methodological guide to social cost-benefit analysis

7/29/2019 Methodological Guide to Social Cost-benefit Analysis

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METHODOLOGICAL GUIDE

TO SOCIAL COST-BENEFIT

ANALYSIS

DraftVersion 1

26 April 2011

The Methodological Guide to Social Cost-Benefit Analysis was drawn up in implementing by the Office of the Prime

Minister of the Republic of Lithuania (the OPM) the project Improvement of Performance -Based Management

(VORT). The Methodological guide was prepared by the public body Europos socialiniai, teisiniai ir ekonominiai

projektai under Service Agreement No MPT-043 of 25 May 2010 concluded with the Office of the Prime Minister of

the Republic of Lithuania.


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DOCUMENT APPROVAL

Office of the Prime Minister

Signature:

Name, surname, position:

Date:


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TABLE OF CONTENTS

ACRONYMS................................................................................................................................................................... 4

1. INTRODUCTION .................................................................................................................................................... 5

1.1. WHO ARE THE ADDRESSES OF THE METHODOLOGICALGUIDE TO SOCIAL COST-BENEFIT ANALYSIS? ......................................... 5

1.2. WHAT IS A COST-BENEFIT ANALYSIS, WHEN IS IT CARRIED OUT AND WHAT ARE ITS ADVANTAGES ? ............................................. 6

1.3. WHAT IS THE PLACE OF A COST-BENEFIT ANALYSIS IN THE PROCESS OF DECISION IMPACT ASSESSMENT IN LITHUANIA? .................. 8

1.4. IS THE COST-BENEFIT ANALYSIS THE ONLY TECHNIQUE FOR THE ASSESSMENT AND COMPARISON OF ALTERNATIVE DECISIONS? ...... 10

2. APPLICATION OF THE COST-BENEFIT ANALYSIS TECHNIQUE FOR PROPOSED DECISION IMPACT ASSESSMENT ... 14

2.1. DESCRIPTION OF A PUBLIC POLICY PROBLEM AND JUSTIFICATION OF THE REQUIREMENT OF THE STATES ACTIONS ...................... 15

2.2. SETTING THE GOALS OF A PUBLIC INITIATIVE ................................................................................................................. 16

2.3. IDENTIFICATION OF REALISTIC ALTERNATIVE SOLUTIONS TO THE PROBLEM .......................................................................... 16

2.4. ASSESSMENT OF ALTERNATIVES................................................................................................................................. 182.4.1. Setting the scope, assumptions and period of assessment ...................................................................... 18

2.4.2. Identification of costs, benefit and stakeholders that incur/receive them ............................................... 19

2.4.3. Estimation of costs and benefit in monetary terms .................................................................................. 212.4.3.1. What costs and benefit should be included in the analysis? ................................................................................. 222.4.3.2. Real and nominal value .......................................................................................................................................... 232.4.3.3. Estimation of costs and benefit in monetary terms in the case of non-existance of market prices ...................... 242.4.3.4. Assessment of an administrative burden............................................................................................................... 29

2.4.4. Estimating and discounting cash flows .............................................................. ....................................... 312.4.4.1. Estimation of cash flows ........................................................................................................................................ 312.4.4.2. Discounting ............................................................................................................................................................ 31

2.4.5. Methods for assessing and comparing alternative options ...................................................................... 332.4.5.1. Net present value .................................................................................................................................................. 332.4.5.2. Internal rate of return ............................................................................................................................................ 362.4.5.3. Payback period....................................................................................................................................................... 382.4.5.4. Benefit-cost ratio ................................................................................................................................................... 40

2.4.6. Assessment of risk and uncertainties ................................................................. ....................................... 402.4.6.1. Sensitivity analysis ................................................................................................................................................. 412.4.6.2. Scenario analysis .................... ...................... ...................... ...................... ...................... ..................... ................... 42

2.5. SELECTING THE OPTIMUM ALTERNATIVE AND COMMENTS ON ITS IMPLEMENTATION ............................................................ 43

3. INSTEAD OF CONCLUSIONS: USEFUL TIPS AND MOST FREQUENT MISTAKES ....................................................... 44

ANNEX 1 RECOMMENDED FORMAT OF COST-BENEFIT ANALYSIS PRESENTATION ................................................. 46

ANNEX 2 EXAMPLES OF COST-BENEFIT ANALYSIS .................................................................................................. 48

ANNEX 3 DISCOUNT FACTOR ................................................................................................................................. 49

ANNEX 4 GLOSSARY ............................................................................................................................................... 50

ANNEX 5 RECOMMENDED BIBLIOGRAPHY ............................................................................................................. 52


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ACRONYMS

B/C Benefit/costs

CFt Cash flow over period t

EU The European Union

FV Future value

II Initial investment

IRR Internal rate of return

NPV Net present value

PV Present value

PDIA Proposed decision impact assessment

RoL The Republic of Lithuania


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1.INTRODUCTION1.1. Who are the addresses of the Methodological Guide to Social Cost-

Benefit Analysis?

