The Copenhagen Consensus 2008, Cost Benefit Analysis, Money, and Institutions

The Copenhagen Consensus is the brain child of self-described ‘skeptical environmentalist’ and statistician Bjorn Lomborg; housed at the Copenhagen Business School, it seeks to apply cost benefit analysis to the world’s leading problems in development, poverty, the environment, etc., with the assistance of a range of leading economists, and come up with not just a list of issues, but a prioritized list of issues, showing how much money invested will lead to what kind of gains. It is controversial because Lomborg is controversial. I am generally a fan of the method and conclusions of the Copenhagen Consensus, but I imagine that among Opinio Juris readers that will be … controversial.

An example of the kinds of recommendations made by the Copenhagen Consensus can be found, for example, in a May 22, 2008 Wall Street Journal article by Lomborg, “How to think about the world’s problems.”

Research for the Copenhagen Consensus, in which Nobel laureate economists analyze new research about the costs and benefits of different solutions to world problems, shows that just $60 million spent on providing Vitamin A capsules and therapeutic Zinc supplements for under-2-year-olds would reach 80% of the infants in Sub-Saharan Africa and South Asia, with annual economic benefits (from lower mortality and improved health) of more than $1 billion. That means doing $17 worth of good for each dollar spent. Spending $1 billion on tuberculosis would avert an astonishing one million deaths, with annual benefits adding up to $30 billion. This gives $30 back on the dollar.

Heart disease represents more than a quarter of the death toll in poor countries. Developed nations treat acute heart attacks with inexpensive drugs. Spending $200 million getting these cheap drugs to poor countries would avert 300,000 deaths in a year.

A dollar spent on heart disease in a developing nation will achieve $25 worth of good. Contrast that to Operation Enduring Freedom, which Copenhagen Consensus research found in the two years after 2001 returned 9 cents for each dollar spent. Or with the 90 cents Copenhagen Consensus research shows is returned for every $1 spent on carbon mitigation policies.

At the core of this is the method of cost benefit analysis, and at the core of that is the necessity of comparing apples to apples, not apples to oranges. In order to do that, CBA expresses different costs and benefits in monetary terms, as Cass Sunstein explains and defends, with limitations, most recently in his book Worst Case Scenarios. These kinds of comparison questions become more important as it looks like the comparisons inevitably do involve apples and oranges:

Four new civil wars are expected to break out in the next decade in low-income nations. Compared with no deployment, spending $850 million on a peacekeeping initiative reduces the 10-year risk of conflict re-emerging to 7% from around 38%, according to Copenhagen Consensus research by Oxford University’s Paul Collier.

Because of war’s horrendous and lasting costs, each percentage point of risk reduction is worth around $2.5 billion to the world. Thus, spending $850 million each year to reduce the risk of conflict by a massive 30 percentage points means a 10-year gain of $75 billion compared to the overall cost of $8.5 billion, or $9 back on the dollar.

In other areas, too, sound economic analysis suggests solutions that we may at first find unpalatable.

Poor water or sanitation affects more than two billion people and will claim millions of lives this year. One targeted solution would be to build large, multipurpose dams in Africa.

Building new dams may not be politically correct, but there are massive differences between the U.S. and Europe – where there are sound environmental arguments to halt the construction of large dams and even to decommission some – and countries like Ethiopia which have no water storage facilities, great variability in rainfall, and where dams could be built with relatively few environmental side effects. A single reservoir located in the scarcely inhabited Blue Nile gorge in Ethiopia would cost a breathtaking $3.3 billion. But it would produce large amounts of desperately needed power for Ethiopia, Sudan and Egypt, combat the regional water shortage in times of drought, and expand irrigation. All these benefits would be at least two-and-a-half times as high as the costs.

On balance, I favor this kind of cost benefit analysis, even if only used in a weak sense to produce not a rule of decision, but simply information that a decisionmaker should not be without. And in many areas, I think it ought to provide the rule of decision as well.

I am also interested, however, in the approach the Copenhagen Consensus (with its emphasis on monetizing costs and benefits and, as a final result, a methodological emphasis on what to spend money on and how much) takes with respect to international development. It does not, as Ronald Bailey notes in this article, take into account the institutional issues of international development – the ones that, for example, William Easterly puts at the forefront of why development in the form of spending money has not produced long term economic growth. The Copenhagen Consensus, as the article notes, has not managed to address corruption, governance, and the institutional infrastructure questions of development, in part because of a methodological preference to focus on money:

During the question and answer period, I noted that the CC08 process looks to shower money on problems, but does not address many of the institutional impediments for making sure that the money would actually be spent effectively. In fact, I suggested, the reason poor countries are poor is because they do not have effective governance and economic institutions. Lomborg responded that of course institutions are important, but the Copenhagen Consensus was focusing chiefly on “what can money do to help.” He pointed out that the Copenhagen Consensus conference in 2004 considered corruption as an issue, but couldn’t figure out how spending money would be able to help fix that problem. Earlier Prime Minister Rasmussen correctly observed, “No problem has ever been solved only by throwing money at it. We must prioritize.” Unfortunately, as New York University development economist William Easterly has documented, the West has thrown $2.3 trillion dollars in aid to poor countries during the past five decades without much to show for it.

