observed. It is the lack of preference individuals show towards environmental goods that results in a warm glow effect. This effect describes how motivations such as the moral satisfaction of adopting a particular WTP distort individual’s true values of WTP and therefore they are not accurately expressed (Kahneman and Knetsch (1992)). Where these calculated values are used within a CBA, a lack of validity, could result in significant consequences for society such as the undervaluation of environmental costs. Therefore, the use of this method can be consequently considered unethical.

The way in which the data for CV is collected further lends itself towards ethical scrutiny. The questionnaire is distributed amongst a sample of the population but where the sample used is too small or possesses demographic preference, the aggregation of WTP will not be representative of the whole population and therefore will show bias. This bias will go on to be reflected in the CBA where projects undertaken may not result in a net benefit for society as a whole.

Yet Not all values are estimated by this technique. Most values used in the CBA are derived from accurate market prices. The extent to which CV will lead to unethical outcomes is thus determined by the number of costs/benefits valued in this way. Furthermore, CV has been proven to show reliability in its calculations through its ability to reproduce its data. Ethical backing should be given to this method due to its statistical reliability. Evidence to support this has been shown in a study of the Exon-Valdez Oil disaster where CV results were identically reproduced over two years.

When conducting a CBA, a discount rate is used to reduce values of future cost/benefits to their present value. It is within this process of discounting that the question of equity between current and future generations arises (Pearce, main document). The present values of the future cost/benefits appear to have insignificance relative to the values possessed before discounting was applied leading to concerns regarding intergenerational fairness. 

Where for example costs are discounted, projects may be passed by current generations that are detrimental to future generations. This is immoral and lacks sustainability in approach. However, this argument is limited by how reducing the discount rate to 0%, equivalent to not discounting, will still result in intergenerational inequality through relative compensation requirements as implied by Kalder hicks.

In comparison to other economic methods however, such as a Multi-Criteria Analysis (MCA), the CBA provides in theory a greater means of ensuring an ethical outcome is achieved. Where an MCA only has the ability to to compare conflicting projects to make a decision the CBA provides a defining rule to which the net impact on society can be assessed.

Both monetary valuation and economic method produce ethical arguments that lead to their involvement in the decision-making process being questioned. However, although these ethical arguments exist within each technique, the key ethical consideration that needs to be accounted for is the actions of the decision maker itself. These techniques can only guide agents in the decision making process. Where rent-seeking behaviour is present, there will be a disregard to the advice that these methods yield. As a final judgement, the ability for an ethical outcome to be achieved is therefore not determined by the techniques themselves but by the users who make choices regarding their application in the decision making process.