The benefit of punitive damages

Congress and the president decided decades ago to ban new offshore oil drilling. However, even without the federal ban, the threat of big jury awards would have chilled an oil rush in the ocean. Drilling offshore is dangerous, and there is an ever-present risk of catastrophic environmental damage. If juries were free to impose big penalties for environmental destruction, the risk of catastrophe would weigh heavily on the ledger.

With the Supreme Court limiting punitive damages to a 1:1 ratio of “actual” damages, juries’ hands are tied, even in the face of grossly irresponsible conduct like we saw on the Exxon-Valdez. This limit on liability will be a warm blanket for the next generation of offshore oil explorers.

Bad idea drilling

Given the massive risks of offshore oil drilling it is hard to believe that Bush or McCain — who has also supported new drilling — could produce a credible cost-benefit analysis showing that it makes economic sense. The value of the oil would have to offset threats to natural resources and the large value that Americans place on unspoiled wilderness and unharmed ecosystems.

Even aside from the risk of drilling, bringing more oil into the economy will produce little long-term benefit. While it might reduce the price of gas in the short run, it will also reduce incentives to develop more fuel efficient cars and alternative energy sources. Supply-side strategies like offshore oil drilling are ultimately doomed to fail. The result will be more pollution — threatening public health and contributing to global warming — with little tangible benefit to show for it.

Suspenders — no belt

With the ban in place, the threat of big liability was a belt-and-suspenders safeguard. But now that the Court has taken away the belt, and the president has lifted the executive ban, all we have is Congress — already panicking over the price of gas. This is not a comforting thought.

As long as there is a perception that environmental protection is bad for the economy, support for strong regulation will always be tepid. The fact is, that economic analysis often justifies strict environmental and public health regulation. Often, it is only when the economics are manipulated or ignored that a laissez-faire approach to the environment present a tempting mirage. But if Congress continues to labor under the false idea that good economics supports less regulation, the suspenders are in danger of coming off. Even if Congress stays strong, if the public believes that environmentalists’ concerns are trumping economic values, there will be a price paid in November.

Cost-benefit analysis can help

Without the threat of big jury awards looming over offshore oil rigs, it is doubly important for environmentalists to show Congress and the public that drilling is not only unsound environmental policy, but is also bad economics.

Historically, however, some environmental groups have been hesitant to embrace cost-benefit analysis. That hesitation has historical, not conceptual, roots. Cost-benefit analysis came on the scene during the tenure of President Ronald Reagan, and was used as a smokescreen for his antiregulatory agenda. Many environmental groups developed an institutional distaste for cost-benefit analysis after seeing it continually used and abused to roll back hard fought gains on environmental issues.

In researching our book, Retaking Rationality, we found that over thirty years, antiregulatory interests have left their mark on cost-benefit analysis, creating several biases in how economic costs and benefits of regulation are measured. In order for cost-benefit analysis to realize its full potential, progressive groups will have to fight these biases.

Supporting the suspenders

Without the threat of harsh liability, Congress is the only backstop on offshore oil drilling, especially if Senator McCain wins the election in November. Cost-benefit analysis may be just the tool required to give Congress the backbone it needs to stand up to the special interests urging more drilling as a band-aid for this country’s oil addiction.

To build this backbone, environmentalists will have to drop their old concerns about economic analysis, and give cost-benefit analysis the benefit of the doubt. The tool is there for them to use; they need only pick it up.

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Cost-benefit analysis, correctly applied to many environmental problems, will show that strong environmental regulation is often economically efficient. Although some environmentalists, including Lisa Heinzerling in a recent post, have expressed reservations about the use of cost-benefit analysis to evaluate environmental rules, rejecting cost-benefit analysis instead of seeking to reform it would be a major strategic error for the environmental movement.

Heinzerling raises some legitimate concerns about cost-benefit analysis as it is currently practiced, but unfortunately she condemns cost-benefit analysis wholesale based on certain flaws that are not inherent to the technique. For example, Heinzerling argues that discounting benefits that accrue to future generations is a mistake, and results in “treating the future as less important than the present.” I couldn’t agree more — discounting benefits to future generations is a major source of anti-regulatory bias in cost-benefit analysis. In fact, my recent book with Michael Livermore, Retaking Rationality: How Cost-Benefit Analysis Can Better Protect the Environment and Our Health, has a whole chapter attacking the practice of intergenerational discounting.

