Cost-Benefit Analysis and Relative Position
44 Pages Posted: 14 Aug 2000
Date Written: July 2000
Current estimates of regulatory benefits are too low, and likely far too low, because they ignore a central point about valuation - namely, that people care not only about their absolute economic position, but also about their relative economic position. We show that where the government currently pegs the value of a statistical life at about $4 million, it ought to employ a value between $4.7 million and $7 million. A conservative reading of the relevant evidence suggests that when government agencies are unsure how to value regulatory benefits along a reasonable range, they should make choices toward or at the upper end.
We begin by showing that the nation is nearing the end of a first-generation debate about whether to do cost-benefit analysis, with a mounting victory for advocates of the cost-benefit approach. The second-generation debate, now underway, involves important issues about how to value costs and benefits. Conventional estimates tell us the amount of income an individual, acting in isolation, would be willing sacrifice in return for, say, an increase in safety on the job. But these estimates rest on the implicit, undefended, and crucial assumption that people's well-being depends only on absolute income. This assumption is false. Considerable evidence suggests that relative income is also an important factor, suggesting that gains or losses in absolute income are of secondary importance unless they alter relative income. When a regulation requires all workers to purchase additional safety, each worker gives up the same amount of other goods, so no worker experiences a decline in relative living standards. The upshot is that an individual will value an across-the-board increase in safety much more highly than an increase in safety that he alone purchases.
Regulatory decisions should be based on the former valuation rather than the latter. When the former valuation is used, dollar values should be increased substantially - conservatively, by 25 to 50 percent. Upward revisions of such magnitude clearly have important implications for a broad range of policy debates currently informed by cost-benefit analysis.
We also show that an understanding of the importance of relative position suggests a rationale for various nonwaivable contractual terms in employment law, such as health care, parental leave, job security, and leisure. These terms, which have been attacked as welfare-reducing by many economists, give people important benefits with little or no impact on relative economic position. As with regulations that boost workplace safety, such contract terms may therefore be much more attractive when purchased by all than when purchased in isolation.
JEL Classification: K00, K20, K32
Suggested Citation: Suggested Citation