Driesen on Cost Benefit Analysis (CBA) vs. Economic Dynamic Analysis (EDA)
There are several ways to read The Economic Dynamics of Law by David Driesen. One is as an attempt to construct and defend a new normative foundation for law in fields as diverse as property and financial regulation. This reading judges the project against the extremely ambitious expectations that it sometimes seems to set for itself. Another way of approaching the book is as a set of reform proposals to the standard cost-benefit analysis methodology that has been practiced by federal administrative agencies in the United States for the last three decades. This reading is more modest conceptually but more demanding of political and practical realism.
Viewed as an alternative to the law and economics tradition of cost-benefit analysis, the “economic dynamic analysis” (EDA) that Driesen proposes runs into a number of substantial difficulties. It lacks the clarity and rigor of these more established perspectives. Sometimes, it seems to mirror the methodologies that it purportedly opposes. Where EDA departs from cost-benefit analysis or the law and economics framework, it often seems to stray in normatively troubling directions.
Dismissing EDA as an unattractive conceptual alternative to law and economics, however, would miss what is most useful in Driesen’s effort. By highlighting areas where cost-benefit analysis, as practiced, fails to live up to its promise, while broadly endorsing the goals of rigorous policy analysis, The Economic Dynamics of Law makes a valuable contribution that falls somewhere between the now familiar opposing camps that, on the one hand, downplay the difficulties in cost-benefit analysis methodology and, on the other, seem to question the value of careful ex ante comparison of regulatory alternatives. By inhabiting this middle ground, Driesen demonstrates what productive conversations about the future of cost-benefit analysis can look like, and in the process makes a number of helpful reform proposals that ought to be taken seriously by policymakers.
The threats that motivate Driesen are real. A chapter on the 2008 financial crisis points to the failure of regulators to identify and aggressively mitigate risks in the banking and mortgage sector. The effects of the crisis continue to reverberate, and there is no guarantee that the seeds for the next crisis have not already been sown. Similarly, a chapter on climate change notes that, despite a decades-long scientific consensus on the issue, there is still no global regime to cut greenhouse gas emissions. Uncoordinated domestic policies have proven altogether inadequate to the scale of the problem.
For Driesen, the “neoclassical economic framework” bears substantial blame for these policy failures. For the most part, this view serves as a starting place for his analysis, rather than a conclusion that is vigorously argued. The evidence that Driesen does introduce is unlikely to persuade anyone who does not already agree. For example, Driesen cites the work of a leading climate economist, William Nordhaus, as an illustration of how the economic mindset leads to policy timidity on environmental issues. [p.207 et seq.] But in more recent work, Nordhaus has offered a strong defense of aggressive measures to control greenhouse gas emissions, and his models, along with those of other climate economists, have been used by the Obama Administration to justify its regulatory moves in this area. If economic reasoning supports the most important measures currently in the works to confront the problem of climate change, it is hard to see how it is the source of our failure to act.
In fact, the economic dynamic analysis that Driesen proposes shares much in common with the mainstream economic perspective. While EDA is not formally defined in the text, Chapter 4 provides a general description, and the many affinities of Driesen’s DEA with mainstream economics are readily apparent. For example, Driesen describes EDA as involving the study of “the economic incentives [that] law creates” as well as “countervailing incentives [that] might counteract legal ones.” [p.68] Of course, viewing law as an ex ante system of incentives rather than a set of ex post remedies for past wrongs remains one of the enduring contributions of the law and economics movement. Driesen also describes EDA as attending to the public choice consequences of policy making; what he calls “empowerment analysis.” Such public choice analysis is a staple of law and economics reasoning (see, e.g., the Wikipedia entry for public choice). Driesen also asks that EDA make predictions based on a “bounded rationality assumption,” [p.64] a concept that, although it has its origins in psychology and behavioral economics, is now well accepted within the mainstream economics community. Driesen also counsels “choosing the most efficacious way of achieving the goals the society has agreed upon,” [p.69] “consider[ing] a range of alternatives,” [p.70] and “choos[ing] among efficacious measures that avoid undesirable consequences.” [p.70]. This all sounds much like cost-effectiveness (the selection of lowest-cost measures to achieve social goals), a mode of thinking that is far from foreign to basic economic analysis.
Driesen sometimes seems to recognize as much, straining at times to distinguish EDA from cost-benefit analysis. One passage is particularly telling:
At this point [after a discussion of policy alternatives to address financial risk], readers accustomed to the neoclassical economic perspective may find it difficult to distinguish economic dynamics from standard CBA. Although economic dynamic analysis can take both the advantages and disadvantages of economic arrangements or proposed policy changes into account, it does not do so by quantifying costs and benefits. . . . Without ruling out the possibility of some quantitative analysis entering the picture, [EDA] requires qualitative judgment, including an imaginative exploration of alternatives that might be possible if energy now devoted to CBA gets employed to think about alternatives. [p. 92]
But these purportedly distinguishing features of EDA (a wide range of alternatives and the exercise of “qualitative judgment”) are included in President Clinton’s executive order 12,866, John Graham’s A-4 Circular, EPA’s Guidelines on Conducting Economic Analysis, and President Obama’s executive order 13563—the foundational texts defining the methodological aspirations of cost-benefit analysis in the American administrative state.
