Whose Benefits and Costs Matter?

When evaluating a policy, program, or project, an analyst will often face the question of whose benefits and costs matter. This issue is crucial for developing the concept of “standing” as part of the evaluation of a program’s impacts. All stakeholders who are affected by a policy, program, or project should be accounted for in the CBA.

A secondary issue faced by CBA analysts is which perspective should be used in the evaluation framework. The perspective component is related to the “players” involved in the CBA. Specifically, we have assumed that in the context of economic applications, a social perspective is appropriate to ensure we are effectively calculating the net social benefit from the perspective of a government. Social CBA is focused on evaluating projects based on impacts affecting society as a whole. So far, we have assumed that an analyst can effectively capture all positive and negative impacts, and then predict and monetise these impacts from observed information. Nevertheless, this is not as easy as it seems because non-market impacts can be difficult to measure (which will be covered extensively in Chapter 12).

However, there are other perspectives that may be needed to evaluate a project.  This chapter starts with the simplest approaches to CBA perspectives, including the market perspective and a firm’s private perspective. These are often referred to as financial appraisals, financial analysis, or financial CBA. Once we understand these approaches to CBA, it becomes clearer how we can implement the relevant applications or economic theory to produce a social CBA perspective and the disaggregated social CBA.

The Issue of Standing

The concept of standing was coined by Whittington and MacRae (1986). Standing involves the identification of whose benefit and whose costs should be accounted for in the analysis. Identification of those parties with standing allows for effective recognition of the benefits and costs that will be explicitly accounted for in the cost-benefit analysis. In general, a social CBA approach accounts for all impacts, and pinpoints who the benefits or costs accrue to.  By identifying the “winners” and “losers” of a project, we consider which impacts need to be explicitly accounted for. Consequently, the problem of identifying those with standing, defines the scope of our analysis. This leads to a few questions:

• Whose preference matter?
• Which preferences should count?
• What are the challenges relating to identification of preferences and standing?

Whose preferences matter?

Without defined standing, a cost-benefit analysis cannot be conducted. Standing determines the costs and benefits that are included in the calculation of the net present value (NPV). Therefore, it is a key component in the preliminary stages of the development of a CBA.

However, there is no “hard and fast” rule on how to identify the relevant parties with standing. The goal of defining standing is to evaluate the project for those who are most likely to be impacted either positively or negatively. If standing is not correctly identified, there can be bias introduced into the calculation of the NPV.

It is important to also note that often there are relevant protocols that outline the standing that should be used (see for example the comparison in this paper by Abelson, 2020). This is especially for the instances where CBA is used frequently by the public sector. Variations of standing exist between authorities, however the concept itself is the same – standing accounts for who the benefits and costs accrue.

Conceptually, the identification of standing is easiest when the analyst considers and assesses those groups who have experienced changes in income, capital, investments, time, etc. It is important to note that when determining standing, political and moral debates should not be considered. Best practice is to decide at the beginning of the CBA evaluation process – whose benefits and costs matter.

Which preferences should count?

In application, all preferences of all individuals impacted by a policy, project, or program must be accounted for in the CBA. The purpose of understanding which preferences count is to ensure that groups or individuals who may be impacted have their welfare counted if they cannot express their own preferences regarding the project or intervention. For example, with the response to COVID-19 impacts associated with mental health, stress, fear, and anxiety should be accounted for when considering restrictions and lockdowns. Additionally impacts on child development would also need to be accounted for as primary and secondary students shift between online and face-to-face learning.

Overall, when considering which preferences matter, it is critical to be mindful of ethical and social impacts in the identification of standing issues.

What are the challenges relating to identification of preferences and standing?

There are a few issues when considering which preferences to include or exclude when evaluating standing. These include:

(1) Jurisdictional reach: When conducting a social cost-benefit analysis, there are often issues relating to jurisdictional impacts. For example, the Queensland government may not be concerned with the impact of a policy on the neighbouring state New South Wales. From the perspective of the Queensland government, the preferences of New South Wales should not be accounted for in a CBA as it is beyond their jurisdictional reach. This creates problems when there are spill-over effects of policies e.g., PCR test requirements to enter into Queensland during December, 2021.

