6 Quantitative modelling-cost benefit analysis
When deciding whether (and where) to build a road, there are always winners and losers. For example, new roads take up land, may act as barriers between areas, might inflict noise on some people and have a host of other environmental impacts. On the positive side, the road will save time and money for those who use it, and may aid development (i.e. contribute positively to the social and economic milieu). As decisions made about such matters affect a great number of people in many different ways, it seems reasonable to investigate the economic costs and benefits of different options and see where they fall. Cost Benefit Analysis (CBA) developed as a decision-making tool to address these sorts of issues, and allows a researcher to evaluate a selection of possible choices or scenarios.
In CBA, a monetary valuation is assigned to each item or parameter to be studied over the period of time in question. This value is based on expert information – a judgement on the best available information on the cost or benefit of the item in question. Using a relatively straightforward rationale from economics, future costs or benefits are depreciated; that is, future costs are given less weight than present ones. Because all the parameters of each option are given monetary values, everything has to be evaluated on the same basis. It can then be shown whether overall benefits exceed costs, and which option under consideration represents the best value to society (i.e. which has the highest ratio of benefits to costs).
When using CBA, a crucial consideration is that both internal and external costs are usually taken into account. Internal costs are those which are paid by some party (like a consumer buying a carton of milk, or a road-user paying for petrol). External costs, or externalities, are costs that can be assigned, but are not paid for. In the Reading I will shortly ask you to read, car pollution is identified as an external cost. Other costs like this might be acid rain caused by air pollution, the cost of scrapping vehicles, and societal costs, such as the breakdown of communities. As there is no market in such externalities (by definition no-one actually pays for them up front), they are much harder to evaluate than internal costs, where the going rate can be based on what people actually spend.
An example of a problem which can be tackled with CBA is “Which is better overall for society and the environment – using milk bottles made out of glass, or milk cartons made of foil-lined cardboard?” Because of greater cost of manufacturing, glass bottles cost more to begin with. However, a CBA should address each issue discreetly and over its lifetime. In the case of a returnable glass bottle the overall lifetime is longer, so over that period the overall cost is lower than the equivalent number of cartons, which can only be used once each. Conversely, there are some negative costs which need to be taken into account – e.g. bottles need to be collected, washed and re-processed. In the case of the carton, a cost would have to be assigned to disposal – not just the fee for dumping or burning it, but the consequential land or air pollution effects. Depending on which values are attached to which component, either glass or cardboard might appear more beneficial in terms of cost. Thus, in CBA one must track costs and benefits very precisely and ensure that as many as possible relevant factors that could influence the final outcome are included. Failure to do so can dramatically change the results.
CBA has gained popularity as a research method because of its increased use by policy makers, including the various UK governmental departments. In theory, CBA allows a researcher to pose various solutions to a problem and apply established principles to see which solution provides the highest net benefit (or lowest overall cost if the scenarios are all pessimistic). This can give the policy-shaping team a sense of having found a definitive solution – in spite of the method’s sensitivity to the inclusion or exclusion of different factors and to the selection of expert information. CBA is a method which compares different scenarios or options based on an economic valuation of their internal and external costs and benefits. It is popular with policymakers because of its perceived numerical rigour and transparency, but has been criticised on account of the need to monetarise all decision variables and the narrow range of scenarios which are sometimes used.
An important criticism is that CBA methodology requires all factors to be expressed in terms of money. That has led to arguments about how external costs are valued – particularly valuing things like environmental impact, species loss, amenity loss, emissions etc. With the development of CBA, the values placed on external costs have tended to increase as information on environmental costs has improved, and as public awareness of the environment has increased. So for example, the extinction of a species of moth may now be given a much higher value than the time savings of car commuters, even though this may not have been the case in the past. The trend with CBA and derivative methodologies is towards placing more rigorously derived values on such external costs, but there is still much debate about how best to incorporate them, or whether they can be faithfully valued in money terms at all.
A second key criticism is that the range of options considered in a CBA is often narrow. Frequently it was used only to decide between different road building options, and not whether some other approach would maximise societal benefits over societal costs. This is addressed in the Reading by Fellows & Pitfield (2000), where the authors show that managing traffic demand can produce a better CBA result than accepting demand as given and building a new road. So while this is a criticism of the way that CBA is sometimes used, it does not apply to all uses of CBAIn their paper, Fellows & Pitfield consider easing road congestion by examining the effect of increasing car-sharing, using CBA. The geographic setting is the area surrounding Birmingham, the second most populous city in the UK, where congestion causes loss of business income through lost time, and to some extent, wasted fuel. The building of roads (e.g. a major bypass) would alleviate congestion, and the authors compare car-sharing scenarios with the building of an orbital road around Birmingham. Note that the authors are not keen to entertain the idea of an orbital road. They argue against it on the grounds that new roads are too expensive and that increased road growth only leads to more congestion.
In the Reading, Fellows and Pitfield refer to a specific CBA application called COBA. This is the CBA package used by the UK Transport Department to assess road-building schemes. COBA established standard values and procedures to ensure that all road building schemes were evaluated on a common basis, but for some people the way it is designed and has been used is controversial. By using COBA to make their analysis, they have demonstrated their point in terms of the relevant policymaker’s analytical tool.
Now read Fellows & Pitfield (2000), An economic and operational evaluation of urban car-sharing, making notes about the methodology. Pay attention to the following:
- the use of expert information.
- which costs have been included and which have been left out (e.g. the cost of traffic noise in the urban environment).
- the assumptions behind the different scenarios that are evaluated.
A question raised by the paper, is this: Assuming the authors want to seriously consider car-sharing as an option for reducing urban traffic congestion, what other research methods might they use to triangulate on whether it is desirable? The concept of triangulation suggests that greater confidence can be placed in research findings based on the points of agreement between the results of diverse methods. Triangulation therefore relies on an understanding of the sources of bias embodied in the different methods – their strengths and weaknesses as vehicles for engaging with the research context. We will consider triangulation in unit 5. One possibility would be to do some kind of preferred status study, where people’s preferences are explored through survey and interview. Another option might be to take a case study approach: study existing car-sharing schemes and try and understand how these could be scaled up (if already in existence in Birmingham) or the lessons about implementation transferred (if the case study comes from somewhere else).
CBA is a popular method because it simplifies decisions – it reduces complexity by converting all known factors into economic values and comparing options on a single scale. Because of this, and because decisions are based on figures, it is transparent, at least as far as declaring the basis of the calculations. However, it also has its flaws. Relying on CBA alone can be problematic, because of its sensitivity to the selection of relevant factors, and the assignments of values based on expert information. Furthermore, not all relevant factors are easy to value, and some would argue that there are things which simply cannot be valued in money terms.