Economics Clarifies Choices About Managing Risk

Government officials making decisions about such issues as allowable pesticide residues in foods, nuclear reactor safety standards, and air quality standards face a difficult problem. On the one hand there is the evident desire of the public to reduce the risks inherent in modern life. On the other hand reducing these risks is costly. So choices about risk policy involve tradeoffs. Risk management refers to the process through which a variety of considerations—scientific, legal, political, economic (benefits and costs), and even philosophical—are taken into account and a decision is reached concerning an environmental regulatory problem.

Economics can contribute in a number of ways to managing risks to health and the environment. At a basic level, economics can help to inform decision makers about how much various regulatory approaches or pollution control options will cost society. Upon first blush, this might seem pedestrian and straightforward. In fact, it might even appear that engineers rather than economists are better able to make such determinations, especially when the options under consideration involve primarily structures and equipment.

But appearances are deceiving. One of the real, albeit subtle, virtues of economics is its focus on what are called opportunity costs—that is, what society must give up in the form of other desirable things in order to pursue a desired goal such as reduced environmental risk. Under some circumstances, expenditures for pollution control equipment, cleaner fuels, or the like will closely approximate true opportunity costs. However, often this correspondence between money expenditures and opportunity cost is lacking. For example, rules on private behavior such as mandatory recycling of household wastes or limits on eating fish caught by sports fishermen involve no direct money outlays, but they impose costs in the form of time or reduced satisfaction. An economic perspective on costs provides valuable insights about the nature and magnitude of these forgone opportunities.

An important criterion for the rational management of risk is that any reduction in risk be accomplished at the lowest possible economic cost. Economic analysis can help to identify the least costly way to accomplish a particular reduction in environmental risk. Used in this way—how we can accomplish X for as little as possible—the application of economics goes by the name of cost-effectiveness analysis.

Besides helping to identify and properly measure costs, economics can help us to understand how these costs (as well as benefits) are distributed among the population. For instance, we might be interested in knowing whether residents of rural areas would bear a disproportionate share of the costs of an acid rain control program. Or, we might wish to know whether financing Superfund cleanups via direct budgetary outlays is more or less regressive in its impacts than financing those same cleanups through taxes on manufacturing firms. Again, we might want to determine whether the favorable effects of a policy are distributed equally among current and future generations. Economics can help us answer these questions.

Normative guidance

Using economics merely to supply information about the costs of different options is one of its less controversial applications in risk management. The challenge comes when economics is used to answer questions like: What should we do about the problem of pesticide residues in foodstuffs? Which cleanup strategy is best at the XYZ site? Here economics is being asked to go beyond the purely informational—beyond describing what would happen here or there—and instead is being asked to provide normative guidance to decision making—that is, to help us answer the question, What ought we do?

To answer normative questions like these, economists generally rely on a branch of economics known as benefit-cost analysis. Economists view benefit-cost analysis as akin to common sense. This is because after peeling away the analytical veneer, formal benefit-cost analysis essentially asks: If we pursue a particular policy option, what good will come of it and what will we have to sacrifice to get it? It is a simple extension to ask whether the former is worth the latter.

Although benefit-cost analysis can clarify the pros and cons of taking particular actions, its application to the problems of environmental risk management has not gone smoothly. It is not embraced in any major environmental statutes except the Toxic Substances Control Act of 1976 and the Federal Insecticide, Fungicide, and Rodenticide Act of 1972. Nor is it the rule in other regulatory statutes protective of public health (for example, those having to do with occupational safety and health, or consumer products. In fact, the balancing of benefits and costs appears to be prohibited when the Environmental Protection Agency sets most standards for air and water pollution and the regulation of active or abandoned hazardous waste disposal sites. Similarly, the well-known Delaney clause in the Federal Food, Drug, and Cosmetic Act of 1938 explicitly prohibits the head of the Food and Drug Administration from considering the health benefits associated with certain food additives if these additives are known or suspected of causing cancers in humans. Moreover, although the last three presidents have issued executive orders mandating that benefit-cost analyses accompany any new proposed or final regulations, federal regulatory agencies have often resisted, and Congress has battled to have these presidential orders weakened.

In addition to the political unease over benefit-cost analysis, there is also more than a little public concern about its use in environmental decision making. This concern is harder to document, but it shows up often in public meetings, opinion polls, and everyday discussions.

Political unease

Political reservations about using benefit-cost analysis to help make risk management decisions are based on several concerns.

Distributional issues

Benefit-cost analysis is in one sense distributionally neutral. That is, a dollar's worth of benefits (or costs) count the same regardless of the economic position, geographic location, or other characteristics of the individuals to whom they accrue. This can spell trouble in political circles.

Consider, for instance, the case of acid rain. Emissions of sulfur and nitrogen oxides from coal-fired utility and industrial boilers, as well as from mobile sources, are believed to be responsible for damages to aquatic ecosystems, forests, agricultural products, materials, and even human health. A variety of control measures are available and reasonably well understood. If risk managers decide to use the "polluter pays" principle, there would be very uneven geographic distributional effects. Because states in the Ohio River valley are emitters of large amounts of sulfur dioxide, they would bear a heavy share of the total costs of controlling emissions. Application of the polluter pays principle could cause electricity bills in those states to increase by as much as 15 to 20 percent. Such geographic concentration of costs has been one of the stumbling blocks to amending the Clean Air Act of 1970 to deal with acid rain.