(2) Considerations of future generations: When conducting a CBA there can be impacts that extend beyond the current generation. Usually when selecting the time horizon, we evaluate a project over a set timeline. However, benefits and costs can accrue well into the future. Given the length of time these benefits and costs will accrue over into the future, often when discounted these will have relatively small net benefits. Consequently, these kinds of projects are unlikely to be approved. This is a particular conundrum for environmental policies. For example, climate change policies will have impacts on both current and future generations. However, when considering climate change policies often only the preferences of current generations are accounted for.

(3) Valuation of life: Valuing life is a contentious issue in both health economics and cost-benefit analysis. There are two approaches often used; (1) the value of human capital and (2) the willingness-to-pay for medical inventions. When evaluating the preferences of an adult under these circumstances for inclusion in the CBA there are clear techniques to use. However, we cannot easily account for the preferences of newly born infants. An infant has not developed sufficiently to understand their preferences or make judgements. Furthermore, an infant does not have the resources to pay for their own care. This creates clear issues relating to ethics of valuing a life (discussed in more detail in Chapter 11).

(4) Unethical behaviours or socially unacceptable preferences: In some instances, people may have preferences that are considered unethical or illegal. If a thief has a preference to steal cars, their willingness-to-pay would be positive to engage in the activity. However, there are people who have a willingness-to-pay to avoid these activities (in the form of law enforcement, car alarms etc.). Therefore, we do not include preferences for criminal activities when evaluating standing. Similarly, the gains from the use of illegal goods or services should not be accounted for (such as illicit drug use or black markets).

(5) Distribution of impacts: Willingness-to-pay (WTP) for a policy will often depend on the distribution of wealth. Traditionally in CBA all groups with standing are assessed using equal weights. This is problematic as the impact of the project may change the WTP. Additionally, it is well known that WTP is heterogeneous across the distribution of wealth. Consequently, it is important to consider who the policy or intervention is directed at.

Consequently, we define those groups with standing in a CBA we include:

(1) Those who have standing on the basis outlined by the law or ethical standards.

(2) Those impacted by the project, policy or program regardless of their ability to convey their preferences.

Therefore, when evaluating standing we consider what is right or wrong by societal norms. Note that there is no clear method for identifying those who have standing in a project – it is about capturing those who “should” be accounted for.

Perspectives

The perspective component of a CBA is related to the “players” involved in the project. Perspectives can be considered the analytical viewpoint used in the analysis. This is often termed as “accounting stance”, “scope” or “lenses” of analysis depending on the reference material. The assumption so far has been to evaluate a policy, program, or project using a social cost-benefit analysis approach taking a perspective predicting and monetising impacts to society as a whole (also known as a societal perspective). However, it is sometimes useful to look at sub-level perspectives in response to narrower interests of those who commission the CBA.

By identifying the perspective an analyst is attempting to determine if the project is financially viable from various viewpoints such as the company, firm, business, government department, government level (local, state, or federal) involved in the investment. For example, a healthcare provider may want to know if the investment in new monitoring machines is worthwhile from a business perspective (investor perspective). Whereas a government may want to compare alternative road projects to identify the best option for the use of resources (government perspective). In either of these decisions, it may be deemed unnecessary, time consuming, or potentially difficult to evaluate the societal impacts.

Different perspectives can lead to different results. In practice, CBA analysts often approach the evaluation of a project based on the client who commissions the CBA. The purpose of this section is to highlight four potential perspectives that can be utilised in the evaluation of an intervention, project, or program.

Perspectives are different to the concept of standing.

Standing is about whose benefits, and costs need to be accounted. Perspective is the scope of the cost-benefit analysis. It is important to provide explicit context in any CBA report relating to the perspective utilised in the analysis.

Perspective Approaches

The literature identifies the best perspective to evaluate the impacts of a policy from an economic approach is to use a “societal perspective” where all costs and benefits are accounted for to improve total economic welfare.  However, we consider 4 perspectives for cost-benefit analysis in this course:

(1) Market Perspective

(2) Private Firm/Investor Perspective

(3) Social Perspective

(4) Distributional/Disaggregated Social Perceptive.

This provides well rounded insights into the decision-making from an investor perspective, the social perspective, and the distribution of impacts across stakeholders. By considering all four perspectives we achieve a well-rounded understanding of whether a project is worthwhile or not.

