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7.7. Economic Analyis/RIA Reviews: A Summary

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Two interrelated questions arise in attempting to determine what the reviews have to say. First, how good are the RIAs? Second, how does EPA utilize them? The quality of the RIAs might dictate how they are utilized.

Synthesizing the six reviews to answer these questions is difficult in part because the reviews tend to address different questions. For example, Hahn alone considers nearly the entire universe of RIAs but only to answer the second question. He doesn’t focus on the quality of the RIAs. Most of the other studies consider a small subset of RIAs to focus primarily on the quality question.

Regarding that first question, quality, what do the studies say? Let us consider two of the more frequently expressed shortcomings and also two of the more insightful studies.

Several of the studies – Morgenstern, Luken and Fraas, API, and GAO – criticize the RIAs they reviewed for considering too few options. GAO’s critique provides the additional insight that the optimal control level should be bracketed by inferior alternatives precisely to demonstrate that it maximizes net benefits.

Where there is a single variable to represent the regulation, say, tons per day of emissions, the task of choosing a set of regulatory alternatives is simple. However, the problem may be multi-dimensional. There may also be the more interesting issue of designing economic instruments. Each instrument provides one or more alternatives to be assessed. When the dimension of economic instruments is admitted, it may be difficult even to know if all possibilities have been identified let alone evaluated.

Perhaps the next most common criticism of the RIAs is the failure to monetize benefits. This is found in GAO, API, and Luken and Fraas. Without monetization, a study probably can be no more than cost-effectiveness although that may be adequate in some cases especially where there is little statutory flexibility. A variety of techniques exist to monetize benefits: hedonic wage and property value studies, the travel cost method and contingent valuation. All have their problems.

Two of the studies – API and GAO – provide particularly cogent critiques. The following paragraphs concentrate on them.

The GAO study takes EPA to task for failing to provide or failing to emphasize uncertainties in its RIAs. GAO suggests using Monte Carlo analysis and encourages clearer presentation of alternate outcomes of given regulations. EPA has acknowledged GAO’s criticism and its RIA guidelines reflect the need to address uncertainty.

GAO also addresses distributional effects, that is, who pays versus who benefits. GAO raised that issue years before the Clinton administration’s executive order required its consideration. GAO seems to be alone among the reviews in raising that matter.

GAO also argues that there is a need to expand the scientific and economic databases upon which RIAs rest. Here, they are referring to more fundamental research to establish physical relationships and economic techniques that RIAs can draw upon. EPA has acknowledged this criticism and points to research work in progress to address this concern.

API has made telling points regarding two of the RIAs: lead in gasoline and sulfur in diesel fuel. In both cases, the private benefits from improved fuel efficiency and reduced engine wear allegedly would exceed compliance cost. API raises the question of why lead and sulfur weren’t reduced without regulation. If private markets work, there should have been less lead and sulfur in fuels – or else the studies were seriously in error.

The API review also raises the important issue of social cost versus compliance cost. The latter ignores the “welfare wedges” in a static partial equilibrium analysis. In a dynamic or general equilibrium analysis, even more cost elements may be overlooked.

Let us turn now to the second question of how RIAs are utilized.

Hahn and Luken and Fraas note that agencies often fail to utilize RIAs to maximize net benefits. They choose inferior alternatives or adopt regulations with costs greater than benefits. Hahn is somewhat dismissive of the justification that the agencies’ hands are tied by statutory constraints; they seem to do the same thing even without constraints. Of course, if agencies regard the RIAs as seriously flawed in principal or execution, they may be promoting society’s interest in doing so.

If, however, we accept the conclusion of many of the studies reviewed here that the RIAs are of good quality, then our foremost conclusion should be that regulators are doing society a disservice in failing to give more weight to the studies. Welfare gains are needlessly being foregone. Further, if the net benefit estimates are indeed valid, then we might also seek relaxation of the statutory constraints against greater utilization of the RIA results.

It is easier to criticize than to create and it is in the nature of a review, or a review of reviews, to concentrate on the former. However, there is much positive that can be said of RIAs. In that regard, it is worth repeating Morgenstern’s summary comment:

EPA’s suggestion that RIAs as a whole pass their own benefit-cost test is also well taken. As noted earlier, three rules, enhanced by RIAs, produced net benefits of $10 billion, more than a thousand times what was spent on RIAs during the relevant period.

RIAs are less than ideal but the state of the art does not permit ideal RIAs. Fundamental breakthroughs may need to made in economics to produce ideal RIAs. An especially weak area would seem to be valuation of benefits for which no markets exist. It may take a breakthrough as dramatic as, say, game theory was at its introduction, to resolve the valuation issue.

Nevertheless, RIAs are clearly useful in the development of policy. Even the severest of the critics, Hahn, essentially argues that their results should be taken more seriously so that policies that maximize net benefits will be adopted.

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