# _4.2 Benefit estimation_

In the absence of public goods, merit goods, externalities, imperfect information, indivisibilities, economies of scale, market power, and distributional issues, there would be no rationale for public expenditure, and the supply of all goods and services could be left to private producers. On the other hand, public production would do no harm, provided the outputs were sold freely at prices equal to marginal cost. In the presence of one (or indeed all) of these problems, there may be scope for public expenditure to improve outcomes. It does not necessarily follow that there should be public production; it may be better for the public sector to purchase privately produced goods and services and then make these available to private economic agents on terms that do not necessarily reflect these purchase costs. Whether or not the goods and services are publicly produced, this poses a valuation problem.

Economists tend to be most comfortable with valuations based on actual transactions where some reliance can be placed on revealed preference. That works well when pure private goods are exchanged on competitive markets, but becomes more problematic or possibly infeasible in the circumstances that make public expenditure appropriate. In some cases indirect techniques are possible, which can still utilize revealed preference to value things even when they are not directly bought or sold. A prominent member of this group is the rather oddly named hedonic pricing approach.<sup>3</sup> For example, variations in the prices paid for otherwise similar houses which are more or less exposed to airport noise can be used to attach a capitalized value to the flow of noise nuisance, even though there is no market in noise itself. The same approach can be used to price flood risk, which may differ sharply between closely neighboring properties. Another indirect approach uses drivers’ differential preparedness to pay bridge or motorway tolls to save journey time to generate a demand curve for time savings, even though, once again, there is no market for time itself.

In other cases, these indirect methods fail, and reliance is frequently placed on contingent valuation and related methods which have recourse not to actual but to hypothetical choices, using surveys and interview techniques. This approach has been much used in the USA to value environmental costs and benefits. It is extremely contentious, and has generated quite a vituperative literature between opposing economists.<sup>4</sup> Part of the problem has been the frequently rather remote nature of the hypothetical questions. A major alternative to this approach has been a reliance on expert judgements.

Cost-benefit studies have frequently utilized a mixture of all three approaches (indirect revealed preference, contingent valuation, and expert judgement). It would be appropriate to take a similarly eclectic approach in the present context. However, the mix may be rather different. Indirect revealed preference may not be too helpful; if, ex ante, _all_ the property on a small island is susceptible to catastrophic wind damage, there will be no useful variation in

> 3 For an early but influential illustration of a very large literature, see Brown and Mendelsohn, 1984.

> 4 See, for example, the fairly belligerent exchanges in the Journal of Economic Literature, 2012, between Kling et al, Carson, and Hausmann.

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