Wednesday, July 16, 2008

Life's value 

My friend and loyal reader jw sent along an article on the value of a life being used by EPA.
It's not just the American dollar that's losing value. A government agency has decided that an American life isn't worth what it used to be.

The "value of a statistical life" (VSL) is $6.9 million in today's dollars, the Environmental Protection Agency reckoned in May � a drop of nearly $1 million from just five years ago.

The Associated Press discovered the change after a review of cost-benefit analyses over more than a dozen years.

Now where do you get that $6.9 million from? There are two ways traditionally used in cost-benefit analysis. One is to take my estimated income over my lifetime, discount it to present value and come up with the sum. That number is likely to be relatively low, almost certainly less than $6.9 million. (If yours is not, congratulations -- you're a pretty rich fellow!)

The other way to find that out is to look at different jobs with different levels of safety or risk. Figure out the probability of a job fatality for the different occupations, and then compute how much additional pay the average worker receives in the riskier job. For example, one of the job opportunities I might have is to work as an adviser to, say, the central bank of Afghanistan. How much more would you have to pay me to go there versus, for sake of comparison, the central bank in Mongolia? Afghanistan is riskier, and if we can figure out how much riskier it is and compare it to the wage differential required to hire economists into both positions we have some measure of the value of a life. Indeed, this is what EPA is using:
...economists calculate the value based on what people are willing to pay to avoid certain risks, and on how much extra employers pay their workers to take on additional risks. Most of the data is drawn from payroll statistics; some comes from opinion surveys. According to the EPA, people shouldn't think of the number as a price tag on a life.

The EPA made the changes in two steps. First, in 2004, the agency cut the estimated value of a life by 8 percent. Then, in a rule governing train and boat air pollution this May, the agency took away the normal adjustment for one year's inflation. Between the two changes, the value of a life fell 11 percent, based on today's dollar.

EPA officials say the adjustment was not significant and was based on better economic studies. The reduction reflects consumer preferences, said Al McGartland, director of EPA's office of policy, economics and innovation.

"It's our best estimate of what consumers are willing to pay to reduce similar risks to their own lives," McGartland said.

But the EPA's cut "doesn't make sense," said Vanderbilt University economist Kip Viscusi. The EPA partly based its reduction on his work. "As people become more affluent, the value of statistical lives go up as well. It has to." Viscusi also said no study has shown that Americans are less willing to pay to reduce risks.

At the same time that the EPA was trimming the value of life, the Department of Transportation twice raised its life value figure. But its number is still lower than the EPA's.
There's no good reason for them to use different numbers, so that there has been convergence between DoT and EPA should be considered a good thing, caterwauling by liberal blogs notwithstanding. Here's a white paper from 2004 that EPA has posted that describes their study of VSL. Part of the problem is that people sort themselves into jobs in part depending on the attitudes towards risk. The report takes, for example, the observation that night clerks at convenience stores tend to be older and male. Older individuals tend to make more because of experience; males have been noted to earn more than females. Should all of the difference between the pay the night clerk and the morning clerk receive be attributed to the greater chance of armed robbery at night?

Interestingly, that paper includes a study done by Viscusi, which puts VSL at $6.9 million in one estimate. You would need to adjust that for inflation from 2003.

The implications of this for the drilling debate should be obvious. We have on one side a desire to reduce the price of gasoline and other energy products, which clearly increases the welfare of our citizens. Against that we have to weight the cost to the environment, which might include the loss of wildlife. What is the demand for wildlife? If you look at it in market terms, the location of ANWR matters as it provides less value to tourism than a similar-sized area on the California coast. We can compute the value of ANWR or any other place by looking at how much people will pay to travel there, and how many people do so. Take for example this 2001 piece that says 2500 people travel there and pay $4000 each to go. That's $10 million a year; discounted at 5% in perpetuity says the value of tourism in ANWR is $200 million. Now that number is almost assuredly too low -- there must be other tours. But as well, tourism would not fall to zero if rigs were put there. If we assume the tourists are there to see caribou, and if caribou will remain after the rigs are put in, some fraction of the 2500 will still go. A survey might tell you how many.

The benefits are likely to be large; sure, it might take years to get production (though Larry Kudlow (h/t: Dave) points out that in California, one estimate says you get drilling within one year), but that is an easy correction to the spreadsheet on which you do the cost benefit analysis.

Democrats have ignored tradeoffs on energy for years, and a few Republicans have joined them at least until now. A format exists to make sound calcuations about the tradeoffs. It is good to see liberals considering the meaning of VSL. Now to get consistent application of the method...

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