Relation to traditional cost-benefit analysis

A natural question is, How does this approach compare with traditional economic cost-benefit analysis, where benefits are measured in units of money (rather than of wellbeing)? The answer is that the results of existing cost-benefit analysis can be incorporated very easily into the wellbeing framework. For we know the impact that money income has on wellbeing, and we can always therefore convert any benefits measured in money into benefits that are measured in units of wellbeing. To be precise, if income is Y and X is a policy variable, the effect of the policy on wellbeing is given by

$\frac{\mathrm{dW}}{\mathrm{dX}}=\frac{\mathrm{dY}}{\mathrm{dX}}.\frac{\mathrm{dW}}{\mathrm{dY}}$(2)

where dY/dX is the effect of X on income, and dW/dY is the marginal utility of money.

This approach is often very useful, because for some policies it is easier to measure their effects initially in monetary units. This applies not just to direct effects on wages or other incomes (due, for example, to educational investment), but also to intangible benefits (like reduced journey times). These intangible benefits are in this case valued by what people’s behaviour shows they would be willing to pay for them (by their revealed preference).Footnote ⁵

But willingness to pay works only when people can show by their choices how much they value different outcomes. Sometimes they can do this, but very often they cannot. They can do it for things like transport, industrial production, education and some aspects of the environment. But many outcomes are not things that people can choose – they are things that just happen to people through outside influences – what economists call external effects. People fall sick, children get abused, elderly people get abandoned and people get mugged. We cannot learn about how much people value these experiences by observing choices. So how are we to evaluate policies like vaccination, or child protection, or family courts, or elderly care, or police protection? Measuring benefits in units of wellbeing is an obvious solution.

Critics might argue that, even though people can’t show their values by their choices, we can ask them hypothetical questions about how much they would in principle be willing to pay to promote these goods? Unfortunately, however, it has been shown repeatedly that asking people hypothetical questions about how they value things produces nonsensical answers.Footnote ⁶

So data on the happiness effects of activities may offer a better route to evidence-based policy making. But why not then translate those wellbeing estimates back into units of money? Thus, suppose we know the effect of a policy upon wellbeing. We could compute the equivalent gain in income that would increase wellbeing as much as the policy would. This equivalent variation in income could be computed by dividing the change in wellbeing by the marginal utility of income. Thus, if policy X improves wellbeing by dW/dX, the equivalent variation in income is given by

$\frac{\mathrm{dY}}{\mathrm{dX}}=\frac{\mathrm{dW}}{\mathrm{dX}}/\frac{\mathrm{dW}}{\mathrm{dY}}.$(3)

This is the reverse operation to that in equation (2). The resulting aggregate benefit measured in units of money could then be compared with the cost.

There are, however, two overwhelming objections to this approach. First, it automatically makes changes in happiness less important if they occur to poor people – it treats a dollar as the same whether it belongs to a Trump or a tramp. To avoid this, the results could be analysed separately for different income groups, applying a different marginal utility of income to each group. This re-establishes wellbeing as the measure of benefit, so why not simply stay with it in the first place?

Second, we might not want to simply add the ∆Ws, but rather to give extra weight to those with low initial happiness. If the monetary valuation procedure is followed, there is no way to do this, since the happiness level of each individual has become invisible. We may or may not want to give extra weight to those who are most miserable (see Chapter 2), but it is helpful to retain the ability to do so.

Note that throughout this chapter we assume that the total budget is determined by political considerations. We do not use the wellbeing approach to determine the total of public expenditure. The same thing happens with traditional cost-benefit analysis – projects are often rejected even if their monetary benefits exceed their costs. The reason is that there is not enough public money to finance all projects whose benefits exceed their costs. In consequence, the only projects that get through are those with a high enough ratio B/C, with the cut-off value being frequently higher than 1.

The alternative approach would be to allow wellbeing cost-effectiveness analysis to determine the total of public spending. But this would lead to much higher public expenditure. For example, if W = 0.3 log Y, the value of a healthy life year (with W = 7.5) is in England $750,000. But England’s NICE does not sanction the expenditure of more than $40,000 per additional life-year.Footnote ⁷

Taxes and regulations

Going on, there are other important public policy problems besides how to spend a given budget total. There is the issue of how to structure the taxes. The approach here can be straightforward. If we envisage a self-financing tax change, we would simply evaluate how this alters the happiness of each member of the population and aggregate these changes (assuming we are simply maximising the sum of wellbeing across all members of the population). We should also use wellbeing as the criterion for whether to introduce a new regulation or to abolish an old one.Footnote ⁸

Five major issues

It is time to address some thorny issues. First, there is the issue of the discount rate. We discussed this in Chapter 15, where we suggested something like 1.5% per annum.

