Capacity Building On Regulatory Review
Impact Analysis Module
‘Applying cost benefit analysis
to regulatory proposals’
21-25 March 2011
Rod Bogaards
Productivity Commission
Australian Government
Productivity Commission
Some things just don’t add up!
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A sobering thought …
• There are significant challenges in using CBA
• Mainly because it is inherently difficult to accurately
measure benefits and costs in dollar terms
• But even when it is difficult to measure benefits and
costs with any precision, applying the CBA framework is
important and useful
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Questions to be addressed
•
What is Cost Benefit Analysis (CBA)?
•
When did Australian Governments develop a heightened
interest in CBA?
•
Why is CBA useful?
•
Where does CBA fit into the RIS/RIA process?
•
When should you conduct CBA?
•
What are the basic steps in conducting CBA?
•
What services could be provided by a CBA Unit?
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What is Cost Benefit Analysis?
• CBA is an analytical tool used to assess the benefits
and costs of regulatory proposals
• Given sufficient information, CBA can:
• calculate the net benefits for each proposal
• rank proposals by their net benefits
• recommend the proposal with the greatest net
benefit
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When did Australian Governments develop a
heightened interest in CBA?
• Government decisions of 2005/2006 gave renewed
focus to CBA
• Implications:
• government agencies need to build their capacity
to use CBA to improve the quality of regulatory
impact analysis
• greater use of CBA expected by governments for
regulatory proposals
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Why is CBA useful?
• CBA examines costs and benefits from the
perspective of the community as a whole:
• it forces a wider view on decision makers
• promotes comparability and encourages consistent
decision making
• its aim is to maximise community net benefits
• CBA includes all costs and benefits – it tells the whole
story
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Why is CBA useful?
• CBA provides a summary of the efficiency effects of a
policy
• But CBA can draw attention to equity issues
• by identifying who gains and who loses from a
regulatory proposal
• but it is up to decision makers to decide whether
distributional impacts/equity issues are important
and need addressing
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Where does CBA fit into the RIS/RIA process?
1.
Problem
2.
Objectives
3.
Options
4.
Impact analysis
5.
Consultation
6.
Conclusion and recommended option
7.
Implementation and review
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When do you need to conduct CBA?
• Should be a greater focus on valuing impacts in
dollars for regulatory proposals, particularly those
with ‘significant’ impacts
• But non-monetised costs and benefits should not
be excluded from consideration in CBA
• Impacts should be reported in CBA as follows:
• monetised
• quantified, but not monetised
• qualitative, but not quantified or monetised
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Existence of non-monetised costs and benefits
presents a challenge
• Agencies should consider non-monetised impacts
adequately but not overplay them
• If a proposal shows large monetised ‘net’ costs
the onus is on the government agency to clearly
explain why non-monetised benefits would tip the
balance
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What are the basic steps in conducting a CBA?
1.
Specify the set of policy options
2.
Decide whose costs and benefits count
3.
Catalogue the impacts and select measurement
indicators
4.
Predict the impacts over the life of the
regulatory proposal
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What are the basic steps in conducting a CBA?
5.
Monetise (attach dollar values to) impacts
6.
Discount future costs and benefits to obtain
present values
7.
Compute the net present value for each policy
option
8.
Perform sensitivity analysis
9.
Rank the policy options
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1. Specify the set of policy options
• Specify the set of policy options to solve a
problem
• One of the options should always be ‘maintain
current arrangements’
• The number of potential options can be large
• Analysts typically analyse only a few feasible
options (usually < 6)
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2. Decide whose costs and benefits count
• Usually only take account of costs and benefits at
the national level – from the Malaysian
community’s perspective
• Some argue costs and benefits to non-nationals
should also be included for international/global
issues
• However, for most regulatory proposals,
measuring national costs and benefits is
appropriate
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3. Catalogue the impacts and select
measurement indicators
• Identify the full range of impacts of the regulatory proposal
• Identify incremental costs and benefits relative to the base
case (i.e. ‘maintain current arrangements’)
• Changes that would have occurred anyway should not be
attributed to the regulatory proposal
• Choice of measurement indicator depends on data
availability and ease of monetisation
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4. Predict the impacts over the life of the
regulatory proposal
• Impacts should be quantified for each time period
over the life of the regulatory proposal
• Prediction of future impacts is difficult – there will
always be some uncertainty surrounding the
outcome of a regulatory proposal
• Forecasts of costs and benefits require some
assumptions to be made – these should be
justified and made transparent
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5. Attach dollar values to all impacts
• We measure costs and benefits in dollar terms to enable
comparisons to be made
• Analysts must estimate impacts in a variety of
circumstances:
• competitive markets
• distorted markets (e.g. externalities)
• no market signals (e.g. human life)
• Problems arise where markets do not work well or do not
exist - in these cases techniques are available to estimate
impacts
• revealed preference techniques
• stated preference techniques
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6. Discount future benefits and costs to obtain
present values
• Costs and benefits of regulatory proposals are spread out
over time
• Positive market interest rates indicate that people value a
