Policy Analysis Tools:

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Policy Analysis Tools

• Cost-Benefit Analysis

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Cost-Benefit Analysis

• A technique for systematically estimating the
  efficiency impacts of policies
• Valuable in identifying and categorizing costs
  and benefits for rational decision making in the
  public arena
• Used with variable success in a broad range of
  public policy areas
• Success of use depends on the degree to which
  cost and benefits can be monetized

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Cost-Benefit Analysis

• It can answer logical, rational questions such
  as
• Should government produce a good/service?
• e.g., public housing, parking garage
• Should government intervene in the market?
• Regulating airline safety, automobile safety
• How much of the good/service should be produced?
• Superfund cleanups, public transportation

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Getting a handle on the costs and benefits of
proposed policies
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Cost-Benefit Analysis

• It is a technique that can be used to evaluate
  government projects and programs. It encompasses
  an appraisal of a policy based on the costs and
  benefits of the project, measured in comparable
  units within and across time.

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Limitations to Cost-Benefit Analysis
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Limitations to Cost-Benefit Analysis
Most policies involve budget allocation costs.
However, many policy benefits and costs are
neither tangible nor economically visible.
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Limitations to C-B Analysis in the Social Policy
Arena

• Measurement of benefits
• Some excellent sources of data
• flood control, bridges, cancer screening
• Some immeasurable benefits
• Impact of education, welfare programs
• Benefits of greater safety, wildlife preservation

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Limitations to C-B Analysis in the Social Policy
Arena

• Measurement of costs
• Direct outlays are easy to determined
• Private cost
• Burden on taxpayers, inequities
• Social costs
• Concentrated highly visible costs (housing,
  welfare)
• Widespread invisible (tax burden)
• Opportunity costs (rarely considered)

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Limitations to C-B Analysis in the Social Policy
Arena

• Criterion of efficiency
• Bottom line for decision making?
• Issues of equity
• Who pays, who gains?
• Externalities
• Unintended side effect ( and -)
• Offsetting behavior

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Advantages of Cost-Benefit Analysis
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Advantages of CBA

• Provides a decision making tool that is based on
  objective standards
• Allows for a quantitative comparison between
  multiple solutions for policy problems
• Can be used to monitor the efficiency of existing
  programs

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Some central C-B concepts before we start
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Central C-B Concepts

• Time Value of Money
• Cost of life

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Cost-Benefit Concepts

• Time Value of Money
• inflation
• discount rate

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Inflation

• A dollar today is always more valuable than a
  dollar next year
• Consumer Price Index
• An index of prices used to measure the change in
  the cost of basic goods and services in
  comparison with a fixed base period
• Measures inflation
• Considerable variation across time

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Inflation

• In a cost-benefit analysis decisions must be made
  in constant dollars
• You cant add apples and oranges

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How do we deal with inflation and the value of
money over time?

• How do we add
• apples and oranges

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Discounting

• Discounting takes care of two factors that make
  it difficult to add up monies over time
• The influence of inflation
• The earning power of money
• Using a discount rate you extract out the
  inflationinterest effect from future costs and
  benefits
• Future dollars are worth less today

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Discounting

• In addition, using a discount rate you are
  assuming that money invested today can grow at
  a compound rate, producing more money in the
  future
• You need less money now to produce a specified
  amount of money in the future

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Cost-Benefit Concepts

• Discount Rate Formula

Dn Present Value Dollars in the future r
Discount rate (InflationInterest) n Number of
Years
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Discount Rate

• Choice of a discount rate is speculative and
  subject to much debate
• What will future inflation rate be?
• What will investment yields be in the future?
• Discount rate
• Estimate (inflation rate bond yield rate)
• E.g., 2 68 discount rate

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An example
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Present Value

• Assume that you will be given exactly 1,000 from
  Grandma on your birthday for the next 3 years.
  How much is this 3 year b-day present worth to
  you TODAY? Assume an annual interest/discount
  rate of 6.

