Tuesday, October 30, 2012

Value of life

Economists get into trouble they don’t deserve for a lot of bad reasons. One area where this is highly prevalent is when discussing the value of life. Those who don’t understand economics well misunderstand what an economist is really saying about the value of life. Importantly, economists are generally interested in the value of a statistical life. This is important to understand. Let’s consider some hypothetical situations to tease out these distinctions.

First, let’s arbitrarily assume the value of a statistical life (VSL) is $10 million. This isn’t the value of each life uniformly. Rather this is an average approximation of the value of a general human life for purposes of analysis at the margin. That last part about marginal analysis is key. We’ll come back to it shortly.

Consider a baby somewhere in America. This baby may grow up to be the next Steve Jobs or a terrible criminal, but probably something in between. In the former case his economic contribution to society will be vastly greater than $10 million, and in the latter his contribution will be considerably smaller if not negative. But we don’t know ahead of time what a person will turn out to contribute economically, and further this definition of a life’s value is not what an economist is getting at. To see that consider this false bargain:

The baby and a new building worth $10 million are located directly beneath the path of an approaching meteor. The implication of the economic value of life is not we are generally indifferent between moving the baby or the building out of the way. This should be obvious on its face as it is a lot more difficult (read expensive) to move a building than it is a baby. But what if next to the baby was an $100,000 armored car containing $9.9 million worth of gold? Are we indifferent now?

To ask the same question a different way consider this: An evil person somewhere in America has this baby in his clutches. He threatens that unless he is paid $10 million of societies resources (not paper money), he will inject the baby with a lethal dose of cyanide. We are certain never to catch this evil person or recover any of the resources given in exchange for the baby, but we will certainly get the baby back completely fine if the ransom is paid. Is the proper economic thinking here that we are indifferent between paying the ransom and letting the baby perish? You’re gut tells you no, and your gut is correct. The economic thinking on the VSL has nothing at all to tell us about these decisions. The key is marginal analysis.

The VSL is a tool for marginal thinking; that is, thinking about the costs and benefits of an incremental change. VSL tells us that the value of avoiding an increase of 1% in the chances of getting a baby into the path of a meteor or clutches of an evil person is some figure that when divided by .01 equals a number like $10 million. But the circumstances of actually being in the dilemma dictate entirely different thinking. Value is ultimately a subjective concept. The value of the next cup of water you will drink is vastly different if you are lost in the desert or chatting about last night’s football game at the water cooler. To attempt to extrapolate either of those values out to be the value of the Earth’s water supply would be complete foolishness. Similarly, to equate a decision made to avoid an incremental increase in risk multiplied by the weighted quantity all possible risks and the value of avoiding total risk (risk of certain death in an immediate moment) is foolishness as well.

Like the great Mr. T said, “I pity da fool who [confuses thinking at the margin with thinking in the aggregate]”.