Benefit-Cost Analysis for Policy

Benefit-cost analysis monetises both costs and benefits and tests whether net benefits are positive, allowing comparison across completely different kinds of policy on a money scale. Cost-effectiveness analysis leaves the benefit in natural units (such as lives saved or QALYs) and reports cost per unit of effect, avoiding monetisation but limiting comparisons to programs sharing the same outcome. BCA answers whether a policy is worth doing at all and how it ranks against unrelated policies; CEA answers which of several programs delivers a given outcome most cheaply.

Discounting converts future pounds into present value, and because the effect compounds over time, the chosen rate dramatically changes the appraisal of projects with long-horizon or intergenerational impacts — climate policy being the classic example. A higher rate shrinks distant benefits and can make a long-payback project fail; a lower rate favours it. Guidance such as the Green Book specifies a social discount rate and often a declining schedule for very long horizons precisely because the choice is so consequential and value-laden.

The basic net-present-value test is an efficiency criterion based on the Kaldor-Hicks principle: it asks whether winners could in principle compensate losers, not whether they actually do. It is therefore blind to distribution by default. To address this, analysts can report the incidence of costs and benefits across income or social groups, apply distributional weights that give greater value to impacts on worse-off groups, or present BCA alongside a separate equity analysis. Modern guidance increasingly requires distributional analysis precisely because aggregate efficiency can mask serious inequities.