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Present Value

• Assume that you will be given exactly 1,000 from
  Grandma on your birthday for the next 3 years.
  How much is this 3 year b-day present worth to
  you TODAY? Assume an annual interest/discount
  rate of 6.

Today
1
2
3
1,000
1,000
1,000


?
Dn
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Present Value (Formula) Dn / (1r)n

• (1,000)/(1.06) 1 (1,000)/(1.06) 2
  (1,000)/(1.06) 3

0
1
2
3


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Cost-Benefit Analysis Overview
How is a cost-benefits analysis done?
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Step 1 Identifying Relevant Impacts
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Identifying Relevant Impacts

• Identify all relevant impacts
• Classify them as costs or benefits for various
  groups
• Choosing geographic boundaries
• e.g., flood control, public libraries, etc.
• Choosing relevant groups with preference standing
• Whose costs and benefits will be measured in a
  decision to improve security in a local prison?

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Step 2 Monetizing Relevant Impacts
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Monetizing Relevant Impacts

• Valuing inputs
• Measurable costs (objective)
• Opportunity costs (subjective)

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Monetizing Relevant Impacts

• Valuing outcomes
• Benefits of policy/program (objective)
• Willingness to pay (subjective)

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Step 3 Discounting for Time and Risk
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Discounting for Time and Risk

• Discounted future benefits/costs
• Taking account of risk
• Capital depreciation

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Step 4 Choosing Among Alternative Policies
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Choosing Among Alternative Policies

• Cost benefit ratio
• Benefits/Costs gt 1 implement policy

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Numerical Example
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Cost-Benefit AnalysisAn Example
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Taxing alcohol to save lives

• Highway fatalities caused by alcohol impaired
  drivers
• Problem of younger drivers
• Innocent lives lost
• Injury and property damage
• Cost of morbidity health care, accidents at
  work, loss of productivity, etc.

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Identifying the Costs and Benefits Over a
Specified Period of Time

• Time Period 1 year
• Benefits (1) Tax revenue
• 30 increase in tax
• Consumer drink less (-16.6 in demand)
• ESTIMATE Increase of 16,739 billion

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Identifying the Costs and Benefits Over a
Specified Period of Time

• Benefit (2) Reduction in fatalities
• 1,650 fewer young driver fatalities
• 1,270 non-driver fatalities from young drivers
• 861 driver and non-driver fatalities from gt21
  year old drivers
• Assume each life is worth 1million
• Benefit (3) Reduction in property damage
• 0.65 billion/year

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Identifying the Costs and Benefits Over a
Specified Period of Time

• Benefit (4) Health and productivity gains
• Absenteeism and workplace accidents
• 4.29billion in annual health savings
• 6.61billion in productivity savings

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• How to count lives saved
• Three estimates
• Upper bound consumers of alcohol are totally
  uninformed about increased risks of alcohol
  consumption all drivers and victims fatalities
  regarded as benefits
• Lower bound consumers of alcohol are totally
  informed about increased risks of alcohol
  consumption only victim fatalities regarded as
  benefits
• Best guess between the two

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Another example
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School Bus SafetyEnhancement Program

• Installation of seat belts on school busses to
  ensure child safety when traveling on the bus

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Identifying the Costs and Benefits Over a
Specified Period of Time
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Identifying the Costs and Benefits Over a
Specified Period of Time

• Time period
• Assume a 20 year decision period
• Benefits
• Assume the only benefits are childrens lives
  saved
• No injuries are taken into account in this
  example
• Assume each childs life is worth 1,000,000
  today
• Assume that 350 childrens lives are lost on
  school buses each year in the state directly as a
  result of no seat belts

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Identifying the Costs and Benefits Over a
Specified Period of Time

• Costs
• Assume it costs it cost 4,000mill to install the
  seatbelts on all school buses in the state
• Assume that it costs 10mill to maintain these
  seatbelts in useable order in the first year
• Assume that after 10 years many of the seatbelts
  have to be replaced at a cost of 200mill in 2017
  (Capital depreciation)

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Identifying the Costs and Benefits Over a
Specified Period of Time

