Effici.ency Aspects of Governmental Compensation , . Payments: the Federal Highway Program

There is a well-developed literature of project evaluation based on the assumption that a project is "efficient" if losers could, potentially, be compensated by gainers. In sharp contrast, relatively little systematic work has been done to develop a corresponding economics of project evaluation under actual compensation criteria. This is largely because the amount of compensation that is actually paid is thought to influence mainly the income distributional consequences of public programs. In this paper, we develop a simple model of bureau behavior in which changes in compensation requirements induce public sector decision-makers to alter decisions about both the size and type of projects undertaken. We test some empirical predictions of the model using U.S. Department of Transportation data on highway construction. We find that the presence of compensation requirements had a significant impact on the level of total federal-aid highway construction by state. It appears that public agencies engaged in highway construction responded to the introduction of requirements that displacees· . be compensated as if those requirements represented increases in the costs of their highway activities. Even though payment of compensation may not have changed the real social costS of highway construction, but only their distributional impact, it appears to have had an impact on real output decisions. EFFICIENCY ASPECTS OF GOVERNMENTAL COMPENSATION PAYMENTS: THE FEDERAL HIGHWAY PROGRAM Joseph J. Cordes and Burton A. Weisbrod In the welfare economics literature, the concept of hypothetical compensation permits the loss restrictive test of potential Pareto superiority to be used in place of the stricter test of actual Pareto superiority in the evaluation of public programs. There is, in fact, a well-developed literature of project evaluation based on the assumption that a project is "efficient". if losers could, potentially, be compensated by gainers. In sharp contrast, relatively little systematic work has been done to develop a corresponding economics of project evaluation under actual compensation criteria. This is largely because the amount of compensation that is actually paid will influence the income distributional consequences of public programs, and e~onomists have sought to avoid making evaluations that require definite value judgments regarding alternative distributions of income. Just as efficiency-oriented programs are almost certain to have unintended distributional consequences which may give some justification for compensation, so too compensation programs may affect the efficiency with which resources are used in the public sector. This is so because any attempt to provide compensation will inevitably alter the incentives that decision-makers face. For example, depending upon how compensation payments are financed, the magnitude of the payments will affect both the absolute and relative budgetary costs of projects as perceived by agencies and the private net benefits of projects perceived by specific