Such discounting is not a necessary part of cost-benefit analysis, as Heinzerling claims. Instead, it is a flawed methodology currently used in the regulatory process — in part, perhaps, because there have been too few environmental voices in support of cost-benefit analysis that does not use discounting.

Heinzerling also argues that it is the fault of industry and the federal government — not environmentalists — that cost-benefit analysis is biased against regulation. She points to a number of examples where environmentalists have advocated for better cost-benefit methodology. It is true that on several occasions, environmentalists and other pro-regulatory groups have become politically engaged on certain methodological issues.

Perhaps most notable was the successful fight against a practice of the Bush administration to undervalue risk reduction for older Americans, dubbed the “senior death discount” — another methodological fallacy explored in our book. The senior death discount was bad economics, and when environmentalists and others (including the AARP) organized to fight it, they handed the Bush administration an important defeat. This example underscores the importance of the environmental community engaging in the debate over cost-benefit analysis — when they fight on these issues, they can win.

But usually, they have been absent from the regulatory conversations in which the most important decisions on cost-benefit analysis were made. In particular, our book explores at length how the environmental community failed to take advantage of the opportunities provided by the Clinton administration to reform cost-benefit analysis. Instead of seizing the moment and working to counter the antiregulatory biases adopted during the Reagan and Bush Administrations, environmental groups declined to engage either in conversations with the Office of Information and Regulatory Affairs (the key player in the area) or with EPA as it developed its extremely important guidelines for the preparation of cost-benefit analyses.

Responsibility for the current impoverished state of cost-benefit is shared. Industry, in seeking less stringent regulation, favors cost-benefit methodologies that are biased against regulation. Federal regulators may, at certain times, have had anti-regulatory proclivities as well. But if pro-regulatory groups (and scholars like Heinzerling) focused more of their efforts on reforming cost-benefit analysis rather than futilely trying to persuade the federal government to abandon it, there would be fewer biases, and cost-benefit analysis would not be so manifestly anti-regulatory. This does not mean that cost-benefit analysis would be perfect — but it would likely be better.

To be sure, there are non-cost-benefit analysis reasons to regulate. But there are cost-benefit reasons as well, and environmentalists should use those reasons to buttress their arguments. By arguing that cost-benefit analysis is anathema to environmental values, Heinzerling does the environmental community a disservice by encouraging it to drop a potentially powerful set of arguments that could support its policy initiatives. Limiting the political coalition for strong environmental regulation is not a recipe for success in Congress. We need to use every tool in the kit to convince the entire American public that environmental regulation makes sense for everyone — and that environmentalists are not just trying to impose their set of preferences on the rest of the country. Cost-benefit analysis can be used to make this argument convincingly.

Heinzerling also makes an aesthetic case against cost-benefit analysis. She states that because environmentalists “prefer concreteness over abstraction,” they should reject cost-benefit analysis because “the glimpse of the infinite in a summer storm” is “foreign to the cost-benefit mindset.” Both of her premises are incorrect. First, environmentalists come in all shapes and sizes. The environmental movement embraces scientists and organic farmers, evangelical environmentalists and environmental economists. The movement is big enough to incorporate abstract thinkers. Second, even if some environmentalists do prefer the concrete to the abstract, it would be foolish to allow this preference to override the need to use data, models, and analysis — all necessary abstractions — to understand the pressing problems facing our planet.

It would be equally foolish to avoid making common cause with Americans who are not convinced by appeals to “spring’s first warbler” and who prefer hard numbers to back up policy choices. In building the political coalition for strong environmental rules, groups should call attention to the beauty of the natural world, our innate sense of justice, and our moral obligations to each other and the planet. But cost-benefit analysis, and economic arguments generally, fit comfortably among the range of reasons that people believe in strong regulation. As our book discusses, both reason and compassion need to be part of the arsenal of environmental groups.

Most pollutants — including all carcinogens — are no-threshold contaminants. They have adverse health effects at every concentration, though of course the effects are worse at higher concentrations. There is no such thing as a “safe” level. Without understanding the economic consequences of regulation, there is simply no intelligible way to decide how to regulate such contaminants because there will always be some residual exposure (whether one-in-a-million, one-in-a-hundred-thousand, or one-in-a-billion).