• Time Value of Money
• Assume that the cost of a childs life increases
  at 3 per year (inflation)
• Assume that the cost of maintaining seatbelts on
  school buses increases by 3 per year (inflation)
• Assume that money invested today in a fund can
  earn 3.7 interest per year above inflation and
  that inflation is running at an average of 3 per
  year (6.7 discount rate)

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Lets recap what we know so far
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Cost-benefit analysis

• Provides a rational framework for decision making
  in the public arena
• Allows us to compare multiple solutions to
  problems simultaneously
• Provides an objective criterion to base the
  decision on (efficiency, or at least benefits gt
  cost)

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But..the approach has limitations

• Measurement of costs and benefits
• Efficiency criterion not always applicable
• Cannot take into account equity issues in cost
  distribution
• Often cannot predict externalities that can
  significantly impact the analysis

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Despite limitations still a useful tool

• Time value of money
• Concept of inflation
• Value of the Consumer Price Index
• Capital depreciation
• Andof course the discount rate

Lets consider the discount rate one more time
before moving on
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A discount rate is a single combined number that
estimates two components

• What the inflation rate will be in future years
• What percentage interest rate above inflation
  money will earn so that it grows in future years.
  

For example if you accept a rate of return on
your bank investment that is under the average
inflation rate (lt 2.4 apr in 2008) you will be
losing money in every subsequent year. If the
rate is at inflation, youll be simply protecting
your money, not making your money work for you.
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So..

• If inflation is running at 3.5 and youve
  managed to get a rate of return on your invested
  money from the bank of 6.3 you are beating
  inflation by 3 and your money is working for
  you.
• The concept of a discount rate assumes that the
  rate of return on invested money that is greater
  than inflation on average.
• How much greater depends on the value of the
  discount rate you choose to use in your
  cost-benefit analysis.

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Now..onto the next question
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Question

• Can lives saved or lost be reasonably monetized?

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Well, even if you dont.

• the Federal government values lives every day.

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Federal Aviation Administration(Flight TWA 800)
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• TWA Flight 800 was a TWA passenger flight that
  disintegrated while flying from John F. Kennedy
  International Airport (New York) to Charles de
  Gaulle International Airport (Paris) in 1996,
  killing all 230 aboard. The incident has been one
  of the most investigated crashes in aviation
  history.

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• The aircraft was flying more than eight miles off
  the coast of East Moriches, New York (on Long
  Island) when the plane's center wing fuel tank
  exploded. The aircraft developed cracks around
  the nose as a consequence of the explosion, and
  the front part of the aircraft broke off
  (including the cockpit and first class section).
  The left wing ruptured, and the leaking fuel from
  the left wing tank ignited in the air, triggering
  a second explosion.

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• A four-year investigation by the U.S. National
  Transportation Safety Board, the only official
  investigation to date, concluded that fumes
  inside the center wing tank ignited, causing the
  explosion. The NTSB concluded that the spark was
  created by faulty wire insulation and an
  electrical arc.

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• The NTSB contends that the explosion could have
  been prevented by use of a system to smother
  flammable vapors inside fuel tanks, rather than
  the industry standards of the time that focused
  on eliminating ignition sources that could enter
  them from the outside.

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The Cost of Saving a Life
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Can we reasonably value a life?

• And, are all lives lost of equal value?

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An alternative method

• LIFE YEARS SAVED

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LIFE YEARS SAVED

• Avoiding a particular risk of death today means
  that you are more likely to live the
  statistically average life span.
• The difference between this average life span and
  a premature death is the number of life years
  saved.

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Consider the case of mammograms.

• If we gave every woman in the U.S. an annual
  mammogram we would detect some breast cancers in
  the early stages and prevent some women from
  dying prematurely

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Mammogram screening

• But, since the number of women whose lives would
  be saved is small, the cost per life saved would
  be high since wed be screening lots of women who
  never get breast cancer.
• Besides, in the absence of a mammogram women
  would most likely get an annual physical breast
  exam, which might detect the cancer anyway.
• So, we need to focus on the additional cost of
  the mammogram policy and compare it to the net
  additional benefit (additional life years saved)
  of adding the mammogram policy.
• Remembering that policy benefits will differ for
  women of different ages.

