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On the Use of Distributional Weights in Social Cost-Benefit Analysis: Reply to Layard and Squire

Richard Layard objects to two of my reasons (Harberger 1978) for rejecting a distributional weights approach. The first of these was that "if the weights differ too much between people, they could be used to justify excessively inefficient projects." On this matter, my subsequent thinking has taken a different turn from the one expressed in my paper. I feel I have been enlightened by this new turn, and I hope readers will be, too. The essential point is that whatever limits we place on the amount of inefficiency we are willing to accept in order to obtain a given (perhaps distributional) objective, the setting of such limits need not impinge on the distributional weights we apply. The setting of such limits is a separate act from the choice of weights. It imposes a separate and additional constraint on the choice of projects and programs. It may alter the conclusions to which the use of distributional weights would lead us, but not by altering the weights themselves. Instead, it does so by overriding certain conclusions to which the use of weights might bring us. As I see it now, the efficiency constraint stems from the application of a particular rule of project evaluation (and of applied welfare economics generally), namely, that one should not attribute to any action a benefit which is greater than the least alternative cost of achieving the same result. Thus, for example, in the evaluation of a hydroelectric project, the "benefit," independently estimated, might be $1.6 billion, but the project should not be undertaken if it costs more than $1.0 billion, assuming this to be the net present value of the full economic costs of bringing about the same benefits via an alternative thermal project. It is through the application of this rule that the Hicks-Kaldor principle of potential compensation in effect nullifies distributional weights. Consider a project whose cost is $1 million and whose benefits are $900,000, unweighted. For simplicity, let these $900,000 in benefits all accrue to families with distributional weights of 1.2. Weighted benefits are therefore $1,080,000, apparently justifying the