dollar in the future less than a dollar now
• To reflect this, future benefits and costs are discounted to
present values which expresses them as an equivalent
amount in today’s dollars
• The OBPR’s preferred approach is to base the discount rate
on market-determined interest rates and suggests using a
real discount rate of 7%
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7. Compute the net present value of each
alternative policy option
• Net Present Value (NPV) is equal to present value
of benefits minus present value of costs:
NPV = PV(B) – PV(C)
• If all costs and benefits cannot be valued in
dollars, outline why non-monetised impacts are
large or small relative to monetised impacts
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8. Perform sensitivity analysis
• There is usually considerable uncertainty about
predicted costs and benefits
• Sensitivity analysis shows how these uncertainties affect
the CBA results
• Three types of sensitivity analysis:
• worst/best case analysis
• partial sensitivity analysis
• Monte Carlo sensitivity analysis
• If the sign of the net benefits does not change after
considering the range of scenarios, there can be
confidence in the CBA results
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9. Rank the policy options
• The analyst should specify which option is the
most efficient
• Generally, it will be the one with the largest
NPV
• The recommendation should be clearly
presented
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CBA accuracy
• The usefulness of CBA depends on its accuracy
• Accuracy depends on how well the analyst performs the
nine steps
• Each step is subject to errors but most important errors
occur in steps 3, 4 & 5 relating to:
• specifying the cost and benefit categories
• predicting the costs and benefits
• valuing the costs and benefits in dollars
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Common CBA pitfalls
• Downplaying or ignoring non-financial social benefits
and costs
• Double counting benefits
• ‘Before/after’ rather than ‘with/without’
• Selecting a discount rate to deliver a particular result
• Ignoring uncertainty – no sensitivity analysis
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Consider the counterfactual – ‘with and
without’
Net benefits
With regulation
Without regulation
Time
Regulation
introduced
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Determining impact valuations from secondary
sources
• Obtaining valuations is time consuming and
resource intensive
• Least-cost approach is to use previously
estimated valuations – don’t have to reinvent the
wheel
• Refer to such estimates as ‘plug-ins’ or ‘benefits
transfer’ or ‘information transfer’
• Although catalogues of impact values are not
comprehensive, considerable progress has been
made
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Frequently used ‘plug-ins’ include:
• Value of a statistical life or life year
• Value of travel time savings
• Value of recreational activities
• Value of nature (species or habitats)
• Cost of noise pollution
• Cost of air pollution
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Valuing mortality risk reduction or the value of
a “statistical” life (VSL)
• How much would individuals pay to achieve a
small reduction in the probability of death?
• Revealed preference and stated preference
studies can provide estimates of willingness to
pay for small changes in mortality risk
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VSL is not the value of an ‘identified’ life!
• VSL is the aggregate amount that a group of individuals are
WTP for a risk reduction
• If people are WTP, on average, $12 for a risk reduction from
5 in 500,000 to 4 in 500,000
• VSL = $12/0.000002 = $6 million
• It does not mean that an individual would pay $6m to avoid
(certain) death this year
• It does imply that 500,000 similar people would together
pay $6m to eliminate the risk that is expected to kill one of
them randomly this year
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No set formula for attaching dollar values to
impacts
• High quality analysis may require professional
expertise – consultants can be useful
• Different impacts may call for different estimation
techniques
• Will depend on the nature and complexity of issue
and availability of information
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CBA should be undertaken for all
‘significant’ regulatory proposals
• Definition of ‘significant’ requires some
judgement
• Scale of CBA should be commensurate with
magnitude of problem
• Agencies should devote more resources to
problems where stakes are greater
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Preparing proposals with a greater focus on
quantification: key challenges
• Proper resourcing
• Getting the right skills
• Collecting high quality information
• Consulting with stakeholders
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What services could be provided by a CBA Unit?
• Providing assistance on technical issues
• Advising how to improve CBA done in-house or
undertaken by a consultant
• Training/Workshops on CBA
• Developing CBA guidance material on a ‘needs
basis’
• Repository of CBA reports
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And remember…
• Even though many RIA systems require CBA the
proportion of RIA that actually manage to fully
quantify costs and benefits, and produce a robust
NPV result, remains relatively small
• But don’t despair, even if some costs and benefits
remain unquantified, applying the CBA framework
provides a very good discipline when examining
regulatory proposals
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Useful CBA References
• Office of Best Practice Regulation 2010, Best Practice
Regulation Handbook (Appendix E), June.
• Commonwealth of Australia 2006, Handbook of Cost
Benefit Analysis, January.
• Boardman, E.A., Greenberg, D.H., Vining, A.R. and
Weimer, D.L. 2006 Cost-Benefit Analysis: Concepts and
Practice, 3rd edition.
• OECD 2006, Cost-Benefit Analysis and the Environment:
Recent Developments
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Key messages
• CBA is a pragmatic tool for drawing attention
to the likely impacts of regulation
• Quantifying costs and benefits is challenging
but not impossible (given sufficient time, skill
and resources)
• CBA can play an important role in improving
the quality of regulatory proposals – even
when valuation is difficult
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