At other times, Driesen does more clearly depart from standard economic rationality. And it is here that he runs into more serious trouble. Driesen returns several times to the theme that “law does not function as a master allocator of resources, but provides a framework for avoiding economy-wide disasters and creating opportunities for economic development.” [p.53] Few would probably argue that law should be a “master allocator” of anything, but limiting the role of law to avoiding economy-wide disasters and establishing a framework to growth is a surprisingly conservative proposal for a scholar affiliated with the Center for Progressive Reform. A large number of environmental regulations, for example, would not meet these demanding criteria. The Environmental Protection Agency estimates that tens of thousands of people die every year from exposure to particulate matter. This is a grave problem, but is neither an “economy-wide disaster” nor a serious impediment to “opportunities for economic development.” EPA is contemplating new rules to require power plants to install expensive new technologies in order to reduce the number of fish that are killed when they are sucked into water-cooling structures. These fish kills are problematic, but again, they do not amount to a serious threat to economic growth. Were decision makers exclusively focused on economy-wide risks, they would weigh the effects of a stringent water-cooling rule on energy prices more heavily than the harm to fish in the status quo. Similar examples abound in many policy domains: payday lending might pose no existential threat to the economy, even if the practice severely disadvantages certain consumers; the occasional unsafe product is unlikely to substantially affect GDP. Only when we introduce some measure of welfare, and accept a role for government as at least partially about the efficient allocation of resources and risk rather than simply a facilitator of private transactions, do many environmental, public health, safety, or consumer protection regulations make any sense.
A defender of EDA might try to square the circle here by arguing that it also allows for “normative commitments” aside from avoiding economy-wide disasters, such as promoting “a healthy environment.” [p.51] But we get very little here on where these (non-welfarist?) normative commitments come from. Perhaps the answer might be that they are delivered exogenously from a political process that culminates in lawmaking. But then EDA would give us no guidance on how a legislator might select those commitments. More troubling, when the shape of those commitments (as instantiated in statutes) is unclear, which is to say all the time, EDA seems to either default to a kind of libertarian minimalism focused only on the most extreme negative outcomes, or regulatory maximalism that requires unjustified sacrifices for the sake of minor benefits.
Let’s return to the water-cooling rule as an example. In the Clean Water Act, Congress established a requirement that firms employ the “best technology available for minimizing adverse environmental impact,” from water pollution. Does this reflect a normative commitment to reducing pollution simpliciter, or a normative commitment to achieve a reasonable balance between technological costs and benefits? It is hard to say; the Supreme Court found the questions sufficiently unsettled to defer to the agency’s judgment. Under an EDA framework, how should the agency proceed? If avoiding economy-wide catastrophes is the priority, perhaps EDA means that the agency should interpret the statute conservatively, require readily available off-the-shelf technologies that raise few prospects of economic disruption, and move on to more important questions. Or perhaps EDA means that the agency should regulate to the hilt, subject only to the constraint of shutting down whole industries. If maximizing welfare isn’t the goal, in what normative direction does EDA point when agencies are called on to regulate in the face of congressional ambiguity? The only place that EDA seems to avoid in these cases is the reasonable middle, where benefits and costs are weighed against each other to maximize people’s well-being.
But it is in this reasonable middle that Driesen’s most important contribution is offered. As an alternative to cost-benefit analysis, EDA is problematic. But Driesen’s exposition of EDA points to many ways in which cost-benefit analysis can and should be improved. Despite an ostensible commitment to the exercise of qualitative judgment, too often analysts focus on the raw numbers rather than the broader context. Scenario analysis and other “softer” analytic tools may indeed be helpful when information is low and stakes are high. The endogeneity of preferences to policy, adaptive preferences (which reduce the long-run welfare benefits of increasing average consumption), and the importance of positional goods are typically under-examined in practice. While behavioral economics has become important in many regulatory contexts, its consequences for cost-benefit analysis have not been fully explored. Path dependencies, and especially the public choice consequences of policy, are often accounted for behind the scenes rather than through explicit analysis and normative debate.
Ultimately, Driesen’s book serves best as a set of recommendations from a perspective that is not altogether friendly to the project of cost-benefit analysis, but is not altogether hostile either. Viewing an imperfect three-decade experience with cost-benefit analysis in the American regulatory state, Driesen focuses on the shortcomings and failures and looks for another way. But the gravitational pull of cost-benefit analysis is hard to avoid, and EDA often ends up too close to cost-benefit analysis to serve as an alternative. Where it strays from the logic of law and economics, EDA runs the risk of floating away into unattractive territory. But The Economic Dynamic of Law is nonetheless a useful reminder that the practice of cost-benefit analysis on the ground often fails to meet the highest aspirations of its proponents and the reasonable expectations of its critics.