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Capacity Building On Regulatory Review
Impact Analysis Module
Applying cost benefit analysisto regulatory proposals
21-25 March 2011
Rod Bogaards
Productivity Commission
Australian Government
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Some things just dont 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 andcosts with any precision, applying the CBA framework isimportant and useful
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Questions to be addressed
What is Cost Benefit Analysis (CBA)?
When did Australian Governments develop a heightenedinterest 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 benefitsand 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 netbenefit
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When did Australian Governments develop a
heightened interest in CBA?
Government decisions of 2005/2006 gave renewedfocus to CBA
Implications:
government agencies need to build their capacityto use CBA to improve the quality of regulatory
impact analysis
greater use of CBA expected by governments forregulatory proposals
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Why is CBA useful?
CBA examines costs and benefits from theperspective of the community as a whole:
it forces a wider view on decision makers
promotes comparability and encourages consistentdecision making
its aim is to maximise community net benefits
CBA includes all costs and benefits it tells the wholestory
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Why is CBA useful?
CBA provides a summary of the efficiency effects of apolicy
But CBA can draw attention to equity issues
by identifying who gains and who loses from aregulatory proposal
but it is up to decision makers to decide whetherdistributional impacts/equity issues are importantand 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 indollars for regulatory proposals, particularly thosewith significant impacts
But non-monetised costs and benefits should notbe 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 impactsadequately but not overplay them
If a proposal shows large monetised net coststhe onus is on the government agency to clearlyexplain why non-monetised benefits would tip thebalance
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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 measurementindicators
4. Predict the impacts over the life of theregulatory 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 policyoption
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 aproblem
One of the options should always be maintaincurrent arrangements
The number of potential options can be large
Analysts typically analyse only a few feasibleoptions (usually < 6)
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2. Decide whose costs and benefits count
Usually only take account of costs and benefits atthe national level from the Malaysiancommunitys perspective
Some argue costs and benefits to non-nationalsshould also be included for international/globalissues
However, for most regulatory proposals,measuring national costs and benefits isappropriate
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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 basecase (i.e. maintain current arrangements)
Changes that would have occurred anyway should not beattributed to the regulatory proposal
Choice of measurement indicator depends on dataavailability 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 periodover the life of the regulatory proposal
Prediction of future impacts is difficult there willalways be some uncertainty surrounding theoutcome of a regulatory proposal
Forecasts of costs and benefits require someassumptions 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 enablecomparisons 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 notexist - in these cases techniques are available to estimateimpacts
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 outover time
Positive market interest rates indicate that people value adollar in the future less than a dollar now
To reflect this, future benefits and costs are discounted topresent values which expresses them as an equivalentamount in todays dollars
The OBPRs preferred approach is to base the discount rateon market-determined interest rates and suggests using areal 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 valueof benefits minus present value of costs:
NPV = PV(B) PV(C)
If all costs and benefits cannot be valued indollars, outline why non-monetised impacts arelarge or small relative to monetised impacts
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8. Perform sensitivity analysis
There is usually considerable uncertainty aboutpredicted 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 afterconsidering the range of scenarios, there can beconfidence in the CBA results
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9. Rank the policy options
The analyst should specify which option is themost efficient
Generally, it will be the one with the largestNPV
The recommendation should be clearlypresented
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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 errorsoccur 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 benefitsand 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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Without regulation
Regulation
introduced
With regulation
Consider the counterfactual with and
without
Net benefits
Time
f
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Determining impact valuations from secondary
sources
Obtaining valuations is time consuming andresource intensive
Least-cost approach is to use previouslyestimated valuations dont have to reinvent thewheel
Refer to such estimates as plug-ins or benefits
transfer or information transfer
Although catalogues of impact values are notcomprehensive, considerable progress has beenmade
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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 asmall reduction in the probability of death?
Revealed preference and stated preferencestudies can provide estimates of willingness topay 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 areWTP for a risk reduction
If people are WTP, on average, $12 for a risk reduction from5 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 togetherpay $6m to eliminate the risk that is expected to kill one ofthem randomly this year
N t f l f tt hi d ll l t
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No set formula for attaching dollar values to
impacts
High quality analysis may require professionalexpertise consultants can be useful
Different impacts may call for different estimationtechniques
Will depend on the nature and complexity of issueand availability of information
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CBA should be undertaken for all
significant regulatory proposals
Definition of significant requires somejudgement
Scale of CBA should be commensurate withmagnitude of problem
Agencies should devote more resources toproblems where stakes are greater
P i l ith t f
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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 needsbasis
Repository of CBA reports
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And remember
Even though many RIA systems require CBA theproportion of RIA that actually manage to fullyquantify costs and benefits, and produce a robust
NPV result, remains relatively small
But dont despair, even if some costs and benefitsremain unquantified, applying the CBA frameworkprovides a very good discipline when examining
regulatory proposals
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Useful CBA References
Office of Best Practice Regulation 2010, Best PracticeRegulation Handbook (Appendix E), June.
Commonwealth of Australia 2006, Handbook of Cost
Benefit Analysis, January.
Boardman, E.A., Greenberg, D.H., Vining, A.R. andWeimer, D.L. 2006 Cost-Benefit Analysis: Concepts andPractice, 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 attentionto the likely impacts of regulation
Quantifying costs and benefits is challengingbut not impossible (given sufficient time, skilland resources)
CBA can play an important role in improvingthe quality of regulatory proposals evenwhen valuation is difficult