Market Perspective

The market perspective of a cost-benefit analysis is the most basic CBA that can be conducted. The market perspective involves evaluating the policy, project, or program purely based on the market prices of impacts. This is a financial appraisal in the simplest form, emphasising and evaluating only benefits and costs that can be evaluated based on market prices. This perspective ignores who the gains and losses accrue to and does not consider whether market prices represent the true value of goods and services. Market distortions and market failures are assumed away, along with taxes and financing (loans) of a project that would impact the investor’s decision.

Investor Perspective

The investor or private perspective refers to the party that is engaging in the project.^[1] A private firm has the goal of maximising their profit. Therefore, a CBA from the perspective of a firm or business is fundamentally different to a social CBA as the firm is only interested in specific costs and benefits that affect their profitability. The idea of conducting this type of CBA is to understand whether a project is worthwhile from an investor perspective. No private sector company would undertake a unprofitable project. The costs and benefits are those solely related to running the project:

• Costs are outflows of cash from a business which include wages paid to employees, purchases of inputs to produce goods and services, rent paid for buildings, equipment and capital purchases, loan repayments and interest payments, taxes, and other expenses.
• Benefits are inflows of cash to a firm or business in the form of revenue from sales of goods and services, interest from investments and even government subsidies.

Under this perspective, an analyst is treating the program, policy, or project as a private investment. This type of analysis aligns with the application of financial appraisal discussed in Chapter 1. ^[2]

It is important to note that if a government takes a market or investor perspective as their sole component in their decision-making, the overarching goal is to maximise the use of their own financial resources. Adopting this limited perspective is intuitively against the role of government. At various levels (local, state, or federal), governments do not exist to maximise the amount of money in the treasury. Instead, governments exist to provide goods and services that are not provided by the private sector such as streetlights, roads, heath care, etc. Consequently, from a government policymaker perspective it does not make sense to limit a CBA to the market or investor perspective as the goals of the CBA are fundamentally different.

Social Perspective

The social perspective is the basis of social cost-benefit analysis. In a social cost-benefit analysis, all impacts borne by the project must be included in the analysis. This includes any social impacts, environmental impacts and corrections for market failures or distortions.  The goal is to evaluate an intervention from the viewpoint of society to determine whether the project, program, or policy is beneficial to society or the economy as a whole. This is done at an aggregate perspective level. For example, if the project is for the development of a new local road in Brisbane, intangible benefits including time saved, safety improvements, as well as environmental impacts must be accounted for in the analysis. These values would need to be predicted and monetised as part of the process covered in the analysis. Shadow prices are used to reflect the true value of goods and services in a social perspective.

Distributional Social Perspective

Social cost-benefit analysis at the aggregate level ignores distributional level effects. The distributional social perspective is the process of disaggregating the results of the social cost-benefit analysis such that the benefits and costs can be attributed to various groups within society. This is often considered crucial by policymakers as the costs and benefits that accrue to the public may not accrue to groups evenly. Evaluation of these impacts is important to ensure that there are no unintended consequences from conducting an intervention or project. Additionally, policymakers and other stakeholders are likely to be interested in the impacts that affect the population even if decisions are driven by other factors (political or social), as it provides a better understanding of societal issues and social preferences (Robinson et.al, 2019. p.62).

More specifically, evaluating the impacts across all stakeholders allows clear identification of the Kaldor Hicks criterion which is described in detail in Chapter 6. At this point, we can define the Kaldor Hicks compensation criterion – a policy is more efficient as long as there is a net gain to society as this enables compensation between winners and losers of a project, resulting in a net gain to society. Therefore, the social perspective to CBA allows for governments to identify whether the process of redistribution is required as part of the compensation process. From a government approach to CBA, it is important to ensure decision-makers are not creating polices where the rich benefit at the cost of the poor. Therefore, if equity is important as part of the evaluation criteria of the policy or project, we need to evaluate the impacts on a disaggregated level.

To find the distributional impact, we identify rents accruing to stakeholders in terms of their gains or losses. We can then use this information to determine whether there are any undesirable consequences of the project or intervention. More details will be discussed in Chapter 9 once a foundation level knowledge has been developed.

References

Robinson, L. A., Hammitt, J. K., Cecchini, M., Chalkidou, K., Claxton, K., Cropper, M., … & Wong, B. (2019). Reference case guidelines for benefit-cost analysis in global health and development. Retrieved from https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4015886

Whittington, D., & MacRae Jr, D. (1986). The issue of standing in cost‐benefit analysis. Journal of Policy Analysis and Management, 5(4), 665-682.