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Market Failure and Government Intervention

government intervention by weighing the costs and benefits of government intervention. Each government agency develops its own procedures for studying its regulations or projects.  The Army Corps of Engineers was first required to weigh commercial benefits and costs of projects in the River and Harbor Act of 1902.  Cost-benefit analysis began to be widely used after the Flood Control Act of 1936 and the experience with dam building helped define a standard procedure to be followed in such projects.  This procedure was codified by the U.S. Bureau of the Budget (the precursor to the present Office of Management and Budget) in 19523 to help settle disputes between different interest groups.

Economic theory was methodically applied to cost-benefit analysis only in the early fifties.4  Certain practices such as the use by some agencies of a zero discount rate were criticized.  Furthermore, useful approaches to the accommodation of multiple goals were suggested including economic development, environmental quality, and quality of life.5  Cost-benefit analysis was applied in a wide variety of applications including the analysis of urban renewal projects, transportation systems, social spending, and defense.  It had spread to state and local governments as well as governments in developing nations.

While it had generally been applied to projects which resulted in greater development, cost benefit analysis was redirected by the Nixon administration toward regulation.  The Office of Management Budget reviewed regulatory actions and required reports from agencies on the objectives, alternatives, benefits, costs, and reasons for regulation.6  This procedure was augmented in the Carter administration to consider the direct and indirect effects of regulation and the selection of the least burdensome forms of regulation.

With new social regulation, agencies developed their own reporting formats which the government attempted to standardize.  Economic Impact Analysis was a method for analyzing the effects of regulation on prices, output, employment, and the financial health of firms.   However, this kind of study had a biased focus on the negative impacts of regulation, not the benefits.  One variant of economic impact analysis called closure analysis showed how much regulation could be applied without shutting any firms down.  Implicitly, unprofitable markets might pollute at will while profitable markets would be comparatively regulated.

Many agencies also used cost-effectiveness analysis.  Cost effectiveness analysis permits the focus to be solely on the costs of a project; the implicit assumption is that different alternatives will each achieve the given objectives.  Agencies like EPA would often use a variant

    (  U.S. Bureau of the Budget.  Budget Circular A-47 (see Campen p. 17)

(  Eckstein 1958, Krutilla and Eckstein 1958; McKean 1958  See Campen p. 17.

(  Campen page 19. Ralph A. Luken "Weighing the Benefits of Clean-up Rules Against Their costs" EPA Journal p. 9 (cover of journal shows people struggling against EPA)

(  EPA Journal , op. cit., p. 9

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