The legislation governing proposed decision impact assessment in Lithuania recommends

employing the technique of either a cost-benefit analysis or a cost-effectiveness analysis in

carrying out an expanded impact assessment. This document is a methodological guide that

presents the main principles of social 1 cost-benefit analysis. The Methodological Guide is

addressed to everyone wishing understand the application of the technique of cost-benefit

analysis in order to evaluate the impact, costs and benefit of public initiatives. The

Methodological Guide to Cost-Benefit Analysis is relevant to the employees of state institutionsdrafting legal acts and other decisions and wishing to more extensively assess the impact of

public initiatives.

The Methodological Guide was developed as a primer on economic analysis of public

interventions providing persons without economic education or experience in applying the

technique of cost-benefit analysis with the basic knowledge. Those wishing to gain

understanding of more complicated points off cost-benefit analysis application are recommended

to study a more extensive literature (several recommended sources of bibliography are indicated

in Annex 5 to this Guide).

The Methodological Guide consists of several sections.

The introductory chapterpresents a brief overview of the purpose and advantage of applying

the technique of cost-benefit analysis, its place in the process of decision impact assessmentand possible variations of this technique.

The Guides second chapter step by steps introduces the key principles of cost-benefit

analysis for assessing the impact of public interventions.

Thefinal section presents the most frequent mistakes and useful tips on how to avoid them.

Annexes provide additional relevant information: examples of cost-benefit analysis

application, references to bibliography, definitions of the main terms, etc.

1Cost-benefit analysis which is applied to estimate the requirement of public interventions is sometimes referred to as

asocial cost-benefit analysis

as it evaluates the benefit and costs of a decision for the public. Where a private entitycarries out a cost-benefit analysis for a certain project he takes into account only the benefit and costs for himself.

Purpose of the Methodological Guide

This Methodological Guide is aprimeron the economic analysis of public interventions designed for

everyone wishing to get familiarised with the application of the cost-benefit analysis technique in

order to evaluate the impact, costs and benefit of public interventions.


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In developing the Methodological Guide to Cost-Benefit Analysis account was taken of the

academic literature in this field and the cost-benefit analysis methodologies of the institutions of

other countries (e.g. Great Britain, New Zealand, the EU, etc.)

1.2. What is a cost-benefit analysis, when is it carried out and what are itsadvantages?

States have limited resources which they use for addressing public problems. In addition to

public expense for buying goods and services or for social assistance, the State also has a great

impact on businesses and population when adopting various rules governing their activities

(regulation) or setting taxes. The adoption of legislation itself does not cost much but the

regulations laid down in legislation often make a great impact on the whole economy.

In planning a public initiative it is always relevant to analyse whether or not a state interventionis necessary, which problems should be addressed first using the available limited resources,

what methods of intervention implementation should be selected, and what is the envisaged

impact of a public initiative (regulation, tax, assistance or public expenses) on society and its

separate groups.

The cost-benefit analysis is a widely applied technique of economic analysis which allows the

determination and evaluation of economic costs and benefits, both direct and indirect, of a certain

public initiative. These costs and benefits are expressed in terms of money. This technique is

suitable for evaluating the net benefit of an intervention and comparing different alternatives of

the intervention with each other. The cost-benefit analysis is carried out when the envisaged

consequences of an intervention for the implementing organisation cover much more thanfinancial consequences alone. The aim of the cost-benefit analysis is determine whether or not an

intervention is necessary and whether or not it will contribute to public welfare. Another

advantage of the cost-benefit analysis lies in the fact that it provides a uniform methodological

basis for the assessment of the impact of a decision in various aspects.

The main features of the cost-benefit analysis are the following:

cost-benefit analysis should be used for the evaluation and comparison of all (i.e. not only

one) realistic alternative solutions/measures to the problem at issue;

the consequences of a public initiative economic benefits and costs are assessed

regardless of which public group or institution derives or incurrs tehm;

it aims to estimate in monetary value all most important constituents of the initiatives costs

and benefit (not only those having clear market value);

cost-benefit assessment is based on the principles of (a) individuals willingness of pay for

goods or services and (b) willingness to accept a compensation for negatives consequences.

(For more information on these principles see chapter 2.4.3 of the Guide);

assessment takes into account the impact of the time factor on the value of cost and benefitflows.

Cost-benefit analysis a technique of economic analysis allowing the evaluation and determination

of economic costs and benefit, both ditrect and indirect, of the particular public initiative.


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Can be applied for the assessment of public

initiatives of different nature

alternatives

The carrying out of the cost-benefit analysis itself results in costs and therefore its benefit should

be above the costs. (Furthermore, the cost-benefit analysis may be carried out at different levelsof detail. In adopting a decision on the requirement to carry out the cost-benefit analysis of a

particular public initiative and the level of its detail it is very important to observe the principle

ofproportionality, i.e. the level of detail of the analysis should depend on the importance, the

envisaged impact extent and riskiness of a decision and data availability. In Lithuania it isrecommended to apply the cost-benefit analysis for assessing the impact of the most importantdecisionsand only if the required data or resources to collect them are available.