Imprecise information

Politicians view benefit-cost analysis of risk management options with suspicion for another reason. Estimates of benefits and costs must rest on a foundation of knowledge of the physical, biological, and engineering systems involved, as well as the economic factors determining monetary values. For example, it must be possible to answer such questions as: How much will indoor radon concentrations be reduced by air filtration equipment? How many fewer cases of lung cancer will there be if radon levels are reduced? How much will emissions be reduced by vapor recovery devices on gasoline pumps? What effect will this have on atmospheric ozone levels? What will be the impact on agricultural productivity of reduced ozone concentrations?

None of these question is easy to answer. We sometimes have no more than well-educated guesses about the answers to these technological, physical, and biological questions. Some critics therefore believe that benefit-cost analysis can be rigged; that it will more often than not be used to justify a risk management decision that is taken not for analytical but rather for political or other reasons.

Myth of abundance

One of the uses of benefit-cost analysis is to help ration scarce resources among competing ends. This use is a reflection of the fact that there are more things worth doing than there are resources with which to do them. While this sounds innocuous enough, politicians generally prefer to avoid making explicit such declarations. No politician is likely to gain much support for telling a group that, although they are bearing some environmental risk from problem X, the risk is relatively small and the money necessary to reduce it could be better spent elsewhere. Even when it knows better, the public likes to be told that its government is working to eliminate all environmentally transmitted risks. Sensing this, politicians shy away from analytical approaches based on the premise that resources are finite and priorities have to be set.

Public unease

Politicians aside, the public has additional concerns about applying benefit-cost techniques to risk management problems.

Uncompensated risk

Benefit-cost analysis is silent on the question of whether the losers from any risk management policy should be compensated. In practice, therefore, even policies that result in aggregate benefits in excess of costs could still leave some people worse off. It would be natural for the losers to oppose the policies. And this opposition could be quite vocal if the losses were concentrated among a relatively small group of people.

Nowhere is the issue of uncompensated risk more clearly visible than in the problem of proposed siting of LULUs (locally undesirable land uses) such as hazardous waste incinerators and low-level nuclear waste disposal facilities. Those around any proposed site will reject the argument that it is in the best interest of society for them to accept the increased risks that these facilities pose. And very often their opposition will prove successful. In an effort to deal with this impasse, analysts have begun to propose mechanisms for compensating the losers.

The "right" to be risk-free

Many citizens feel that they have a basic and inalienable "right" to be free from contaminants in the water they drink, the air they breathe, and the food they eat. They resent these rights being weighed against economic dislocations, balance-of-trade concerns, and other seemingly impersonal factors.

There is a ready response to such objections. First, even those rights guaranteed in the Bill of Rights are not absolute. For instance, one's freedom of speech is restricted when it comes to standing up in a crowded theater and shouting "Fire!" While no formal benefit-cost analysis supported these relatively mild restrictions on our basic rights, they are premised implicitly on the notion that completely unfettered speech or assembly may sometimes do more harm than good. In other words, the benefits of some restraints may be worth the costs.

To those who would argue that we have a right to be free from all environmental risks, the counterargument would run as follows. First, in a fundamental physical sense, we can never be free of such risks. Primitive wood burning pits put harmful particulate matter in the air, and the human digestive system ensures that some wastes will always be with us. Thus, a no-risk world is simply impossible. Even if it were not, some risks would surely be judged to be so small in comparison to the costs of alleviating them that it would be best to accept them.

Economics is the science of scarcity, and society is surely limited in the resources it can allocate to the control of environmental risks. Thus, it is important to think analytically about which risks we want to address first and how much control we wish to pursue. Like it or not, tradeoffs will be made when these risks are addressed. This follows directly from the observation above that society's resources are limited. Because this is so, we simply cannot eradicate any and all risks.

At some point decision makers will have to say to themselves that additional risk reductions will be so expensive that they are probably not worth additional effort. The virtue of economics is that it makes these decisions explicit. In other words, it forces decision makers to say openly, for example, that society cannot afford to spend $1 billion to save an additional life through more stringent regulation of substance X. While such acknowledgements are often painful, they do enable the public to see the tradeoffs that their elected officials are making and object if they disagree with them. Pretending that such tradeoffs do not have to be made only means that they will be made implicitly and out of the public eye.

One conclusion, then, is that the public and its political leaders would be well served if the public better understood economic methods and their application to problems of environmental risk management. The fact that this is a familiar refrain does not detract from its importance.

Sauce for the goose, however, is sauce for the gander. Just as it would behoove the public and its political leaders to better understand the economic approach to risk management, so too must economists understand why their message is so often ignored. While benefit-cost and cost-effectiveness analyses have their strengths, they also have weaknesses, some of which are nearly fatal in the political realm. Until economists do more than pay lip service to the importance of distributional concerns in real policy-making, for instance, they will remain peripherally involved in policy formulation at best.

Economists must also understand that the public cares about more than simply the statistical magnitude of risks. It is also concerned about the mechanisms through which these risks are transmitted, the degree to which the risks are voluntary, the benefits that accompany the risks, and other dimensions that are often disregarded in standard economic analyses. Until these concerns are acknowledged and incorporated in our economic models, economists may dismiss as irrational responses that make very real sense.