Cost-Benefit-Analysis as a Tool for Impact Assessment

EPOS Summer School19 June, 2008

Benjamin GörlachBenjamin GörlachFederal Environment Agency

OverviewOverview

• Part I: CBA as a tool for impact assessment• General introduction: Cost-Benefit Analysis• CBA vs. other types of economic appraisal

I d i i ki li i i• Impact on decision making, limitations• Part II: CBA – how is it done?

d if i i• Identifying impacts• Calculating benefits – from uses to values

C l l ti t• Calculating costs• Aggregation issues

• Part III: ApplicationEPOS Summer School, Berlin, 19 June 2008 2• Part III: Application

Contents Part IContents Part I

• Cost-Benefit Analysis definedy• Rationale for CBA

CBA d th t f i i l• CBA and other types of economic appraisal• Impact on decision making, limitationsp g,

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Cost Benefit Analysis definedCost-Benefit Analysis defined

• Comparison of costs and benefits of an activity (project, policy …)• Benefits := increases in human wellbeing• Costs:= reductions in human wellbeing• Wellbeing – understood as aggregated personal utility

• If benefits exceed costs, the activity is beneficial overall and should be pursuedp

• Comparison carried out in monetary terms

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Cost Benefit Analysis definedCost-Benefit Analysis defined

• Comparison of costs and benefits:• Annual costs and benefits summed up for the

relevant subset of population• Costs and benefits discounted and summed up

over time• Net present value = sum of discounted benefits

– sum of discounted costs• If NPV > 0 (or Σ Cdisc > Σ Bdisc or B-C-ratio

> 1), an activity is beneficial overallEPOS Summer School, Berlin, 19 June 2008 5

), y

Why CBA for decision making?Why CBA for decision making?

• Ensure efficient use of scarce resources:• If benefits exceed costs, undertaking a project / policy

is a good investment for society• If benefits exceed costs NOT undertaking a project /• If benefits exceed costs, NOT undertaking a project /

policy actually represents a loss of welfare• Justify policy interventionsJustify policy interventions

• Better understand (translate / communicate) the impacts of a project / policyp j p y

• Address market failures (esp. externalities)• Quantify trade-off between different policy objectives

EPOS Summer School, Berlin, 19 June 2008 6• Flag up “soft” issues

Examples: Stern & SukhdevExamples: Stern & Sukhdev

• Recent examples of economic studies used to flag up soft issues:• 2006 Stern Review on “The Economics of

Climate Change” – COPI study with information on costs of action

• 2008 report on “The Economics of Ecosystems and Biodiversity” by Pavan Sukhdev et al. –

COPI dpure COPI study• Neither qualifies as CBA in the strict sense

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CBA and the environmentCBA and the environment

• Next to infrastructure and health, environment has become a predominant field of application for CBA

• No markets for environmental goods and services, hence no market priceservices, hence no market price

• Necessary to infer individuals’ valuation of environmental goods and services throughenvironmental goods and services through monetary valuation methods

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Key assumptions for CBAKey assumptions for CBA

Three key tenets underlying CBA:1. Individuals’ preferences are what matters for

choosing a certain path of action2. Individuals’ preferences can be aggregated to

reflect the preferences of society3. Individual preferences are reflected in individual

willingness to pay (or to accept compensation)i.e. CBA rooted in standard neo-classical

welfare economicsEPOS Summer School, Berlin, 19 June 2008 9

CBA to what does it apply?CBA – to what does it apply?

• CBA applied at multiple levels:• Discrete projects - e.g. infrastructure projects

(roads, dams etc.)• Discrete, well-defined policy measures• Packages of policy measuresg p y• Test / setting of policy objectives

• Origin of the tool is project appraisal –• Origin of the tool is project appraisal –application at policy level relatively recent

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CBA when can it be applied?CBA – when can it be applied?

• Ex-ante CBA (predominant):(p )• Will the expected benefits of a policy / project

exceed (justify) the expected costs?exceed (justify) the expected costs?• How to design a project / policy so that costs

are minimised and benefits maximised?are minimised and benefits maximised?• Ex-post CBA (rare breed):

• Have the benefits exceeded / justified the costs?• Did expected benefits and costs materialise?

