Chapter 9: Distributional Social Impacts

There is an equity-efficiency trade-off when utilising cost-benefit analysis as a decision-making tool. In the previous chapter, we evaluated an intervention or project from the social perspective on the aggregate level. At this point, we need to disaggregate the benefits and costs to identify which groups the benefits and costs accrue to. This involves establishing those with standing in a policy or project as highlighted in Chapter 4.

The goal of evaluating the distribution of benefits and costs is to provide information regarding the attractiveness of the project to the stakeholders involved. Evaluating the distributional effects allows for the identification of equity issues in CBA (OECD, 2018). This allows for an analyst to determine the social desirability of a policy, project, or program. Additionally, when evaluating a policy or project based on market prices, we fail to capture many aspects that are of interest to stakeholders. For example, we fail to capture benefits from employment, government surpluses from taxes and/or subsidies, and external impacts. When implementing a social CBA using the appropriate shadow prices, we capture these impacts indirectly. Disaggregating the effects involves attributing the benefits and costs to sub-groups within the CBA framework. For example, in the “Work for the Dole” program, impacts can be attributed to different groups such as participants (labour), the supporting government, and the community. Participants may gain skills but give up time, the government faces program costs but may reduce welfare spending, and the community may benefit from completed projects such as improved community gardens and facilities.

At this stage, we assume equal weights to all relevant groups with standing, where we measure dollar for dollar the impact the CBA has on each relevant party. This is a limitation of our approach as it does not account for differences between groups within society. To address this issue, it is possible to re-weight the impacts across the distribution to account for inequality or diminishing marginal utility, to verify the desirability of a policy. ^[1]

Identify via shadow prices

The easiest method to evaluate and identify the benefits and costs attributable to various sub-groups involves looking at the use of shadow prices within the CBA. We know whenever there is a difference between the market price and the shadow price there must be a group that gains or loses. Specifically, we can evaluate the benefits and costs based on input and output markets as follows:

For an input market:

• If the market price is greater than the shadow price, the benefit is to the owner of the input.
• If the market price is less than the shadow price, it is a cost to the user of the input.

For an output market:

• If the market price is greater than the shadow price, it is a cost to the government or public.
• If the market price is less than the shadow price, it is a benefit to the government or public.

Therefore, when the shadow price is different from the market price, it is possible to identify the flow of costs or benefits. Following from these general points outlined above, we can readily determine the benefits and costs that accrue to stakeholders with standing in the CBA.

It is important to pick up every instance of difference between the market and shadow prices. The easiest way to implement this in a spreadsheet is to subtract the market prices from the shadow prices. Any positive or negative difference implies a stakeholder with standing is affected and their gain or loss needs to be accounted for.

Identify via financial flows

A second method involves tracking the financial flows. There are two key types: (1) transfers to and from governments, and (2) transfers to and from lending institutions.

Transfers to and from the government

This involves following the financial flows to and from the government in the form of taxes, subsidies, or other government expenditure. It is important to note that taxes and subsidies are transfers to the government. Taxes are an inflow (positive), and subsidies are an outflow (negative).^[2]

Banks

Loans from banks or other institutional lenders are often captured in the disaggregated CBA. In some instances, we may exclude banks and lenders if the lender is a foreign bank/firm. This is due to the jurisdictional considerations discussed in Chapter 4.

Aggregated and disaggregated CBA

It is also worthwhile remembering that if you add the disaggregated results of a social CBA back together, it should sum to the aggregate social CBA.

Example 9.1

Example: Gains to labour

Consider an infrastructure project which involves the purchase of labour for vegetation restoration. To complete the project, we require ten workers. The market minimum wage for workers is $25 per hour. Each worker is required seven hours each day for ten working days. If 60% of the workers hired for the project were otherwise unemployed and their opportunity cost of working is 40% of the market wage, we can calculate the cost of the project as follows:

i) The market perspective = -$17,500 (wage workers hours days)

ii) The investor perspective = -$17,500 (wage workers hours days)

iii) The social perspective = -$11,200 (wage workers hours days employed + OC workers hours days unemployed)

iv) The disaggregated social perspective = Investor perspective (-$17,500) + gains to labour ($6,300) = Social perspective (-$11,200)

As shown in Figure 9.1, if we use a market with a minimum price, we can see that the suppliers of the labour (the workers) can be valued in two ways: if they are currently employed, their labour should be valued at the minimum wage of $25/hour; or if they were unemployed, their labour should be valued at their opportunity cost of being unemployed which is 40% of $25/hour. Therefore, for those who were previously unemployed, supplying their labour produces gains to labour equal to the difference between the wage received ($25/hour) and their opportunity cost (40% of $25/hour). This is then multiplied by the number of workers who come from the pool of unemployed workers.

References

OECD (2018), Cost-Benefit Analysis and the Environment: Further Developments and Policy Use, OECD Publishing, Paris, https://doi.org/10.1787/9789264085169-en.

Weisbach, D. A. (2015). Distributionally Weighted Cost–Benefit Analysis: Welfare Economics Meets Organizational Design. Journal of Legal Analysis, 7(1), 151-182. https://doi.org/10.1093/jla/lau009