A full cost-benefit analysis is be carried out when most key elements of costs and benefit

can be evaluated in terms of quantity and money and if a certain freedom of choice when

formulating the goals and target results of an initiative (e.g. their modelling depending on

alternatives costs is possible) exists.

Where only part of the relevant costs and benefit are quantifiable a partial cost-benefit

analysis is carried out (i.e. only part of important cost and benefit elements is evaluated).

The outcome of analysis should be discussed taking into account the qualitative evaluation of

other costs and benefit.

1.3. What is the place of a cost-benefit analysis in the process of decisionimpact assessment in Lithuania?

Lithuania, like most other countries, has set the requirement to assess the impact of proposed

public policy decisions. The assessment of legal acts and other decisions is regulated by several

different documents, which are indicated in Table 1.

Table 1 The legal acts and methodologies3 regulating impact assessment in Lithuania

Impact assessment methodology/ regulating legal act Assessment object

Resolution No 276 of the Government of the Republic of Lithuaniaof 26 February 2003 on the approval and implementation of theMethodology for proposed decision impact assessment (hereinafter

referred to as the Methodology for PDIA)

Proposed decisions(strategic decisions,programmes, agreements,

negotiation positions)Resolution No 1244 of the Government of the Republic of Lithuaniaof 30 September 2009 on the approval of the Legislative Rules ofGovernment of the Republic of Lithuania (hereinafter referred to theGovernment's Legislative Rules)

Draft legislation

Guidelines on budget programme assessment Programs

Methodology forex-postassessment of decision impact Decisions

Order No 4-152 of the Minister for the Economy of the Republic ofLithuania of 2 May 2006 on the approval of the Methodology for thedetermination and evaluation of an administrative burden on business

Legislation laying downinformation obligations hichare binding on businessentities

3In accordance with the regulatory framework effective during preparation of this Guide.


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Methodology for the determination and evaluation of anadministrative burden on the citizens of the Republic of Lithuaniaand other persons

Legislation laying downinformation obligationswhioch are binding on thecitizens of the Republic of

Lithuania and other persons

Proposed decision impact assessment may be of different level of detail, i.e. either a basic

assessment or an expanded assessment may be carried out. The cases when an expanded impact

assessment may be recommended are presented in Table 2.

Table 2 When should an expanded impact assessment be carried out? Recommended criteria and cases

1. Political, social sensitivity and importance of the question (political decision);2. When new regulation of the area of public relationships is established or essentially changed;3. When a legal regulation concept is being drafted;4. When a Government resolution is aimed at providing a project with the status of a project of

national significance;5. When during inter-institutional coordination of a proposed decision one or more institutions

identifies the need and proposes to carry out an expanded impact assessment and when a decision

drafting institution or the Government adopts a decision to carry out such assessment;6. The minimum margin of the decision impact on the national budget is set;7. When, according to preliminary estimation, the administrative burden resulting from a decision

will exceed the fixed number of hours;8. When preparing the Republic of Lithuania positions on EU legislation of major relevance to

Lithuania.

! As an expanded assessment is carried out for the most important, significant decisions, it isthe technique of cost-benefit analysis or its variations that is recommended to be carried

out during the expanded assessment (for more information see chapter 1.4).

Assessment of the impact of proposed decisions and draft legislation in Lithuania

The Methodology for PDIA defines a proposed decision impact assessment as a technique for

improving the formation of the public policy and decision-making by state institutions and bodies.

The material collected for impact assessment provides information to the decision making state

institutions and bodies about possible alternative decisions and consequences of their

implementation, thus creating conditions for choosing the most suitable solution to the problem.

As prescribed in the Governments Legislative Rules, an institution or working group drafting alegal act must carry out an assessment of the impact of the envisaged legal regulation. Whencarrying out an assessment of the impact of the envisaged legal regulation, information is collectedand analysed and on the basis thereof the possible positive and/or negative impact of the legalregulation provided for in the proposed legal act is evaluated in different aspects.

Source:Methodology for PDIA and Governments Legislative Rules


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1.4. Is the cost-benefit analysis the only technique for the assessment andcomparison of alternative decisions?

Cost-benefit analysis is the main and widely applied technique for quantitative assessment of the

impact of alternatives. Several other applicable techniques of analysis are variations or partial

analyses of the cost-benefit analysis.

Cost-effectiveness analysis. A cost-effectiveness analysis is a variation of the technique of

cost-benefit analysis. It is applied when planning to implement an initiative with a clear fixed

goal (e.g. aimed at a certain established quantitative indicatorto reduce infant mortality to a

certain level, to create the established number of jobs, etc.) and when evaluation of the

benefit of an intervention in monetary units is difficult. The cost-effectiveness analysis

evaluates and compares only the costs (but not benefit) of alternative decisions assuming that

all alternatives will lead to the achievement of the same goal. This technique is often applied

to find the way of achieving the target results at the lowest costs. It cam also be applied forthe purpose of identifying the alternative which will enable the achievement of better results

at the same costs.