Lomborg further suggested that institutional analysis could be implicit in deciding how to prioritize the challenges. For example, if the experts decide that corruption or lack of private property rights would get in the way of effectively deploying money to solve a specific problem, they could give it a lower priority.

But is Lomborg’s last suggestion the right way to deal with these kinds of institutional blockages? Wouldn’t the more exact method be instead to seek to quantify how much investment would be required in order to address, say, institutional corruption or weak governance, and include that in the calculation? Certainly that would alter the ordering of priorities. Of course, this draws in the limits of monetization in a different way – no amount of money can necessarily solve governance issues. So perhaps the right way to express this problem would be to include a governance factor, a multiplier that could be used to discount the expected return taking weak governance into account. At some point, of course, this becomes an exercise more and more disconnected from reality, so perhaps the best method is simply to separate out the quantifiable from the qualitative.

The institutional question, it has long seemed to me, is unavoidable. Perhaps the most important study in development economics I have read in several years is the landmark World Bank study – more important than the Bank seems to understand – Where is the Wealth of Nations? (available as pdf here), which argues seeks to rank countries by economic growth generated by “intangible capital” – the value of “intangible” institutions such as neutral reliable law courts, etc., etc. The same think tanker, Ron Bailey, who asked the question above in the Copenhagen Consensus, has also summarized the World Bank study as follows:

Why are Americans so well off? It’s not just because of America’s fruited plains and its alabaster cities. In fact, it turns out that such natural and man-made resources comprise a relatively small percentage of our wealth.

The World Bank study begins by defining natural capital as the sum of nonrenewable resources (including oil, natural gas, coal, and mineral resources), cropland, pastureland, forested areas, and protected areas. Produced capital is what many of us think of when we think of capital. It is the sum of machinery, equipment, and structures (including infrastructure) and urban land. The Bank then identifies intangible capital as the difference between total wealth and all produced and natural capital. Intangible capital encompasses raw labor; human capital, which includes the sum of the knowledge, skills, and know-how possessed by population; as well as the level of trust in a society and the quality of its formal and informal social institutions.

Once the analytical framework is set up, what the researchers at the World Bank find is fascinating. “The most striking aspect of the wealth estimates is the high values for intangible capital. Nearly 85 percent of the countries in our sample have an intangible capital share of total wealth greater than 50 percent,” write the researchers. They further note that years of schooling and a rule-of-law index can account for 90 percent of the variation in intangible capital. In other words, the more highly educated a country’s people are and the more honest and fair its legal system is, the wealthier it is.

Let’s consider a few cases. The country with the highest per capita wealth is Switzerland at $648,000. The United States is fourth at $513,000. Overall, the average per capita wealth in the rich Organization for Economic Cooperation Development (OECD) countries is $440,000. By contrast, the countries with the lowest per capita wealth are Ethiopia ($1,965), Nigeria ($2,748), and Burundi ($2,859). In fact, some countries are so badly run, that they actually have negative intangible capital. Through rampant corruption and failing school systems, Nigeria and the Republic of the Congo are destroying wealth and ensuring that they will be poorer in the future.

Perhaps one way to think about what it means for the average wealth in the United States to be $513,000 per capita is to think about how much income that wealth produces annually. Not surprisingly, countries with high levels of wealth per capita also produce high levels of income per capita. For instance, in purchasing power parity terms, the United States per capita income is $41,500 annually. This yields roughly an 8 percent return on average wealth.

By comparison, the World Bank study finds that total wealth for the low income countries averages $7,216 per person. That consists of $2,075 in natural capital; $1,150 in produced capital; and $3,991 in intangible capital. By contrast, the average wealth per capita in OECD countries of $440,000 consists of $9,531 in natural capital, $76,193 in produced capital; and a whopping $353,339 in intangible capital.

So if every American has $513,000 in capital, where is it? The vast majority of it is amassed in our political and economic institutions and our educations. The natural wealth in rich countries like the U.S. is a tiny proportion of their overall wealth—typically 1 to 3 percent—yet they have higher amounts of natural capital than poor countries. Cropland, pastures and forests are more valuable in rich countries because they can be combined with other capital like machinery and strong property rights to produce more value. Machinery, buildings, roads, and so forth account for 17 percent of the rich countries’ total wealth. And 80 percent of the wealth of rich countries consists of intangible capital. “Rich countries are largely rich because of the skills of their populations and the quality of the institutions supporting economic activity,” argues the World Bank study.