In defense of cost-effectiveness

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Climate and Energy

Here at the Ecofiscal Commission, our focus on the costs of policy is a bit of a calling card. Yes, we are absolutely interested in the effectiveness of environmental policies (i.e., to what extent do they reduce pollution or environmental damage?) But as a panel of economists, the Commission also cares—quite a lot, actually—about cost-effectiveness (i.e., to what extent do those policies achieve environmental objectives at lowest cost?). Today, I want to unpack that second criterion. Why do we care about costs? When does it make sense to compromise on costs? Can we really have both effective and cost-effective policy?

OK, I’ll be honest. This blog is a little bit inspired by conversations with some of my environmentalist friends. I know lots of smart, innovative people who are passionate about the environment. Some work for environmental NGOs. And they advocate for policy that protects the environment. This is a critical role: they make sure the environment has a voice at the policy table. Environmental outcomes clearly matter in terms of dollars and human health and wellbeing.

Yet sometimes I get the impression that those environmentalists care only about environmental outcomes. And that cost-effectiveness is a distant second or third or even lower on their priority list. Passionate campaigners will say things like, “well, if that’s what it costs to protect the climate, that’s what we have to pay.”  They’ll tell you that industry always exaggerates the costs anyway, so we don’t need to worry about them. They might argue that it’s easier for governments to adopt expensive policies than cheap ones or that other sectors get boutique policies too, so why shouldn’t climate solutions get the same treatment?

But here’s my hypothesis: we’re actually more likely to get effective policy that is durable over the long-term—and consequently better environmental outcomes—if that policy also minimizes costs. Costs matter too, both for the reasons you’d expect as well as a few more.

Costs have real implications for real people

I know that “cost-effectiveness” is a pretty abstract thing. Costs to whom? Measured against what benchmark? Yet minimizing the costs of policy has real, concrete implications.

Let’s start at the level of business. Imagine a relatively prescriptive command-and-control regulation: say a mandate that requires all large emitters to improve their energy efficiency by 25%. This kind of policy would see significant overall emissions reductions. And some firms—maybe those that are due to replace older equipment anyway—can easily make those changes. But for others—maybe newer, more efficient plants— this kind of shift could have really high costs. Those costs have implications. It might mean a firm doesn’t expand, or doesn’t hire that extra employee, or doesn’t invest in risky research and development. Maybe it means they don’t give their employees raises this year.  In the worst case, it might mean an absolute contraction of activity and the laying off of workers, who then have to figure out how to replace their income.

We can also think in terms of fiscal costs. For example, provincial and federal governments have provided biofuel manufacturers with something like $765 million from 2012 to 2015. Government expenditures can seem pretty disconnected from our day-to-day lives, but those costs have implications. Spending that money on biofuel subsidies means that it couldn’t be spent on something else, whether social programs or debt payments, or even tax cuts.

And finally, the same logic holds from a macro-economic perspective. Lower cost policies mean a more efficient allocation of capital and labour. That means stronger economic growth, and as a result higher incomes and more jobs. Stronger growth doesn’t guarantee, of course, that everyone receives equal shares of the pie, but it does make for a bigger pie. In short, economic growth isn’t sufficient to guarantee improvements in welfare, but it sure helps enable it.

“Environment and Economy” cuts both ways

My point here isn’t that any cost is unacceptable. The costs of policies must be weighed against the benefits. And effective environmental policies do have clear economic benefits. Reducing air pollution improves the health of our citizens, particularly children and seniors. Protecting clean water supports industry, recreation, and human health. Reducing GHG emissions contributes to global efforts to avoid costly climate change. But critically, smarter policy achieves these outcomes at lower costs. It realizes more benefits with fewer costs. That’s cost-effectiveness.

We often note that environment and economy aren’t really separate issues at all: protecting our environment is actually critical for our economy. Yet relying too much on unnecessarily expensive policies re-opens that wedge between environment and economy. It creates an opportunity to (falsely) frame environmental gains as economic losses. Smart, cost-effective environmental policies aren’t “job-killing;” the more cost-effective the policy, the more those hoary old talking points ring false. In other words, environmental and economic prosperity can be mutually supportive… if the policies are designed right.

That’s why, in the long-term, relying on high-cost policy is dangerous. It risks undermining support for environmental policies, both specifically and generally. Consider Ontario’s Feed-in-Tariff for renewable electricity. The aims of the policy are admirable. But the costs were high: many subsidy recipients received more subsidy money than they needed in order to be convinced to install solar panels. The result? Lots of backlash. And with implications well beyond renewable electricity in Ontario: high cost policies in Ontario have helped fuel opposition to (much more cost-effectively designed) proposed renewable policies in Alberta.  The implementation of Ontario’s Green Energy Act even sparked doubt around carbon pricing, the most cost-effective policy option available.

What about politics?

Economics isn’t everything. Some readers might be ready to rebut by noting that there are other justifications for higher cost policies. Politically speaking, for example, policies like the feed-in-tariff might be really important in broadening support by building new constituencies and interest groups for low-carbon policies. As a result, they might make space for other, more cost-effective policies later.

And this is true. Just as policy makers shouldn’t rely only on environmental effectiveness as a sole criterion to assess policy, they shouldn’t focus exclusively on cost-effectiveness either. Other factors, like political feasibility, clearly matter too. Our message is that cost-effectiveness matters, not that it trumps all other factors.

Still, as a group of economists, we’ll stick to our knitting here at Ecofiscal and continue to focus on cost-effective policy. Stay tuned for a new report this spring on how to identify and design cost-effective policies to complement a carbon price in reducing GHG emissions.



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