The more clearly the goal and target results of an intervention are defined the easier is the

carrying out of a cost-effectiveness analysis. The technique of cost-effectiveness analysis is

not suitable when a particular initiative purses several different, complex, global goals.

Figure 2 Advantages and weaknesses of cost-effectiveness analysis application

Example 1: the case of cost-effectiveness analysis applicationFor example, in order to reduce the number of traffic accidents in a certain area, the cost-

effectiveness analysis could be employed to compare the costs for one saved life of the followingalternatives: (i) information campaign regarding road safety, (ii) improvement of roadinfrastructure, (iii) imposition of more stringent penalties, etc.


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Advantage of cost-effectiveness analysis

technique application

Weaknesses of cost-effectiveness analysis

technique application

It is an alternative to cost-benefit analysis when

evaluation of benefit in terms of money is

difficult but results are quantifiable

It does not answer the question whether the

public will enjoy net benefit after an initiative

has been implemented (i.e. will benefit be greater

than costs)

Comparison of the alternatives allowing the

achievement of the same or very similar results ispossible

Is not suitable when an initiative pursues several

different goals

Cost utility analysis.A cost utility analysis is another variation of the cost-benefit analysis.

This technique compares relative effectiveness of alternative interventions in pursuance of

two or more defined results/goals.

Multi-criteria analysis. This technique enables the evaluation of the attractiveness of

different alternatives by comparing them according to the selected criteria. These criteria may

have a different level of importance in which case relative weights are attached to them. The

multi-criteria analysis is based on the expert opinion of specialists carrying out an assessment

(when establishing criteria, attaching weights to them, assessing alternatives according to

each criterion, presenting their general evaluation) and it is, therefore, more subjective than

other mentioned techniques of alternatives analysis4. Nevertheless, where the possibilities of

evaluating the key costs and/or benefit in terms of money are missing, the technique of multi-

criteria analysis provides enhanced structural detail and transparency to decision assessment.

4Objective indicators (e.g. price) can also be included.

The aforementioned cost-effectiveness analysis as well as the cost utility analysis allow the evaluationofrelative effectiveness of alternatives in pursuance of the defined goal or several goals (in the case ofcost utility analysis). The measuring unit is most often non-monetary one.


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The multi-criteria analysis, like other aforementioned techniques, does not answer the

question whether or not the benefit of intervention implementation will exceed costs. In other

words, the possibility that the optimum alternative is a do-nothing alternative (status quo)

always exists.

Figure 3 Advantages and weaknesses of applying the multi-criteria analysis technique

Advantages of applying the multi-criteria

analysis technique

Weaknesses of applying the multi-criteria

analysis technique

An alternative to the cost-benefit analysis when

it is difficult to evaluate costs and/or benefit in

terms of money.

Does not answer the questions whether or not the

public will experience net benefit after an

initiative has been implemented (i.e. whether

benefit will exceed costs)

Provides enhanced structural detail and

transparency to decision assessment

Is based on the expert opinion of specialists

carrying out an assessment (when establishingcriteria, attaching weights to them, assessing

Example 2: multi-criteria analysis

Criteria [criterion weight] Non-weighed evaluations in scores

Project isimplementedby theinstitutionitself

Project isimplementedby Supplier No1

Project isimplementedby Supplier No2

Net present value [60 %] 20 100 65

Elasticity [20 %] 80 50 78

Reliability [20 %] 82 90 96Total weighed score 44.4 88 73.8

In the example presented in the Table, the alternative when a project is implemented by Supplier No 1 in all probability would be considered the most attractive

one.


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alternatives against each criterion, presenting

their general evaluation) and it is, therefore, more

subjective


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2.APPLICATION OF THE COST-BENEFITANALYSIS TECHNIQUE FOR PROPOSEDDECISION IMPACT ASSESSMENT

An assessment of the envisaged impactof any initiative shall be carried out in several steps:

1. Description a public life problem;2. Determination of the pursued goals, results and the target situation;3. Identification of realistic alternative solutions to the problem;4. Evaluation of alternatives and their comparison with each other;5. Upon determining the optimum alternative, discussion of its further implementation.

Figure 4 Steps of decision impact assessment

1 ingsnis

Vieosios politikos

problemos

nustatymas

2 ingsnis

Vieosios iniciatyvos

tiksl nustatymas

3 ingsnis

Reali problemos

sprendimo

alternatyv

identifikavimas

4 ingsnis

Alternatyv analiz

5 ingsnis

Pasirinktos

alternatyvos

gyvendinimo

vertinimas

Kokia yra vieosios

politikos

problema? Koks

jos mastas,aktualumas?

Ar valstyb turi j

sprsti? Kas

atsitiks, jeigu

valstyb nesiims

veiksm?

Koki rezultat

norima pasiekti

gyvendinant

iniciatyv?Kaip inosime, ar

valstybs veiksmai

buvo skmingi?

Kokie yra galimi

problemos

sprendimo bdai?

Kurie i j laikytinirealiais ir

svarstytinais?

traukite status

quo kaip vien i

alternatyv.

