Cost Benefit Analysis is so bad we need more of it January 9, 2014 at 5:35 pm
quantified CBA on those rules [in the Dodd Frank Act and elsewhere in financial regulation] amounts to no more than “guesstimation,” entailing (a) causal inferences that are unreliable under standard regulatory conditions; (b) use of problematic data, and/or (c) the same kind of contestable, assumptionsensitive macroeconomic and/or political modeling used to make monetary policy.
This is entirely fair. Coates however makes too much of this, claiming that
While CBA… is a useful conceptual framework, and quantified CBA a worthy long-term research goal, it is not capable of disciplining regulatory analysis [of financial rules] in its current state.
Let me explain why. Any cost benefit analysis of significant financial regulation is plagued with difficulty: not only is it hard to know what both sides are, there is also the significant difficulty that the industry will change in likely unpredictable ways to any regulation. With the best will in the world, it is impossible to quantify either costs or benefits accurately.
However, agencies and others should still conduct CBA. There are a number of reasons for this. First, building a CBA models focusses the mind and brings up hitherto unforeseen issues. Even if you throw away the output, it is still worth doing.
Second, a good CBA model will not produce simple cost and benefit analysis, but ranges of estimates, probability fan charts, or similar. This encourages the modeller to be more honest about model risk and often highlights the fact that, for many policy proposals, they are not certain to work. That doesn’t mean that you shouldn’t enact them, but rather that you should be alert to the possibility of failure, and ready to change policy if the evolving evidence indicates that you should.
Finally, both sides of an argument can and should do CBA. This would focus the discussion on those aspects of the problem that the two sides disagree on, and hence provide a hopefully small set of questions whose answers determine the efficacy of the proposal, or which suggest modifications to it. Wouldn’t it be great if instead of the industry going up in front of a judge and saying ‘the agency didn’t do a CBA, so you should stop them enacting the rule’, both sides instead went up with their own detailed models, and were forced to justify their differing appraisals of a policy proposal?