Cost Benefit Analysis

Cost Benefit AnalysisChapter 1Boardman, Greenberg, Vining and Weimer

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Social Vs Individual CBACBA analysis included a systematic categorization of impacts as benefits (pro) and costs (cons), valuing in dollars (assigning weights) and then determining the net benefits of the proposal relative to the status quo (net benefits=B-C)

When individuals and costs talk of costs and benefits they mean there own costs and benefits. In cost benefit analysis' we consider all of the costs and benefits to the society as a whole. For this reason CBA is also referred to as social cost benefit analysis.

NSB=B-C

There are disagreements with this definition of CBA. First social critics e.g. some political economists, philosophers and some socialists etc have disputed the utilitarian assumption of CBA i.e. that the sum of individual utilities should be maximized and that it is possible to trade of utility gains for some against utility losses for others.

These critics dont want to trade off between one persons befits and another's loss.Second, Participants in the public policy making process e.g. bureaucrats and politicians etc may disagree about the impact isuess,how to monetize them and how to make trade offs between the present and the future.The Purpose and Uses of CBAThe broad purpose of CBA is to help social decision making. The objective is to facilitate more efficient allocation of society's resources. Where markets work well there is an efficient allocation of resources, incase of market failures govt intervention is required. One must be able to demonstrate the superior efficiency of a particular intervention relative to the alternatives, including the status quo. For this purpose the analysts use CBA.Two major types of CBA Ex ante CBA It is the standard CBA as the term is commonly used, it is conducted while the project/policy is under consideration i.e. before it is started or implemented. Assists in the decision to allocate scarce resourcesContribution to public policy decision making is direct, immediate and bureau specific.Ex Post CBA it is conducted at the end of a project. At this time all the costs are sunk.The value of ex post CBA is broader but less immediate as they provide information not only about a particular intervention abut also about the class of such interventions.They contribute to learning by govt managers, politicians and academics.In medias res Analysis are performed during the course of the life of a project. Like ex ante analysis they have the potential of influencing the decision to continue the project.Like ex post analyses they can be based on observation rather than prediction of some costs and benefits.Provides information to predict costs and benefits in future ex ante CBA.

Fourth type of CBA compared ex ante CBA and ex post (or in medias res) CBA of the same project.Useful to policymakers to learn about the efficacy of CBA as a decision making andv evaluative tool. Project specific Decision MakingIn medias res analysis of an ongoing project can also be used for decision making purposes where it is potentially feasible to shift resources to alternative projects. May lead to discontinuation of service oriented program but rarely to termination of a physical investment. In the early stages of the project uncertainty about its actual impacts and about the true net social benefits.So In general ex post studies are more accurate than in medias res studies which are more accurate than ex ante studies. Learning About Potential benefits of Similar ProjectsEx post Analysis provides information not only about a particular policy intervention but also about similar interventions.Furthermore ex post and in medias res analysis contribute to learning whether a particular kind of projects are worthwhile.The potential for societal learning from in medias res and ex post analysis depends on the extent to which the particular project being assessed can be replicated or serve as a general model for other projects.

Learning about the Efficacy of CBAComparison of ex ante with in medias res or an ex post analyses is most useful for learning about the value of CBA. A comparison CBA provides information about the accuracy of the earlier ex ante CBA which in turn provides guidance about the accuracy of future ex ante analyses. Information about the predictive ability of CBA is useful for decision making purposes.Comparison studies help analysts understand the reason for any divergence between predicted and actual benefits or costs.

The Basic Steps of CBA: COQUIHALLA HIGHWAY EXAMPLECBA may look complex, to make it simpler we divide it into nine basic steps. The steps are illustrated using a simple example, the construction of a new highway. Imagine that a cost benefit analyst who works for the Province of British Columbia, Canada was asked to perform a CBA of a proposed highway between the towns of Hope and Merritt. The highway would be called Coquihalla Highway.

Specify the set of alternative projects In this simple example the provincial government required the analyst to consider only two alternative highways one with tolls and one without, relative to the status quo. Provincial govt decided the toll $40 for large trucks and $80 for cars. But in reality the range of alternatives is huge . The highway could vary on many dimensions including the following :

continuedChanging the highway on just one of these dimensions would generate at least one new alternative. Changing two or three simultaneously would greatly increase the number of alternatives.In general if there are n dimensions each with k possible values, there would be K^n alternatives. For with 3 dimensions and three possible values there will be 27 mutually exclusive alternatives. With four dimensions each with three possible values there would be 81!. Resources constraints mean that analysts typically analyze only a few (less than six) alternatives. CBA compares the net social benefits of investing resources in a particular potential project with the net social benefits of a hypothetical project that would be displaced if the project under evaluation were to proceed. The displaced hypothetical project is sometimes called counter factual. Sometimes the status quo is not a viable alternative. If a project would displace a specific alternative rather than a hypothetical one then it should be evaluated relative to the specific displaced alternative.Decide whose benefits and costs count (standing)The analyst must decide whose benefit and costs should be counted.In this example the analysts superiors in the provincial govt were in a position to decide this and not the analyst. They wanted the analyses done from the provincial perspective but also asked for a global perspective. Often contentious whether an analysis should be performed from the global, national, state (provincial) or local perspective. Critics argue that many issues should be analyzed from a global perspective eg enviromental issues.Catalogue the impacts and select measurement indicatorsThis step requires to list the physical impacts of the alternatives as benefits or costs and to specify the measurement indicators. The impacts term is used broadly to include both inputs and outputs. For this proposed Highway the anticipated beneficial impacts are1. Time saved and reduced vehicle operating costs for travelers on the new highway.2. The value of the highway at the end of discounting period of 20 years.3. Accidents avoided due to drivers switching to the shorter safer highway.4. Reduced congestion on existing alternative routes5. Revenues collected from tolls 6. Benefits accruing to new travelers.

The anticipated cost impacts are1. Construction costs2. Additional maintenance and snow removal3. Toll collection4. Toll booth construction and maintenance

ContinuedAlthough the list of impacts appears comprehensive, critics might argue that some relevant impacts are omitted.From a CBA perspective, analysts are interested only in project impacts that affect the utility of individuals with standing. Impacts that do not have any value to human beings are not counted. CBA requires analysts to identify the ways in which the project would make some individuals better off e.g. through improved skills, better education or higher incomes. Analysts should also include the negative environmental and congestion impacts of growth.To treat something as an impact we should know the cause and effect relationship b/w some physical output of the project and the utility of human beings with standing.The identification and cataloguing of some potentially important impacts may depend upon the state of scientific or social science knowledge. Different groups of people view impacts in opposite ways. There are no particular difficulties in specifying measurement indicators of impacts in this category but sometimes the choice of indicator is not so straightforward. The choice of measurement indicator depends on data availability and ease of monetization. Predict the impacts quantitatively over the life of the projectThe proposed highway has impacts that extend over time.Predict for each alternative project the level of all impacts over the life of that project and sometimes beyond it.The analyst must make predictions for the no-tolls and with tolls alternatives for each year and for each category of driver (trucks, passenger cars etc) about1.The number of vehicle trips on the new highway2. The number of vehicle trips on the old road3.The proportion of travelers from British ColumbiaWith these estimates and other info, the analyst cam estimate for the 195 km long highway(a)Vehicle operating costs that users save(b)The number of accidents avoided(c)The number of lives saved

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There are many difficulties in predicting impacts. There are three reasons why prediction is difficult(a) It is often difficult how individuals will respond to a change in even a single program parameter.Second a policy may affect the behavior of third parties in ways that increase or decrease the costs or benefits of the policyThird prediction may require scientific knowledge that is uncertain.