Ianalizuoti

problemos

sprendimo

alternatyvas:vertinti kiekvienos

alternatyvos

gyvendinimo

snaudas, naud.

Rekomenduotina,

kai manoma,iam

vertinimui naudoti

snaud-naudos

analiz.

Kaip pasirinkta

alternatyva bus

gyvendinama?

(atsakomyb,veiksm planas ir

pan.)

Pagal kokius

rodiklius bus

vertinama

gyvendinimo

skm?

Step 1

Identification of a

public policy

problem

Step 2

Determination of

the public

initiative goals

Step 3

Identification of

realistic

alternativesolutions to the

problem

Step 4

Analysis of

alternatives

Step 5

Evaluation of

implementation of

the selectedalternative

What isthe

problem

of public

policy?

What is its

extent and

relevance?

Whatresults are

pursued

through

initiative

implement

ation?

What arepossible

solutions

to the

problem?

To analysealternative

solutions

to the

problem:

to evaluate

the costs

and

benefit ofimplement

How willthe

selected

alternative

be

implement

ed?

(responsib

ility,action


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ation of

each

alternative

.The

recommendation is

to use the

cost-

benefit

analysis

for this

evaluation

, where

possible

plan, etc.)

Should the

State

address it?

What willhappen if

no actions

are taken

by the

State?

How will

we know

whether

the Statesactions

proved to

be

successful

?

Include

status quo

as an

alternative

What

indicators

will be

used toassess the

success of

implement

ation?

The technique of cost-benefit analysis is in particular useful when making the fourth stepof impact assessmentas it allows the determination, evaluation and comparison of the costs and

benefit of different alternatives and the identification of the optimum solution to the problem.

Other chapters of this Methodological Guide more extensively describe the application of the

cost-benefit analysis technique for the assessment of public initiative alternatives. However, prio

to that, attention is also paid to the previous steps of impact assessment they present brief

recommendations on how the problem at issue and the pursued goals should be described and

alternative solutions to the problem be identified. These analytical steps are of great importance

as if any of these steps is implemented incorrectly the subsequent analysis of the costs and

benefits of a decision may be of little use.

2.1. Description of a public policy problem and justification of therequirement ofthe States actions

The definition of a public policy problem and the description of the reasons behind it is an

important first step to the formulation of the goal of States intervention and possible alternative

solutions to the problem. In order to properly describe the problem at issue it is recommended to

discuss several points.

?

What is the problem?

What is the problem? What is its extent and relevance?

How was the situation changing within a certain period of time? How is it likely tochangewhat are forecasts, tendencies?

What public groups, economic sectors are affected most?

What reasons lie behind the problem situation?

Do the available policy instruments help to resolve (or aggravate) the problem?

Does the problem arise from (not from) the interventions under

implementation/implemented, applicable regulation?

How would the problem develop if no action is taken by the State?5

5Prepared in accordance with the 2009 European Commissions Impact Assessment Guidelines. January 2009.

SEC(2009) 92 //http://ec.europa.eu/governance/impact/commission_guidelines/commission_guidelines_en.htm
http://ec.europa.eu/governance/impact/commission_guidelines/commission_guidelines_en.htmhttp://ec.europa.eu/governance/impact/commission_guidelines/commission_guidelines_en.htmhttp://ec.europa.eu/governance/impact/commission_guidelines/commission_guidelines_en.htmhttp://ec.europa.eu/governance/impact/commission_guidelines/commission_guidelines_en.htm


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The description of a situation should provide information about the nature, extent and reasons of

the problem. An overview of the reasons and factors predetermining the problem is in particular

relevant if the aim is to deal with the problem but not to treat its symptoms.

In describing the problem it is important to justify the necessity of State s actions to address it.

Generally, a public intervention is based on the defects of market/regulation or social

(redistribution) arguments. In considering the appropriateness of States intervention/regulation it

is important to consider whether or not the States actions will result in additional distortions of

the markets or the costs greater than benefit.

2.2. Setting the goals of a public initiativeIf, taking into account a problem analysis, the States intervention seems to be necessary, the goal

of an intervention has to be formulated. The goal of a public intervention should be clearly linked

with a solution to the identified problem and elimination of the underlying reasons. Failure to

formulate a clear goal of an intervention poses a risk of ineffective use of resources in addressing

the problem. Furthermore, in this case it is impossible to effectively monitor the course of

intervention implementation and evaluate whether the States actions produced the desired results.

?

What is the goal of a public intervention?

What is aimed by decision implementation? What would be considered to be a successful

result of decision implementation?

Are the pursued goals clearly relating to the problem and underlying reasons?

Are the goals formulated so as to reflect a positive change? (e.g. decreased crime rate,

cleaner environment, higher energy safety)

Do the pursued goals and objectives comply with the strategic and/or other policy goalsand objectives?

Is the success of the set goal or objective measurable?6

Formulation of the goal of a policy intervention creates a basis for the discussion of possible

alternative options of a decision.

