Friday 24 April 2009

Costs of everything, value of nothing

NBR points me to a recent analysis by BERL of the costs of alcohol use in New Zealand. Apparently the Law Society is basing some recommendations towards greater regulation on the report. Kiwiblog also comments. A rather important, but thusfar ignored, point from the report:
This study takes a conventional approach for economic cost studies, which “do not attempt to fully consider the economic benefits of alcohol… and other drugs, and should not be confused with cost-benefit or cost-effectiveness analyses” (Single et al, 2003: 14).
In other words, everything is a cost. Imagine applying this methodology to anything else. What are the costs of car use? Of apple growing? Of coffee? It's very easy to get big numbers on the cost of anything, if you don't offset the corresponding benefits.

If this were a cost-benefit analysis, rather than just a pure cost analysis, things would look very different. First, we'd need to estimate how much folks enjoy the alcohol they drink. We could do that by assuming a linear demand function and extrapolating from the point estimate of the price elasticity of demand. That would be a minor point though. The more important feature would be that many of the costs listed would disappear entirely, washed out by private benefits. Let's work this through. The study counts as costs reduced labour productivity. If you go to work with a hangover, you're less productive. Similarly, if you spend a night out on the town rather than putting in the overtime, you're not producing as much. If we only count costs, then these get included: costs to society via lost output and costs to the government via reduced tax revenues. But if we worry about NET costs rather than gross costs, these have to disappear. Why? Because if I decide to drink and be less productive at work, I'm less likely to get a promotion or a salary increase. My productivity affects my wages. If I decide to be less productive and have a lower expected salary path, that's between me and my employer: I'm bearing the costs. If I decide to do it, that's prima facie evidence that I weigh the benefits as greater than the costs.

The report also counts as costs reduced government tax revenue because of folks being less productive and earning less. By this logic, every time I take a holiday rather than putting in overtime, I'm costing the government money. Think about the underlying assumption here and whether we ought to be viewed as owning ourselves or whether we're cogs for the production of tax revenue for the government.

What other gross costs disappear if we allow for benefits of alcohol consumption? Anything that primarily affects the individual gets dropped. Health, mortality, lost output -- all of those are costs I bear directly. You can make an argument that the health system bears costs, but the report admits that collected excise taxes outweigh the costs to the health system! It's only when they add in taxes on foregone labour income that they can get a negative fiscal effect. Correction 27 April: see below. And again, by that logic, your holiday or OE should be banned because it costs the government money.

I'd previously criticized a similar report on the costs of smoking over in the NZ Med Journal: the O'Dea Report. Lots of similarities between this report and that one. When the desired conclusion drives the method, take care in interpreting the results.

The Law Society should know better than to take this kind of report seriously. I could produce, using the same methodology, a report showing the massive social costs of the existence of BERL, the consulting firm that put out this report. First, assume that their reports have zero value, then add up all the costs of the researchers that waste their time writing them, then add up all the time we waste reading and complaining about them....

Update/correction 27 April I misread the final paragraph of the report. They list excise taxes of $167 million from excessive alcohol use and health costs of $286 million. Note, though, that these are only the proportion of excise taxes paid by individuals defined as consuming "excessively". Actual excise taxes in 2008, by Crown reports, were $573 million. Actual alcohol tax revenue outweighs actual health expenditures on alcohol, but tax revenues from problem drinkers don't cover their health costs. This is always a problem with a linear tax on something that has convex costs. See Felicity Barker's excellent Treasury analysis of 2002 on alcohol taxes.


  1. "First, assume that their reports have zero value"

    Sounds like a reasonable assumption in this case...

  2. "The Law Society should know better than to take this kind of report seriously"

    But it supports their priors :)