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Cost-Benefit Analysis. A presentation by Robin Sherbourne of the Institute for Public Policy Research to the Ministry of Finance 24 June 2003. Overview of Presentation. Cost-Benefit Analysis: Theory Cost-Benefit Analysis: Practice Other Approaches. Private Goods. What are private goods?
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Cost-Benefit Analysis A presentation by Robin Sherbourne of the Institute for Public Policy Research to the Ministry of Finance 24 June 2003
Overview of Presentation • Cost-Benefit Analysis: Theory • Cost-Benefit Analysis: Practice • Other Approaches
Private Goods What are private goods? • Excludable • Rival Examples: food, clothing, cars
Private Goods In a market economy: Buyers (consumers) and sellers (producers) together determine how much gets produced at what price Left to itself market will reach equilibrium which maximises total benefits to consumers and producers
How Are Business Decisions Made? • Businesses interested only in private returns • Invest or not invest? • Will investment yield profit? • Will investment yield private returns greater than private costs?
Example I have N$20,000 should I invest in a taxi? • Cost of taxi N$20,000 • Maintenance, petrol, insurance and wages N$10,000 • Income from fares? 6,000 passengers at N$2 = N$12,000 • Profit = N$2,000 a year • Interest rate < 10% should invest in taxi
Public Goods What are public goods? • Not excludable • Not rival Examples: national defence, roads, street lights, knowledge
Can Business Provide Public Goods? • Imagine a private business that tried to provide national defence, roads, street lights, knowledge • Provision of the “right amount” of public goods harder than private goods
Role of Government • Economic rationale for government is the provision of public goods but… • how much to supply given no price signals that indicate demand?
Cost-Benefit Analysis • Estimates total costs and benefits of a project to society as a whole (not just private costs and benefits) • Willingness to pay not revealed • More difficult than private investment decision • Tries to measure costs and benefits in money terms
Cost-Benefit Analysis • Compares projects using discount rate yardstick • High information requirements • Ongoing research needed • Rough approximations at best • Sensitivity analysis required to test robustness
Cost-Benefit Analysis • Distribution of costs and benefits • Political factors • Strategic factors • Perceptions
Example Should municipality install robots at crossroads? • Cost of robots N$10,000 • Engineering estimates reduction of risk of fatal accident from 1.6% to 1.1% • Statistical value of life N$10 million • Expected benefit is 0.005 x N$10 million = N$50,000 • Benefits outweigh costs therefore install robots
CBA Applied to Namibia • What proportion of public spending is subjected to CBA? • Already applied to some big projects (especially when funded through borrowing) • No government-wide discount rate • No SVL
Cost-Effectiveness Analysis What is the most cost-effective way of achieving given policy goal? Example: Improving quality of education • Improve teacher training? • Improve teaching materials? • Reduce class sizes? • Improve school buildings?
Benefit Maximisation What are the maximum benefits that can be gained from given amount of spending? Example: What is the most number of lives that can be saved with N$10 million? • Road safety? • Primary health care? • Health education? • ARVs?
Conclusions • CBA needed to guide government spending decisions • CBA must be workable • Who should do it? • Need for common values such as discount rate and SVL • Need for monitoring and evaluation afterwards
