How Does Cost-Benefit Analysis Draw Lines in the Sand?

Many of us who write, read, and comment on this blog work frequently with cost-benefit analysis, perhaps typically through discipline specific tools, whether in economics or finance or business or engineering or other disciplines.  In my case, in my day job I’m mostly an international business-finance professor who uses the typical, and really not very sophisticated, tools of net present value, discounted cash flow, and so on, in my day to day work.  I apply these ideas sometimes in my work in public law, but mostly these are, in my case, workaday tools in relatively narrow business contexts.

I understand CBA, that is, at the highly discipline-specific level of standard private firm decision-making.  And I think, after a fair amount of philosophical study, I understand it at the most abstract level as consequentialism, and its many philosophical arguments.  But oddly, I don’t think – despite reading a couple of textbooks and much besides on public (rather than private firm) finance theory – I really understand the “mid-tier” of cost-benefit analysis applied to public policy problems, in the way that, for example, Cass Sunstein writes about pretty much everything as a cost-benefit problem.  Yet this is where CBA seems to be most offered as a policy template – and yet which puzzles me in many ways.

The puzzles include, for example, how one compares different values that seem to me fundamentally incommensurable.  I am currently grappling with the question in precisely this “mid-tier” public policy context of proportionality in the law and ethics of war.  Among other things, it does not seem to be very much of a problem when I am working in private firm CBA, such as NPV.  Why not?  Mostly because private firm decision-making tends, as a matter of process, to force firms to compare projects that are, because of the profit nature of firms, about comparing anticipated rates of return.  Private finance might lead one to consider quite different economic activities – should we invest in Twinkle by Wenlan or steel tubing? – but ultimately we reduce to anticipated rates of return as the common question.

Public finance is different, because the goods sought are both more heterogenous – national security and health – but also often necessary, in some amounts, ratios, and costs.  That is, a private firm mostly engaged in nuclear engineering has no necessary reason, save for some calculation of efficient return, to also invest in a lingerie boutique.  But public entities do have to invest in highly heterogenous and yet essential goods.  It’s easy to say that how much of one social good versus another social good is simply a “normative” question, and once you’ve answered that, then hooray, you’re back to good old CBA – but really, that mostly simply avoids the question in order to get analysis back to a place where one is comfortable, but where the form of CBA analysis is mostly irrelevant.

True but trivial, in other words, as a matter of method.  CBA doesn’t really seem to answer the important question in public (as distinguished from private business) contexts, except by saying that we have to make tradeoffs.  If that is news to you – and, to be sure, it seems to be to many of my law students – then it is important, absolutely.  But beyond that, as applied to problems of incommensurables, rather than the distinctively commensurable world of private firm capital budgeting, it seems rather empty.  Both too much of a method, and too little.

A second, closely related, puzzle for me about cost-benefit analysis, particularly in the context of security debates, is that I do not understand how CBA is supposed to encompass the fundamentally strategic idea of “drawing a line in the sand.”  A line that is, by its nature, arbitrary – not to be crossed without drastic consequences that were not required just short of it, and which do not seem required just crossing it.  We understand intuitively the idea of “boundaries” as having a huge gaming function, to signal intentions and convey threats, warnings, and generally expectations about the future.  In security, diplomacy, international relations, we have no problem with borders, bright lines, fixed rules and threats, all sorts of things.

Additionally, we have a whole structure of such theory in, for example, contract and other legal areas.  Negotiation theory is full of it, for example.  And of course I can make CBA embrace such thinking by inventing a special calculus of costs and benefits associated with clear signals and expectations – but that is the virtue and vice of CBA, in that it can always invent a special calculus of costs and benefits, and finally so what?

But CBA itself does not really embrace such thinking as en essential part of its method.  It is, after all, part of the ‘marginal revolution’ – and drawing lines in the sand is not very naturally reconciled with the incremental decision-making that characterizes marginality.  This is one of the reasons why, in national security and counterterrorism, it is both so easy and, to my mind, so irrelevant to base critiques of national security measures that do involve, directly and indirectly, drawing lines in the sand, on a certain CBA-inspired skepticism about why any such line is arbitrary.  It is arbitrary, says marginalist CBA skepticism, so why get so worried about it?  This is what inspires – quite mistakenly, I think – the CBA skeptics of counterterrorism (John Mueller, as I’ve mentioned before, is perhaps the most ranting).

No airliner downed, in other words, is worth all the costs and uncertain costs and benefits of, say, war.  Sure, we can talk about a “future series of discounted-expected-downed airliners” and see if the costs of the discounted series makes war worth it.   But let’s be clear that in such case, we are forcing quite artificially a method that is rooted in incrementalism to embrace “lines” and discontinuous “cliffs.”

CBA leads to serial decision-making, precisely because it is a method based in the “marginal revolution” – that’s what’s good about it, but also what limits its methodological scope.  That’s part of what makes it so “relentlessly tactical,” as I have quoted Philip Bobbitt (one of the grand strategists, one of the few who can strategically link military history and strategy, diplomacy, and law).  As my colleague Jonathan Baker – now chief economist of the FCC – remarked to me (I don’t think he’ll mind me quoting him), cost benefit analysis is a method of analyzing and reacting to proposed courses of action, it is “not a method of generating them in the first place.”  Not merely inadequate to the analytic task, which requires forms of thinking that go beyond serial “sunk costs” and marginality – but in some way allergic to the idea of strategic forms of thinking that encompass the ideas of line-drawing, initiating action, gambit, and envelopment.  How does one draw the strategic metaphor of ‘envelopment’ into cost benefit analysis?

You can always expand the cost-benefit frame, make it sufficiently elastic to encompass all these costs and benefits across time and space, yes, sure.  But by the time you’ve done that, it seems to me you’ve invented a new method called “strategy” and called it “cost-benefit analysis.”  It is the strategic thinking that does the work, not discounted probability of gain or loss.  So here is my question:

The VC readership is pretty steeped, from various disciplinary perspectives, in forms of cost-benefit analysis.  How does, and how should, and is it really possible, for CBA to take into account the idea of “drawing a line in the sand” in the “arbitrary” sense of here and no further?  When Captain Picard (and, as Ilya points out, that’s Sir Patrick to you, now!) says, at the opening of the Borg movie, “The line must be drawn here,” what theory of decision-making justifies that?  How does it fit, if at all, into cost-benefit analysis?

(And, to be clear, no fair simply bending CBA so far out of shape that one maintains the form but the real work is done by something distinct.  Or at least, if that’s what you’re doing, say so and say why.)

Bonus question:  what is “strategy,” in this case?  I have used the term here by contrast to CBA.  I have also used it by contrast to “tactics”; note, too, that the strategy-tactics distinction does not really occur in general game theory.  What analytically does “strategy” mean, then, as against these analytic categories that have been framed as distinct from it?