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Hillary Rodham Clinton did just that in 1993/94
in an attempt to reform the U.S. health care
system

• She devised the Clinton health care plan in which
  it was decided not to cover a cost for a life
  year saved that exceeded 100,000.

Thats why the plan provided regular mammograms
for women in their 50s (108,401) but not for
women in their 40s (186,635).
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But, even additional years of life are not of
equal value
Concept of morbidity

• Need a measure that captures quality of
  remaining life years

Quality Adjusted Life Years (QALY)
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Lets consider an example
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Quality-adjusted Life Year (QALY)

• Patient Option 1 No Surgery
• 10 remaining years of life
• Quality .6
• QALY 6 years

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Quality-adjusted Life Year (QALY)

• Patient Option 2 Surgery
• 15 remaining years of life
• Quality .8
• QALY 12 years

Where do those extra 6 years of life come from?
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Quality-adjusted Life Year (QALY)

• Patient Option 2 Surgery
• 15 remaining years of life
• Quality .8
• QALY 12 years
• longevity effect (5 X .8) 4yrs
• QOL effect (10 X (.8 - .6)) 2 years

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Alternatives to Cost-Benefit Analysis
..that assist policy makers in their decision
making
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Alternatives to Cost-Benefit Analysis

• Cost-effectiveness analysis
• Risk-Risk analysis
• Health-Health analysis

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Cost-effectiveness analysis

• Makes programs with identical types of outcomes
  comparable
• Shows which program yields the greatest outcome
  per dollar spent
• DOES NOT indicate whether a particular policy has
  positive net benefits overall
• Example Effectiveness of medication versus diet
  in preventing heart attacks compared to the costs
  of the two programs

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Other examples of how cost-effectiveness analysis
is used

• Feb 2000 JAMA Study concluded that annual
  retinal screening for individuals with Type 2
  diabetes may not be warranted on
  cost-effectiveness grounds (QALY150,000).
• Vijan et al. 2000 JAMA Compared with biannual
  screening, annual retinotherapy screening for
  low-risk patients with diabetes cost more than
  100,000 for each QALY
• NEJM 2000 Extending hospital stays beyond 4 days
  for patients with uncomplicated myocardial
  infractions was economically unattractive since
  it cost more than 105,000 per QALY
• Annals of Internal Medicine 2000 Viagra is a
  cost effective treatment for erectile
  dysfunction, producing an incremental QALY for
  the relatively low cost of 11,000

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Risk-Risk Analysis

• Policy analysts have long realized that reducing
  one risk may unintentionally raise another risk
• Risk-Risk analysis can be used to yield a count
  of desired/undesired outcomes in different units
• Does not take account of the costs and benefits
  of a policy
• Example treating drinking water with chlorine
  reduces the incidence of infectious diseases, but
  exposure to chlorine raises the risk of cancer

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Health-Health Analysis

• An analyst who knows how the costs of a program
  are distributed forecasts the number of adverse
  health outcomes induced by the program
• The analyst then compares a count of the
  fatalities averted by a program versus a count of
  fatalities induced by an alternative program

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Health-Health Analysis

• E.g., Passenger-side airbags For every five
  lives saved by passenger-side airbags, a life
  (usually a child) is lost. Thats a 51
  health-health ratio.
• Program beneficiaries (adults) are different from
  those who bear the cost (children), yielding
  DISTRIBUTIONAL differences.
• Disadvantage?
• It confines the analysis to a tally of mortality
  costs.

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In summary

• Comparing methods

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Methods comparing cost and benefits

• Cost-benefit analysis
• benefits - costs (same units)
• Cost-effectiveness analysis
• costs compared to desirable (adverse) outcomes

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Methods comparing cost and benefits

• Risk-Risk analysis
• Measures only probabilities of outcomes
• Health-Health analysis
• Lives saved-lives lost
• Measures only mortality risks

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Methods of Comparing Costs and Benefits
COSTS
Benefits