2.3. Identification of realistic alternative solutions to the problemA subsequent step following the setting of the goals of an intervention is to identify the

alternatives allowing the achievement of these goals. A set of possible alternative options will be

different in each particular case. Sometimes it can include only two alternatives the State

should not deal (status quo) and deal with the problem. Nevertheless, in the majority of cases

more than two alternatives may and should be considered: for instance, alternatives regarding

regulation, alternative forms of regulation or different methods and measures of decision

implementation. Alternatives may be relating to the content or form of a decision. In the case of a

more relevant decision, a larger number of alternatives should be evaluated.

6Prepared in accordance with the 2006 European Commmissions Impact Assessment Guidelines. January 2009.



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At the start of the analytical process the recommendation is to identify and discuss the largest

possible number of alternative solutions to the problem whose set should be subsequently

reduced taking into account their viability and reality. A clear justification for rejecting particular

alternatives and deciding not to apply them any longer should be provided. It is always necessary

to formulate thestatus quo alternative as it not only reveals the imminent consequences in case of

States failure to take actions but also provides a starting-point for the comparison of allalternatives (i.e.status quo alternative is considered to be the baseline scenario).

When discussing the possible alternative options for the problem it is appropriate to take into

account the following principles and advice7:

7Prepared in accordance with the 2009 European Commissions Impact Assessment Guidelines. January 2009.


! In the stage of formulating alternative options for the problem it is important to hold the largestpossible number ofconsultations (both formal and informal) with stakeholder and society groups.

Example 3: alternatives

Alternavtives for regulation

Type Examples

Taxes Pollution tax

Subsidies Payments for the termination of the agricultural activity

Information campaigns Educational campaigns aimed at increasing traffic safety

Trade in pollution permits Trade in greenhouse gas operating permits

Alternative forms of regulation

Type ExamplesSetting of mandatory regulations Regulatory legislation

Self-regulationeconomic operators, by their

own initiative, set standards and requirements

for their activities

The Code of Ethics of Journalists and Publishers

Licences for dentists and dental hygienists, dental care

institutions issed by the the Chamber of Dentists

Co-regulationeconomic operators and state

institutions jointly control a certain area ofactivity

Protection of minors against the harmful information in the

media

Performance-based regulation Setting exhaust gas rates by giving car producers freedom in

choosing how to implement the standards (U.S.)

Implementation alternatives: a few exmpales

Different standards or procedures depending on the specificity of a regulated entity (e.g. large, small

enterprises)

Services are provided by a state institution, private sector, cooperation of the private and public sector

Improved implementation of the existing instruments or initiatives

Different time of implementation, different level of initiative implementation

Interim/permanent measures

Actions at regional, national or international level

Lease, acquisition, construction, repair

Source: The Guide to decision impact assessment of Ireland, Great Britain, and the authors information


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Alternatives should be realisticthe practice of considering only the do-nothing alternative,

the proposed alternative decision and a radical unrealistic alternative should be avoided.

The recommendation is to avoid preconceptioneven though one of the alternatives seems

to be too innovative its topicality may change (increase) upon change of certain

circumstances.Where a regulatory framework already exists in a certain area, the alternatives of ensuring

better implementation and the observance with the provisions should be considered.

Less can mean morewhere a regulatory framework already exists in a certain area but

does not allow the achievement of the desired results, the introduction of new additional

instruments can be not the best decison. The appropriateness of simplifying the applicable

instruments, increasing their consistency or maybe refusal thereof should be considered.

On the basis of the best practices, in each case it is recommended to discuss whether an

alternative to classical legal regulation would be a more appropriate instrument. For

instance, maybe an information educational campaign would be sufficient?

In selecting alternatives for an analysis it is relevant to take into account the alternatives that

would be supported by different stakeholder, public groups; however, this should not beoverestimated.

Alternatives should compete they should produce different options for the problem.

Costs and benefit should be equally assessed with regard to each alternative it is

important to avoid the practice of highlighting the benefit of one alternative but the costs of

the others. This is one of the most common deficiencies of impact assessment.

2.4. Assessment of alternativesAs it has already been mentioned, the application of cost-benefit (or cost-effectiveness) analysisfor quantitative evaluation and comparison of alternative decisions is useful. The cost-effectives

analysis includes several steps:

(1)indication of assessment assumptions;(2)identification of the public groups to be impacted by a decision;(3)indication of a positive impact and possible negative consequences to be experienced by

public groups due to the planned public intervention;

(4)calculation of the envisaged changes of costs and benefit;(5)estimation of the key costs and benefit in terms of money;(6)comparison of alternatives against the set criteria;(7)performance of a market analysis with the aim of achieving more reliable results ofassessment.Each of these steps is more extensively described in further sections of this chapter.