Furthermore, the argument that we should take the least costly path to reducing environmental health risks is very compelling — both politicians and the American public recognize that regulations can have benefits, but they are also closely attuned to the costs that are imposed. When environmentalists are reluctant to engage in cost-benefit analysis, they leave themselves open to the characterization that they are insensitive to the economic costs of regulation, and they can lose a great deal of their potential effectiveness in the political process.

As we prepare for the presidential election and the transition to a new administration, the time is ripe for the environmental movement to reevaluate its feelings about cost-benefit analysis. There is a growing awareness of the need to address a second generation of environmental threats like climate change. But the country is also in the economic doldrums, and there will be fear of any new rules that impose costs on the American public or are seen as hampering economic growth. To make much needed progress on environmental issues in this political climate — full of opportunities but also challenges — environmentalists would do well to drop the fight against cost-benefit analysis, and to take up the opportunity to reform it.

The R. Gallagher coal-fired power plant in Indiana emits over 50,000 tons of sulfur dioxide per year. Sulfur dioxide is a major component of particulate matter — a form of pollution known to cause adverse cardiovascular and respiratory health effects. Sulfur dioxide also mixes with other pollution in the atmosphere to form acid rain. As a result of these adverse health effects, the Office of Management and Budget estimates that each ton of sulfur dioxide released into the atmosphere imposes $7,300 in costs on the American public. This means that the R. Gallagher facility imposes over $370 million worth of costs each year.

Environmentalists have fought for years to clean up or shut down dirty power plants like R. Gallagher. According to an analysis by the Environmental Integrity Project, the dirtiest fifty plants account for 40 percent of sulfur dioxide emissions, but only 13.7 percent of the electric generation. If we cleaned up the worst of the worst, we would make tremendous progress in improving the quality of the nation’s air.

What makes the existence of plants like R. Gallagher so galling is that there is absolutely no reason why they should be allowed to pollute the way they do. Given the massive social costs imposed by plants like R. Gallagher, it makes basic economic sense to invest in pollution control technology — or even build an entirely new efficient plant next door and shut the facility down entirely.

The Bush administration has had almost eight years to fix the problem of R. Gallagher. Despite its professed allegiance to the cost-benefit principles that reveal pollution from the plant as an economic disaster, the administration has done nothing to stop it. Congress, which contains many ostensible fans of cost-benefit analysis as well, hasn’t closed the grandfathering loophole in the Clean Air Act that keeps R. Gallagher in business. When tougher environmental regulation is so clearly backed by sound economic analysis, the only explanation for the policy gap is a failure of the political process. This is not an ideological question; it is not a question of competing values. R. Gallagher, and similar polluting plants, stand as perfect monuments to a political system that has failed the American public.

Eighty percent of success is showing up

But these dirty plants can also serve as an example of how environmentalist can use economics to forward their agenda. Since Ronald Reagan placed cost-benefit analysis at the center of his deregulatory agenda in 1981, environmentalists have developed a strong allergy to economic analysis. They rarely participate in the debates over how cost-benefit is conducted, and do not place economic analysis at the center of their arguments for new and stronger regulation. On the other hand, antiregulatory groups like trade associations representing industrial polluters and conservative think tanks have embraced cost-benefit analysis. They argue that economic analysis shows deregulation is a good thing.

The asymmetry of participation has had several negative consequences. First, proregulatory interests consistently lose ground before the courts and OBM, which for nearly three decades has reviewed all “significant” regulations. Because OMB and the courts look to cost-benefit analysis, groups that cannot frame their arguments in economic terms are bound to lose.

Second, cost-benefit itself has become biased against regulation. It has been shaped by antiregulatory interests with little input from proregulatory interests, resulting in the adoption of several flawed techniques that tend to underestimate regulatory benefits and overestimate regulatory costs.

Finally, proregulatory interests have lost public approval as they have allowed themselves to be portrayed as extremists in pursuit of “big government.” This loss of public support saps political will for new and updated regulatory programs.

