Industry Insights

May, 2011

Cost Benefit Analysis and Environmental Responsibility – Is It Worth It?

By John Barrett, Instructor

When we think of cost benefit analysis, we often consider the total cost approach and taking a long-term view of facilities and their impact. With this broader view comes the issue of social responsibility, requiring careful consideration of investment decisions.

The almighty dollar drives most, if not all, of the analytical approaches used to evaluate development. While the design of individual projects may need to satisfy development parameters determined by engineers and architects, the decision on whether or not to proceed is based on financial reward. Overall benefit is usually judged by one thing...What is it worth?

An analysis of benefits and costs over a defined period is used to determine if a proposed project delivers a positive return and if this return is worth the trouble and risk of proceeding.

The evolution of traditional cost benefit analysis to include social and environmental goods and services is a logical progression and a typical method of integrating both subjective and objective considerations into a single decision model.

Translating social issues into monetary terms is a difficult task. For example, the cost of storm water pollution discharging into a natural waterway may be estimated as the cost of preventing it in the first place (perhaps by building and periodically cleaning holding tanks that filter waste) or the cost of cleaning it up after it has occurred. The lack of accuracy in estimates of this type, when coupled with the effect of discounting in future years, is frowned upon by environmentalists due to the suitability of conventional economics to deal with social issues like environment quality. In many cases, these issues can’t be put in terms of money at all, and are left as hypothetical and typically dismissed.

A favourable cost benefit analysis is one that indicates an acceptable profit and risk allowance within a reasonable time frame. When the principle is applied to public sector projects that have wider social implications, the opinion is that collective benefit must exceed collective cost when measured across the community affected by the proposal. Under this idea, some individuals will be losers and others winners, but provided the collective benefit of winners outweighs the collective loss of losers then the project can be considered beneficial.

This concept can be considered for development with significant environmental content. A project is acceptable if it generates a profit at the expense of environmental wealth, enabling natural resources to be translated into physical assets of perceived greater value. In this case, society is considered the winner and the environment the loser. This is the main failure of traditional monetary based decision tools. They assume that any amount of environmental destruction is acceptable provided higher capital wealth is generated, as if at any time in the future environmental wealth can be recreated from accumulated capital.

Yet cost benefit analysis is still considered the most popular tool for assessment of development performance. It is intended to identify sustainable projects, but in fact this can’t be guaranteed, as the technique is more in line with measuring economic progress than conserving the environment. In the case of projects with considerable environmental impact, financial return may be completely unrealized as it is used primarily for the purpose of choosing between alternative courses of action. Even where costs are included to cover anticipated environmental repair, the process does not require that these expenditures ever actually take place.

We need to find a balance of financial analysis, and legislative control and/or enforcement is necessary if environmental quality is to be protected. Acceptable environmental damage should not be proportional to anticipated benefits. The assessment of sustainable development is more complex and important than financial markers can model.

It’s no secret these technical exercises can be a little mundane or even dry, but measuring the value of the environment and how we fit into it is arguably critical and, so financial decision tools are vital and are a major part of the quest for sustainable development. However, not everything can be adequately expressed in monetary terms, and therefore other criteria must be brought into the decision process to arrive at a balanced judgement. Therefore it needs to be recognized that if the hard numbers do not add up, then the proposal will be rejected, and all other considerations will be of less interest.

In the end, we need to decide what is most important to us. Turning a blind eye to the arguable high costs of planning for our future might turn out to be the wrong choice.

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