Then there is the issue of the length of life. If we know the quality of any additional life-year that a policy would produce, we would value the extra life-year by the quality of life it produces. But otherwise we would value changes in life-years by the average level of wellbeing (in the country in question).

Then there is the issue of how we treat the birth-rate. If we increase discounted WELLBYS by encouraging the birth of more children, would that count as a benefit? If it did, it would almost certainly be the most cost-effective way of increasing the sum of future wellbeing. For example, by switching expenditure from healthcare to child subsidies, we could surely increase the birth rate by more (in %) than we reduced the length of life. This would increase the number of future WELLBYs. But most people would not support the policy. We would therefore propose that, when evaluating the effect of policies, we ignore any effect on total WELLBYs coming from changes in the number of people born.Footnote ⁹

Next, there is the issue of whose wellbeing counts. In principle, it should cover at least the whole of humanity. Every person is equally important. But for private ethics, there are some people who are easier for us to help than others. So, in practice, human society works through a division of labour. People take especial care of people close to them, and this also satisfies the need that humans have for a kind of affection they can only give to a small number of people.

But, when it comes to public policy or charitable activity, the circle of concern has to be widened to include people we do not know, including people in far-off parts of the world.Footnote ¹⁰ Ideally, each government would choose to do whatever it could for the good of humanity. In practice, democratic governments inevitably feel that their main responsibility is for their own electorates. But this responsibility would hopefully include two other important considerations:

• the altruistic desire to help less happy nations and

• the necessity of collaborating with other countries to secure global public goods like fighting climate change and securing world peace.

And what about the wellbeing of other sentient beings, besides humans? They must surely count. There is ample evidence that birds and mammals (at least) have feelings of pleasure and pain. For example, researchers have offered injured birds or mammals the choice between food that includes standard pain-killers and food that does not. Injured animals prefer the food with pain-killers. And, even more important, when they’ve taken the painkiller, they stop whimpering or calling out. This shows that the choice of the painkiller is not simply an automatic reaction to a wound but a reaction to an emotional feeling.Footnote ¹¹

Finally, there is the issue of equity. As we said in Chapter 2, the starting point for public policy analysis could be the Benthamite approach of adding up all changes in WELLBYs, regardless of who they accrue to. But most people would probably wish to give extra weight to improving the wellbeing of those who are least happy. The problem is how to secure agreement on the weights. One obvious approach is to conduct a representative survey of the views of the public, and this is a high priority for future research. In the meantime, one natural approach is through sensitivity analysis, examining how far the results are reversed when different weights are used. Equally, when considering new policy initiatives, it seems natural to focus on those areas of life that account for the greatest amount of total misery.

Experiments

But this is only the beginning of the search for new policies. The next step is to identify specific policy changes that might be considered. Once a plausible policy option has been identified, it would ideally be the subject of a proper randomised experiment in the field. Where it is impractical or unethical to randomise across individuals, it is often possible to randomise across areas or across institutions (schools, hospitals, etc.). From such an experiment would come information on the short-run wellbeing benefits and budgetary costs of the experiment – and then it can ideally be projected into the longer term using a model.

The final result of such an evaluation would be an estimate of the change in WELLBYs per dollar of expenditure – or alternatively the number of people removed from misery per dollar. Or these estimates can be expressed the other way round – as the cost per WELLBY or the cost per person removed from misery. Table 18.2 is a crude illustration of the latter approach. It is a back-of-the-envelope calculation and we only include it to provoke thought and discussion and to encourage the reader to do better. In the table, we have taken four standard methods proposed in the UK for reducing misery. We then estimate what public costs would need to be incurred each year to ensure that there was one less person in misery. (The assumptions are in Annex 18.2.) The outcome is somewhat surprising. Better mental health care is the most cost-effective of the four polices, followed by active labour market policy and physical health care, with income redistribution the least effective. Because redistribution is so expensive and relatively few of those in misery are also poor, it is often more effective to spend public money on services in kind – helping people to help themselves. So in this analysis, the top priority is building up the social infrastructure (health care, skills development, employment, and community services).

Questions for discussion

1. (1) How if at all does the wellbeing approach to public expenditure improve on traditional cost-benefit analysis. Can the two approaches be reconciled? How?

2. (2) How can equity considerations be best incorporated in the design of policies aimed at wellbeing?

3. (3) Would we ignore effects on the number of births?

4. (4) What is your reaction to Table 18.2? How could you improve the analysis?