Cost-benefit analysis (CBA) is a technique economists use to assess the desirability of some action, be it investment in a local highway project or an economy-wide reduction in carbon emissions. On the surface the idea is straightforward: we measure the benefits and costs of the action in a common unit of account (usually money), and if the sum of the benefits is greater than the costs then the project is “worth it.” This simple statement, of course, masks the practical challenges of applying the technique, and arguably misrepresents the way that cost-benefit analysis can best contribute to policy debates. A more nuanced view of CBA is that it provides an organizational framework for identifying the range of potential costs and benefits of an action, and for considering the extent to which they can be meaningfully compared. The requirement that benefits and costs be explicitly listed imposes discipline on the process and encourages concrete discussion. The final decision is then informed (though not necessarily determined) by a comparison of those costs and benefits that can be expressed in comparable terms, along with qualitative consideration of the costs and benefits that cannot.

The intellectual roots of cost-benefit analysis lay in the desire among early twentieth-century economists to make interpersonal comparisons on the well-being effects of policy prescriptions. At issue was the fact that almost any intervention involves winners and losers, implying that a criterion requiring that everyone be made better off would always lead to the status quo. Avoiding this meant making judgments about the relative gains and losses as they are spread out over many people, yet most agreed it was not possible to make meaningful interpersonal comparisons of utility levels. Kaldor (1939) and Hicks (1939) solved this dilemma by proposing that a policy was justified on efficiency grounds if the winners from the intervention could compensate the losers – meaning that the willingness to pay to have the policy among those that gain exceeds the willingness to accept compensation for damages among those who are made worse off. Whether or not the compensation actually takes place is immaterial for the basic efficiency outcome; if the political process deems it desirable, the equity issues can be addressed with suitable income transfers.