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p

CBA & other types of economic appraisalCBA & other types of economic appraisal

• Economic appraisal: policy evaluation based on monetary measurement of impacts• well-defined: CBA and CEA• hybrid forms: partial CBA, MCA, ad-hoc• less-defined: e.g. Cost of Policy Inactionless defined: e.g. Cost of Policy Inaction

• Required / frequently used: NL, UK, N, DKP l i C i i I t A t• Popular in Commission Impact Assessment

• Widely practiced in the US (> 25 yrs)EPOS Summer School, Berlin, 19 June 2008 12

CBA & other types of economic appraisalCBA & other types of economic appraisal

• Other instruments in environmental policy p yusing monetary valuation methods:• Compensation payments environmental• Compensation payments, environmental

liability (e.g. Exxon Valdez, 1989)• Assessments of e ternal costs (e g UK st dies• Assessments of external costs (e.g. UK studies

on social cost of carbon)i l i• Environmental accounting, green GDP

• “Value of everything” (e.g. Constanza 1997)

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CBA & other types of economic appraisalCBA & other types of economic appraisal

Level of accuracy needed

project-level CBACOPI studies

li l l CBA li bilipolicy-level CBA env. liability

env. accountingenv. externality studies gy

Advise onSti l t DetermineObjective:

Justify Advise on policy choice

or design

Stimulate awareness

Determine actual

payments

Justify policy

interventionEPOS Summer School, Berlin, 19 June 2008 14

or design paymentsintervention

Limitations to economic appraisalLimitations to economic appraisal

• Ethical objections to monetarisation;• Objectives other than efficiency (justice);• Doubts / reservations about methodology – e.g.

suspected bias towards aspects that can be easily monetised;

• Economic appraisal seen as constraint for decision making (allegation of black box or truth machine);

• Cost and time for monetary valuation;• Lack of experience, expertise & experts

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CBA in “real life”CBA in real life

• Textbook CBA:• All (relevant) impacts

• Real-life CBA:• Some impacts in verbal-

known and covered• All equally certain

qualitative terms only• Some impacts uncertain

• All impacts quantified in monetary terms, with original valuation

• Some impacts quantified, but not monetised

i i dwith original valuation• All costs and benefits

properly discounted

• Few impacts monetised (original valuation or benefit transfer)properly discounted

• Most beneficial option can be identified

benefit transfer)• Trade-off to be resolved

by decision makers

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can be identified by decision makers

Example: the German Climate PackageExample: the German Climate Package

• German climate policy package (Meseberg)p y p g ( g)• Consisting of 29 individual measures for all

areas except those covered by EU ETSareas except those covered by EU ETS• Intended to achieve 30%-reduction of

greenhouse gas emissions by 2020• Broad lines decided by cabinet in August 07Broad lines decided by cabinet in August 07• CBA carried out for 17 (of 29) measures

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Example: the German Climate PackageExample: the German Climate Package

• Costs: defined as discounted annual investment costs for the private sector and “program costs” for public authorities

• Benefits: fossil fuel savings due to better energy efficiency and use of renewables –energy efficiency and use of renewables no calculation of environmental benefits

• Results expressed in total and per ton of• Results expressed in total and per ton of CO2 reduced

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Example: the German Climate PackageExample: the German Climate PackageMeasure Annual Annual fossil AbatementMeasure Annual

investment cost (bn €)

Annual fossil fuel saving

(bn €)

Abatement cost

(€ / t CO2)CHP support 0,003 - 0,3 12,9

Renewable energy supp. 5,55 4,2 27

i diEnergy saving ordinance 8,43 10,3 - 47

Etc... ... ... ...

Result: Annual investment of € 31 bn vs. SUM 31 36,3 - 26

annual savings of € 36 bn – i.e. net benefit of € 5 bn across all measures

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Actual impact on decision makingActual impact on decision making

• Economic appraisal: popular in rhetoric, yet pp p p yactual use & impact appears limited;

• E g Impact Assessments in the EU and MS:• E.g. Impact Assessments in the EU and MS:• Economic analysis (i.e. CBA) advocated as

i f k f l i i MS idmain framework for analysis in MS guidance• However: little monetary information used –

mainly for economic aspects, much less for social & environmental aspects

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Actual impact on decision makingActual impact on decision making

• Mismatch between policy and academia:• Research – interest in refinement of methods,

less interest in impacts and practicability• Policy – interest in standardised methods, clear-

cut messages, ‘single big number’• Mirrored in available guidance material:

focus on valuation methods, less on ,practical aspects, shortcuts & simplification (exception: work on benefit transfer)

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(exception: work on benefit transfer)

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