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Why is risk aversion unaccounted for in environmental policy evaluations?

Why is risk aversion unaccounted for in environmental policy evaluations? U.S. environmental regulations are increasingly influenced by cost-benefit analyses that are performed based on the guidance of the Office of Management and Budget (OMB). The OMB’s Circular A-4 directs Federal agencies to assume “risk neutrality” in conducting regulatory analysis, and in important instances, this guidance is not supported by economic theory. Risk neutrality is computationally convenient, and it can be justified when only the costs and benefits of regulations themselves are uncertain, because these risks are spread across a large population. However, the Circular A-4 does not distinguish between regulations that cause uncertainty and those that reduce pre-existing (i.e. baseline) uncertainty, such as the potential for catastrophic climate change. Basic economic theory shows that risk aversion should be incorporated into evaluations of policies that reduce pre-existing environmental uncertainty. Regulatory analyses generally ignore these risk-reduction benefits, leading to misinformed policymaking. Quantifying risk premiums is difficult and controversial, but no more so than discounting future costs and benefits to present value terms. Similar to how OMB has established discount rates for use in regulatory analyses, a method for when and how to incorporate risk aversion into policy evaluations should replace the blanket guidance for risk neutrality. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Climatic Change Springer Journals

Why is risk aversion unaccounted for in environmental policy evaluations?

Kaufman, Noah
Climatic Change , Volume 125 (2) – May 13, 2014
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References (18)

Publisher
Springer Journals
Copyright
Copyright © 2014 by Springer Science+Business Media Dordrecht
Subject
Earth Sciences; Atmospheric Sciences; Climate Change/Climate Change Impacts
ISSN
0165-0009
eISSN
1573-1480
DOI
10.1007/s10584-014-1146-8
Publisher site
See Article on Publisher Site

Abstract

U.S. environmental regulations are increasingly influenced by cost-benefit analyses that are performed based on the guidance of the Office of Management and Budget (OMB). The OMB’s Circular A-4 directs Federal agencies to assume “risk neutrality” in conducting regulatory analysis, and in important instances, this guidance is not supported by economic theory. Risk neutrality is computationally convenient, and it can be justified when only the costs and benefits of regulations themselves are uncertain, because these risks are spread across a large population. However, the Circular A-4 does not distinguish between regulations that cause uncertainty and those that reduce pre-existing (i.e. baseline) uncertainty, such as the potential for catastrophic climate change. Basic economic theory shows that risk aversion should be incorporated into evaluations of policies that reduce pre-existing environmental uncertainty. Regulatory analyses generally ignore these risk-reduction benefits, leading to misinformed policymaking. Quantifying risk premiums is difficult and controversial, but no more so than discounting future costs and benefits to present value terms. Similar to how OMB has established discount rates for use in regulatory analyses, a method for when and how to incorporate risk aversion into policy evaluations should replace the blanket guidance for risk neutrality.

Journal

Climatic Change – Springer Journals

Published: May 13, 2014

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