Cost-Benefit Analysis and Other Decision Making Procedures

CBA examines the social justification for a policy proposal. It is thus distinct from a financial assessment which looks only at the bottom-line for the implementing agency. In many instances, however, economic appraisal will consist of both social CBA and the financial case. For example, when a regional authority applies for financial support - under the SCF - to invest in its conventional rail network or a water treatment plant, it will do so first by demonstrating that the relevant project has a social NPV that is positive. However, the EU is also concerned about evidence regarding the financial case for the project. If the financial net benefits are greater than zero then the project will not be financed by the EU. Put another way, this project pays its own way and is judged not to need external financing under the SCF. Put another way, funding is only approved if the project has a social CBA justification but is not financially viable for the authority making the application.

In some circumstances, the monetary value of impacts might be highly uncertain or defy sensible calculation altogether. In such cases, cost effectiveness analysis (CEA) could be used to ascertain the cost at which a proposal is able to secure a unit of some specified benefit. In its simplest form, there is a single indicator of effectiveness, E, which is compared with a cost of C. The usual procedure is to produce a cost-effectiveness ratio (CER): CER = ElC. For example, this ratio might be read as £ per life saved. From this perspective, multi-criteria analysis (MCA), discussed in Chapter 6, is similar to CEA but involves multiple indicators of effectiveness.

A key distinction between CBA and both CEA and MCA is that while all offer guidance on which of several alternative policies (or projects) to select, the latter two approaches are silent on whether or not it is worth adopting any policy action at all. The notion of 'worth doing' only has meaning if costs and benefits can be compared in a manner that enables a judgement to be made about whether costs are greater (or smaller) than benefits. And this, in turn, requires that costs and benefits have a common numeraire which in CBA is money. Nor is it clear how MCA deals with issues of time. How time is treated in CBA is sometimes controversial. But it is at least explicit, whereas in MCA it is implicit. More positively, distributional implications are usually chosen as one of the objectives in an MCA and hence equity concerns can be clearly accommodated. All of this adds to the impression that MCA and CBA are complements rather than substitutes.

Even where costs and benefits can be valued,4 these impacts may have complex pathways. Tracing and quantifying such impacts over the economic life of the project or policy is the necessary precursor to valuing them. Environmental applications of CBA provide perhaps the best illustration here. Measuring physical impacts needs to be based on a sound body of natural science. For example, in the case of evaluating air quality management proposals, this requires an understanding of how air pollutants (reduced from some emission source) otherwise would have been dispersed. This is important because the chief benefit of these proposals is likely to be improved health enjoyed by people currently exposed to reduced pollution. Assessment of these changes in health states (reduced mortality or reduced morbidity) requires an understanding of the epidemiology of exposure and health impact. Only after all this is estimated can the resulting impacts be valued in money terms.

This creates an obvious linkage of CBA to those assessment techniques which seek to quantify physical impacts of policy actions. Environmental Impact Assessment (EIA) is one example. EIA can be thought of as a procedural venue that hosts a number of different appraisal tools. However, it is also the point at which basic information about the physical consequences for the environment of a proposal are measured and collected. In this way, EIA is also an essential input to CBA. CBA covers the other impacts of projects and policies, and goes one stage further than EIA by attempting to put money values on the environmental impacts. Unlike CBA, EIA has no formal decision rule attached to it: for example that benefits must exceed costs. However, analysts would typically argue that its purpose is to look at alternative means of minimizing the environmental impacts without altering the benefits of the project or policy. Whatever the case, EIA and CBA are not substitutes for one another.

Strategic environmental assessment (SEA) provides a further possibly complementary role. Instead of single projects or policies, SEA considers broader programmes of investments or policies. The goal is to look for the synergies between individual policies and projects and to evaluate alternatives in a more comprehensive manner. The emphasis on strategic is important. A weakness of the cost-benefit approach is that, in practice, it does tend to deal with decisions incrementally and in isolation.

An example is the evaluation of impacts on the natural environment that a transport infrastructure project might have. It is important to see the changes in landscape and ecology that might occur here not just in terms of the specific location affected by this specific project but also in terms of the cumulative effect of past decisions (as well as potential future decisions). This strategic view is highly useful if the policy concern is that (some aspect of) the natural environment is maintained overall. What this does is make a principle of 'ecological sustainability' applicable to the portfolio of policy actions. A strategic view, in this respect, would be essential for assessing whether this constraint is being observed.

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