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Is Barack Obama's 'Cost-Benefit' Analysis Too Costly?

President Barack Obama
Photo by: Pete Souza
President Barack Obama

Barack Obama’s editorial in the Wall Street Journal is sure to land him in hot water with the left and perhaps win him a few supporters on the right.

In case you missed the news, the president put his byline over a Wall Street Journal op-ed saying that he will sign an executive order to ensure that federal regulations strike a balance between protecting safety, health and the environment, on the one hand, and economic prosperity, on the other.

For years cost-benefit analysis has been viewed as a libertarian bugbear by the left. When the first requirements for cost-benefit analysis were included in an executive order by Ronald Reagan, the left howled with outrage. Clinton slightly modified the rule but largely kept it in place. Obama seems to be doing the same (although, it should be noted, the exact text of the order do not yet seem to be available.)

NBC news reports that the efforts will be run out of Cass Sunstein’s office inside the Office of Management and Budget. That’s hardly surprising. The entire op-ed reads as if Sunstein had a large role in authoring it. He’s long been an advocate of cost-benefit analysis of government regulation.

Here’s Sunstein in a 1999 paper defending cost-benefit analysis.

I have suggested that cost-benefit analysis, often defended on economic grounds, can be urged less contentiously on cognitive grounds. Cost-benefit analysis, taken as an inquiry into the consequences of varying approaches to regulation, is a sensible response not only to interest-group power, but also to limited information and to predictable problems in the public demand for regulation. These problems include the use of the availability heuristic; social amplification of that heuristic via cascade effects; a failure to see the benefits that accompany certain risks; a misunderstanding of systemic effects, which can lead to unanticipated bad (and good) consequences; and certain emotional reactions to risks. In all of these areas, an effort to identify costs and benefits can properly inform analysis.

It’s important to note that in Sunstein’s interpretation, cost-benefit analysis does not have the implicitly libertarian outcomes that the leftist critics and some free market types expect. Indeed, it could be that both the critics and friends of this new executive order will be surprised.

Sunstein’s cost-benefit analysis, for instance, could well be used to support greater regulation of hedge funds or a stronger version of the Volcker Rule by pointing to the relatively modest costs involved and the potential costs of possible systemic risks. In advance of actually doing the cost-benefit analysis, we cannot know if any particular regulation will pass muster.

I suspect that in actual operation, we’ll discover that Sunstein-ian cost-benefit analysis is modestly pro-regulation. Especially when regulators are allowed to include vague things such as how a regulation impacts on equity, this kind of “watch the consequences” analysis is pretty open-ended and far more subjective than it might seem.

This open-endedness can have political consequences. By forcing regulators to undergo a cost-benefit analysis when considering rules, the president exercises a certain amount of control over government agencies that constantly seek to create space to operate autonomously and are under threat of being captured by special interests. The present administration, for instance, may want to require more regulation of derivatives trading than the CFTC favors.

By forcing the CFTC not to repeal or reject regulatory proposals without subjecting them to rigorous cost-benefit analysis, the executive order has a fighting chance to see its goals pursued, rather than those of the CFTC or the derivatives traders. Cost-benefit analysis is a way of dealing with the problem of regulatory loyalty.

The real problem with Sunstein-ian cost-benefit analysis is not that it will be operationally pro-regulation (or, as leftists fear, anti-regulation). It’s that it is both a product and a source of an illusion of regulatory competence.

But there are clear signs that after 100 years of building the regulatory state, the machinery of regulation is far too complex for anyone to be able to predict the unintended consequences of how a regulation will interact not just with presently existing regulations and social/economic arrangements—which is the most basic step—but with how it will interact with likely future regulations and social/economic arrangements. Absent that basic predictive ability, there is no way to accurately assess the costs and benefits.

That illusion of competence has the tendency to make us less prepared for regulatory failure—that is, for the actual costs of regulation or deregulation. We build ever more fragile social and economic arrangements on the assumption that we can properly predict their costs-and-benefits.

So while Sunstein-ian cost-benefit analysis may help the president overcome the problem of regulator loyalty, it may make the problem of regulatory competence worse. I’ll leave the question of whether the benefit of loyalty outweighs the cost of illusory regulatory competence for someone with more loyalty and competence to answer.

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