A Public Policymaker ’ s Dilemma : Economic Development Meets Complexity Theory

Conventional economics falls short in addressing complex social issues. By examining the cost-benefit analysis framework, this paper analyzes the theoretical underpinnings of mainstream economic development and its problematic assumptions of diminishing returns and optimal market equilibrium. After shedding light on the pitfalls of cost-benefit analysis, and subsequently economic development, the author offers implications that policymakers should be aware of when faced with economic issues characteristic of complexity in the form of increasing returns, multiple equilibria and potential path dependence. All around the United States, public policymakers rely on economic studies to decide on alternative development paths. Do we choose plan A or plan B? At the crux of such works is the process of cost-benefit analysis (CBA) or its manifestations, including cost-effectiveness, regulatory impact analyses, and project or benefit evaluation. Every USA federally funded economic development initiative over $100 million must conduct a cost-benefit analysis in compliance with the Office of Management and Budget. Judges often require a CBA study before authorizing new projects that disrupt the environment. While this technique is pervasive in applied economics, it has poor theoretical foundations and is unable to deal with the emerging science of complexity theory. Regardless, this technique is mainstream and used by the economic development profession suggesting that policymakers ought to be cautious in its application. In the spirit of this dilemma, the following examines economic decision-making in the face of complexity theory. CBA is used as an example of how conventional economic theory falls short when seeking solutions for complex issues. The paper finishes with implications for public policymakers faced with the dilemma of using a tool that may not prescribe appropriate courses of action to spur economic development. Overview of Cost-Benefit Analysis Cost-benefit analysis, and economic development, traces its roots into the 17 century and emerged as a technique in the early 20 century with the passing of the Flood Control Act of 1934. In this field’s seminal work, D. W. Pearce laid the foundation for CBA as a procedure for measuring the gains and losses to individuals in terms of money and then aggregating those money valuations to find net social gains or losses [Pearce 1984, 3]. Kornai identifies three major axioms underlying cost-benefit analysis. These are the existence of a social welfare function, the objective to maximize the social profit function and finally, the assumptions of convexity of production possibility sets along with the concavity of social welfare functions [Chakravarty 1987, 687]. In other words, CBA rests on the existence of consumer surplus; that surplus can be measured in terms of money; and one can determine overall costs and benefits in markets consistent with * The author would like to thank an anonymous referee for helpful suggestions.