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 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