Environmentalists made a particularly grave error by failing to advocate for more neutral cost-benefit analysis during the Clinton administration. When Bill Clinton took office, many expected him to drop cost-benefit analysis from the process of regulatory review. Instead, he embraced it, and took some steps to make it more transparent and fair. Environmentalists had eight years to try and remove the antiregulatory biases from cost-benefit analysis, but they let the opportunity pass. I served on an EPA committee charged with making recommendations about cost-benefit analysis to the agency, and during all of our meetings — which were always well attended by industry groups pushing an antiregulatory agenda — environmentalist never came. When negotiations are conducted with an empty chair in the room, it is hardly surprising when the results come out skewed.

Cost-benefit biases

Many fallacies have made their way into cost-benefit analysis because of this lopsided participation. For example, it too often accounts for unintended negative consequences of regulations without also accounting for similar positive consequences. When setting fuel efficiency standards, the National Highway Traffic Safety Administration assesses negative consequences — like deadlier auto accidents associated with smaller cars — while ignoring positive side effects — like reduced greenhouse gas emissions. The result is weak regulation.

Another example in debates over environmental regulation is the myth of the “health-wealth” tradeoff — the notion that any economic regulation, by reducing economic productivity, will result in loss of life, because income and wealth is correlated with longer life. However, the assumption underlying the idea of a health-wealth tradeoff — that higher income causes people to be healthier — is contradicted by the most recent research on the subject. This research shows the inverse causation, that better health leads to higher income, and that education causes both higher wages and better health.

These two fallacies are among many others that bias cost-benefit analysis against environmental regulation.

Mending cost-benefit

As a new administration enters office, it is important that environmentalists not miss another opportunity to reform cost-benefit analysis. It is not going away. For nearly thirty-years, cost-benefit analysis has been required of all major federal regulation. It has been embraced by both Republican and Democratic administrations, and it is exceedingly unlikely that any new administration will jettison it altogether — it is simply necessary to anticipate the likely economic effects of large regulatory programs.

Perhaps more importantly, cost-benefit analysis can be used to promote the agenda of environmentalists. As we all know, climate change poses grave risks at a global level. Dealing with those risks will not be easy — or cheap. While all three presidential candidates acknowledge that climate change is a problem, and that controls on greenhouse gases are necessary, there is great distance between a campaign promise and a final rule. In order to convince politicians and the American public to overcome their concerns about the tectonic economic shifts greenhouse gas controls will create, environmentalists will need to muster sound analyses showing that their views are justified by good economics.

The country is also in the midst of an economic slowdown, following on the heels of stagnant growth in wages during the Bush administration. Economic anxiety is growing, as recent focus in the Democratic primary on NAFTA and the price of gasoline demonstrates. Without sound economic analysis showing that strong environmental regulations are needed, a public in the grip of job-losses and economic insecurity will look askew at proposed regulation deemed to be “burdening” the economy.

This time, instead of fighting — futilely — to end cost-benefit analysis, environmentalists should fight to mend it. For the past three years, my co-author Michael Livermore and I have studied how cost-benefit analysis has been used, and abused, in environmental law. These abuses are not inherent in cost-benefit analysis, but have arisen because the debate over how cost-benefit analysis has been dominated by industry trade associations and antiregulatory scholars. The only way to transform cost-benefit analysis into a more neutral tool is to take up the debate, to show where cost-benefit analysis has been twisted to justify and antiregulatory agenda.

That is why New York University School of Law will launch an Institute for the Study of Regulation this summer. The purpose of the Institute will be to correct the antiregulatory biases in cost-benefit analysis and show that smart environmental and public health regulation is justified on economic grounds. We hope to work with other organizations in the environmental and public health community to show that regulation is part of a thriving and efficient economy and that under-regulation can be just as costly in economic terms as over-regulation.

There are many symbols in the history of the environmental movement: Storm King Mountain, TVA v. Hill, the Warren County PCB Landfill. Each represents important steps that were taken in this country towards environmental responsibility. By forging a new cost-benefit environmentalism — one that does not fear economic analysis but instead uses both reason and compassion to justify strong environmental rules — perhaps R. Gallagher can become a symbol of something other than political failure. By using economics to show just how wasteful under-regulation can be, cost-benefit environmentalism can be the key to creating the political coalition necessary to make America richer by regulating more wisely.