- New Horizons in Law and Economics series
Chapter 10: A Recapitulation
10.1 THE KHZ CRITERION The standard criteria used to judge whether or not a public investment or a new law or regulation is desirable are referred to as the Kaldor–Hicks (KH) criteria. These represent two different potential compensation tests, one of which – Kaldor – is that a new investment or new law is desirable if the winners could compensate the losers for the loss. The Hicks test is that a project is worthwhile if the potential losers could not bribe the potential winners not to undertake the project. These criteria explicitly leave out distributional effects on two grounds: that their omission is necessary if a measure is to be scientiﬁc, and that whether compensation should take place ‘is a political question on which the economist, qua economist, could hardly pronounce an opinion’ (Kaldor 1939). However, the relationship between the various measures to actually be used (CVs, or compensating variations, and EVs, equivalent variations, and the WTP and the WTA) for welfare analysis and the compensation criteria is not straightforward, as Boadway and Bruce (1984) show and as I discuss in Chapter 3. The CV measures the value of a price change using ﬁnal prices while the EV uses original prices. It was long thought that the CV measure was identical to the Kaldor compensation test and that the EV measure was identical to the Hicks test, but this is not in fact the case (Boadway and Bruce 1984). The use of the KH criteria has been subject to a...
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