2.4.1. Setting the scope, assumptions and period of assessmentThere are several assumptions on the basis of which the cost-benefit analysis is carried out:

a decision may have an impact on various economic sectors as they are interrelated (general

equilibrium);

intangibles are included into analysis if they can be reliably evaluated;all related costs/investments are assessed;


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costs and benefit are evaluated from the perspective of the national economy (i.e. not the

perspective of the Government or an individual institution);

generally, the period covered by the cost-benefit analysis depends on the useful life of fixed

assets (e.g. if a new information system is introduced). However, it is impossible to establish

such period for part of public policy decisions (e.g. for health policy instruments etc.). Insuch a case the recommended period of analysis is 20 years. A longer period is relating to

great uncertainty; furthermore, in many cases cost and benefit flows lose their significance in

the distant future due to discounting.8

Table 3 Assumptions accepted during cost-benefit analysis

Assumption Possible variations

Scope of

analysis

National economy --

Assessment covers the impact on alleconomic sectors (general equilibriumapproach)

Assessment covers the impact on aparticular sector (partial equilibriumapproach)

Period ofanalysis

A maximum of 20 years Another assessment period can be set.E.g. a period longer than 20 years maybe relevant for the assessment of certaindecisions, when an important part ofcosts and/or benefit is likely to appear inthe long-term period (e.g. in the fields of

children education, nuclear energy, etc.).

Intangibles To be included if are realiablymeasurable

Not to include and to carry out aqualitative assessment if realiablemeasurement is impossible

Taxes Prices without taxes are used --

Social discountrate

Proposed interest rate on Eurobondsissued on behalf of the State

Another size of the discount rate is set

2.4.2. Identification of costs, benefit and stakeholders that incur/receive themAn assessment of alternative options for a public problem should be started from the

identification and overview of the consequences of each alternative. The matter of primary

importance is the identification of society groups to be impacted by the decision (directly,indirectly) and indication of the consequences (positive, negative) to be faced by these groups

and when.

8Exceptions are possiblethe impact (benefit or costs) of some decisions can be significant in the distant future too as

for instance, in the field of nuclear energy, in the cases of environmental impact, etc.

! In analysing the costs and benefit of an alternative decision it is necessary to indicatewhich society groups, how and when will be impacted as benefit and costs often unevenly

distribute within society or over time. For example, a certain proposal may be useful for

consumers but may result in adjustment costs for enterprises. Costs and benefit may be

unevenly distributed among macro and micro enterprises, start-ups, etc. A decision to apply

certain measures aimed at protecting consumers against non-quality products may create a

situation when consumers have the chance to choose only more expensive goods/services,

while certain groups of suppliers gain a competitive advantage over other suppliers, etc.


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Positive consequences economic benefit the gain in the welfare of society and stakeholdergroups resulting from the decision at issue. Economic costs are related with the actual use of

resources in the economy and reflect the best possible alternative of the use of resources, i.e.opportunity costs. The opportunity costs mean the costs of the best opportunity (alternative) lost

to use the available resources. In each case it is important to find out what are the alternative

ways/opportunities of using resources (e.g. investment in the public transport system instead of

building new roads).

Tables 4 and 5 indicate the types of the most frequently occurring costs.

Table 4 Types of costs

Costs Type Example

Monetary Quantitativefixed

costs

Remain constant regardless of activity/production volumes

(e.g. office building lease costs are constant regardless of thenumber of people working in the building)

Quantitativevariable costs

Vary subject to activity/production volumes (e.g. electricitycosts may increase when the number of persons working in thebuilding increases)

Quantitativesemi-variable costs

Include fixed and variable components (e.g. buildingmaintenance costs part of which is planned, while another partchanges in proportion to activity/production)

Non-monetary

Quantitative A larger number of consumer complaints, road traffic accidents

Non-

monetary

Qualitative Decreased employee competence

Source: Adapted according to HM Treasure Guidance9

Table 5 Most frequent types of costs

Type of costs Sustained by state institutions

implementing a decision

Sustained by decisions target

groups/society groups

Budget expenses Financial direct expenses fromState and municipal budgets andother funds

Administrative expenses of state

institutions

Human resources required forintervention implementation

--

Implementationexpenses

Policy implementation, monitoring,supervision expenses

Expenses relating to the selection ofthe most acceptable manner of theobservance of requirements

Compliance expenses Uniform implementation expensessee above

Direct expenses sustained by regulatedor intervention-impacted entitiesseeking to comply with the establishedrequirements. These costs include anadministrative burden (for more

9

HM Treasury. The Green Book. Appraisal and Evaluation in Central Government. Treasury Guidance. London. //http://www.hm-treasury.gov.uk./media/3/F/green_book_260907.pdf
http://www.hm-treasury.gov.uk./media/3/F/green_book_260907.pdfhttp://www.hm-treasury.gov.uk./media/3/F/green_book_260907.pdfhttp://www.hm-treasury.gov.uk./media/3/F/green_book_260907.pdf


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Type of costs Sustained by state institutions

implementing a decision

Sustained by decisions target

groups/society groups

information about its assessment seechapter 2.4.3.4.).

