Cost-Benefit Analysis





Since being mandated in the Flood Control Act of 1936 (PL 74–738), cost–benefit analysis has been used routinely in evaluating water projects. Cost–benefit analysis gives decisionmakers a method for evaluating investments in water projects, judging alternative projects, and estimating the impact of various regulatory changes. The basic principle of cost–benefit analysis is that the benefits of a water project must exceed the costs. Therefore, the issue is to measure all the benefits and costs attributable to a project accurately and completely. The application of this principle becomes difficult because of the uncertainty inherent in dealing with projects over time.

The Value of Nonmarket Goods

When conducting project analysis, it should be remembered that all projects will have benefits and costs to the environment not directly accounted for in the planning. These spillovers should be considered so that decision-makers are aware of such costs. Whenever a large public spending program exists, there are both winners and losers.

A major shortcoming of cost–benefit analysis is the difficulty in valuing nonmarket goods . Water projects, by nature, will affect the fish and wildlife habitats in an area as well as recreational and other environmental amenities. Since these benefits and costs are not priced in the market, they are often not included in a project analysis. However, note should be taken of these issues to give decision makers the ability to consider such nonmarket values while evaluating a project.

Valuing the benefit of pollution control is also difficult in cost–benefit analysis and often leads to controversy when studies are publicly released. Economists have no formula for valuing the avoided damage to humans and the environment of pollution control. What is the value of extending life or reducing illness? Still, economics can be useful in determining whether the same water quality improvements might have been achieved at a lower cost or whether the same investment could have purchased greater quality improvements.

Practical Economic Analysis

Despite the difficulty in assigning economic value to certain environmental or human factors, economists and analysts nonetheless can provide decisionmakers with what might be called second-best or practical cost–benefit analysis. Economist John Krutilla summarized the role of economics as follows: "Economic analysis of benefits and costs of long-lived investments involve as much art as science. There is a need to project the relevant course of events within the area of project influence over a very long period of time, and getting to understand human responses to changes in the social and physical environment does not come easily."

Several items must be considered before beginning an analysis of any water project, investment, or spending decision. For example, construction of a public flood-control project or a reservoir often does not consider the effect on fish, wildlife, wetlands, or surrounding watersheds. Or, the evaluation of a water conservation project may not include the effects on the recreational use of a lake or reservoir. Consequently, the fully informed decisionmaker must first determine the scope of the costs and benefits to be taken into account. This way, managers can assure the public that the major relevant factors were considered before making a decision.

Another question concerns the entity to be maximized: Returns to the system? Rate payer benefits? Water use? Environmental concerns? Whether a project is a net benefit to the system, the community, or the environment will depend on the objective that is being sought.

Third, analysts must know the investment criteria. Whether one project is chosen over another or no investment is made depends on the criteria for ranking projects.

Fourth is the relevant timeframe for the project. A period of analysis must be chosen. For example, how long is a reservoir to last? The analyst must also remember that different projects have different cash flows over time; some have early returns, others more distant returns.

Evaluating Dollars Over Time

In project evaluation, benefits and costs clearly accrue over many years. Thus, it is necessary to discount the present value of a project over time: $1,000 is worth more today than it will be 5 years from now. A method is needed to take future costs and benefits and put them into today's dollars.

Planners "discount" future dollars to take into account the time value of money. By using a discount rate , planners can compare today's costs and benefits to those in the future. The discounted net present value is the discounted sum of benefits minus costs. Only projects where net present value is positive would be economically feasible.

SEE ALSO E CONOMIC D EVELOPMENT ; E THICS AND P ROFESSIONALISM ; P LANNING AND M ANAGEMENT , W ATER R ESOURCES .

Jeffrey L. Jordan

Bibliography

Frederick, K. D. "The Economics of Risk in Water Resource Planning." In Water Resources Administration in the United States: Policy, Practice, and Emerging Issues. Martin Reuss, editor. East Lansing: Michigan State University Press, 1993.

Krutilla, John V. "The Use of Economics in Project Evaluation." In Transitions of the 40th North American Wildlife and Natural Resources Conference. Washington, D.C., 1975.

Schmid, A. Allan. Benefit-Cost Analysis: A Political Economy Approach. Boulder, CO: Westview, 1989.

PORK BARREL PROJECTS

The term "pork barrel" dates from just after the American Civil War (1861–1865) and comes from the plantation owners' practice of distributing rations of salt pork to slaves from wooden barrels. The term "pork barrel spending" can be traced to about 1905, defining such spending as "a government appropriation . . . that provides funds for local improvements designed to ingratiate legislators with their constituents." Such spending implies federal legislation filled with special projects for members of Congress to give to the voters back home paid for by federal taxpayers.

Most pork barrel projects, also referred to as line-item, or "earmark," projects, are infrastructure spending on items such as roads, airports, government buildings, and often water projects. However, "ear marks" are not evaluated competitively. Pork barrel projects are often seen as a growing trend for Congress to become heavily involved in local and states affairs through the "power of the purse."

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