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Human Well-Being and Economic Goals

PART IV
Applied Welfare Economics:
Externalities, Valuation, and Cost-Benefit Analysis
Overview Essay Page 1

Frank Ackerman

[A] study of welfare which confines itself to the measurement of quantities of goods and their distribution is not only seriously limited, it is -- at least in those countries where the mass of people have advanced far beyond subsistence standards -- positively misleading. For the things on which happiness ultimately depends, friendship, faith, the perception of beauty, and so on, are outside its range; only the most obstinate pursuit of formalism would attempt to bring them into relation with the measuring rod of money, and then to no practical effect. Thus, the triumphant achievements of modern technology,... the single-minded pursuit of advancement, the craving for material success, may be exacting a fearful toll in terms of human happiness. But the formal elegance of welfare economics will never reveal it.
-- E.J. Mishan[1]

A definitive review of welfare economics in 1960 ended with an eloquent warning (quoted above) against the attempt to measure and monetize everything that people value. Since that time, however, many have rushed in where Mishan feared to tread. As seen in the previous section, the theory of welfare economics has experienced a protracted crisis and discovered inescapable limitations to its analytical power. Meanwhile, applied welfare economics, in the form of valuation of externalities and incorporation of those values into cost-benefit analyses, has become a rapidly growing field. Useful quantitative tools have been developed -- and have been applied far beyond the range of problems for which they are appropriate. As a result, a new round of critiques addresses the theoretical errors and overstatements implicit in the current practice of valuation and cost-benefit analysis.

This section addresses three closely related topics that arise as welfare economics turns from theory to practice: first, the theory of externalities and policies designed to internalize them; second, the debates over valuation of environmental and other externalities, particularly concerning the survey methodology known as "contingent valuation"; and finally, the merits of cost-benefit analysis as a tool for reaching public policy decisions.

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