Adjustment expenses Costs sustained because of theredistribution of resources which isencouraged by behavioural changepredetermined by a policy instrument

(production/consumption).Source: The European Commissions Impact Assessment Guidelines10

In analysing alternative decisions is is necessary to describe, as far as possible, the expected

change in physical measures: for instance, how many new lives will be saved, how much ofpeoples time will be saved, how many accidents will be prevented or how the environmental

pollutionlevel will be reduced after the decision has been adopted. The cost-benefit analysis

requires a clear indication of how the initiative will affect consumption, health, security, leisure

duration, etc., i.e. the items on which human welfare depends.11 It is equally important to explainwhysuch (as described) impact is expectedcausal relationships should be explained.

As quantitative evaluation of all the consequences is often impossible, major focus should be

laid on the key elements of the benefit and costs.

2.4.3. Estimation of costs and benefit in monetary termsThe aim of economic benefit and cost estimation in monetary terms is to determine whether or

not the benefit of a certain initiative is worth the sustained costs and to compare which

alternative is more attractive.

The estimation of costs and benefit in monetary terms is the most difficult stage of the analysis.

The most common recommendation is to estimate in monetary terms only the most important

consequences of a decision. In adopting a decision on which costs and/or benefit require a more

extensive assessment, the recommendation is to use the criterion of significance and the principle

of proportionality. In other words, two questions should be asked:

Are/is these/this costs/benefit significant and relevant? Costs and benefit are considered tobe significant if they can lead to the conclusion on which alternmative should be considered

optimum. Inessential elements of costs and benefit should not be analysed.

Can these/this costs/benefit be reliably and effectively calculated? If the efforts andresources necessary for the calculation of certain costs/benefit are greater that the benefit of

results of this process, a quantitative assessment of such costs/benefit is inappropriate. In

this case the recommendation is to carry out a qualitative assessment of the potential impact.

Further this chapter reviews which costs and benefit should be assessed and how should they be

calculated in terms of money.

10

European Commission. Impact Assessment Guidelines. January 2009. SEC(2009) 92 //http://ec.europa.eu/governance/impact/commission_guidelines/commission_guidelines_en.htm11

Kuodis R. Lietuvai silytinas kat naudos analizs modelis. //http://www.ekonomika.org/
http://ec.europa.eu/governance/impact/commission_guidelines/commission_guidelines_en.htmhttp://ec.europa.eu/governance/impact/commission_guidelines/commission_guidelines_en.htmhttp://www.ekonomika.org/http://www.ekonomika.org/http://www.ekonomika.org/http://www.ekonomika.org/http://ec.europa.eu/governance/impact/commission_guidelines/commission_guidelines_en.htm


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2.4.3.1.What costs and benefit should be included in the analysis?Table 6 presents information about the costs and benefit to be included and not to be included in

the analysis.

Table 6 Costs/benefits to be included/not to be included in the analysis

Costs/ benefit Comments on inclusion/non-inclusion in the analysis

Sunk costs Sunk costs mean the costs which were incurred prior to the assessment periodin question. For instance, such costs include instrument planning, feasibilitystudy development costs. These costs should notbe included in the analysis asthey result from previous decisions and decisions on another (alternative) useof these funds may no longer be accepted.

Capital and operatingexpenses

Cost-benefit analysis should include all cost flows relating to the decisionregardless of whether these are capital or current expenses, operating or one-off

expenses.Depreciation/amortisation

Depreciation/amortisation is an accounting term which in the most generalsense means annual impairment in the real value of tangible assets 12 .Depreciation deductions have no direct economic effect and therefore shouldnotbe included in the cost-benefit analysis. Furthermore, if both the costs ofassets acquisition and the depreciation deductions were included in the analysisthis would mean a duplicate calculation of these costs. Where assets need to be

upgraded during the assessed period, replacement investments should beincluded in that period in which they are made.

Financial transactions Cost-benefit analysis generally does not include the costs of financialtransactions, for instance interest. The reason is that the cost-benefit analysis isrelating to a certain increase/decrease in the supply of certain resources (the

result of decision) on the scale of the entire economnot but not to the re-distribution of funds within economic sectors. Additionally, these costs(interest) are indirectly included in the discount rate and therefore the inclusionof interest in the analysis would mean a duplicate calculation of financialexpense.

Contingencies Where intangible costs/benefit make part of the envisaged costs/benefit of a

decision, they should be included in the cost-benefit analysis. For instance, theassessment of a decision on fitting up new office premises should cover allconstruction contingencies (e.g. as regards increased work volume or work

delay). In the case of lower-scope decisions the value of contingent costs maybe estimated by calculating the impact of a contingent event by the probabilityof that event. Large-scale decisions should use quantitative techniques of risk

assessment (for more information on risk assessment see chapter 2.4.6).Taxes Cost-benefit analysis should use priceswithout taxes, i.e. excluding the value

added tax (VAT) and other indirect taxes. The correction of market prices asregards taxes is of particular relevance in the cases when the impact of taxation

may have the key influence on the decision-making. Where the system of taxesapplicable to alternative decisions substantially differs, such a correction isnecessary in order to avoid inadequate comparison13.

Deadweight loss Deadweight loss means net costs which are incurred by the public due to

12Where the assessment period coincides with the economic life period the residul value will equal zero. It should be

noted that regular maintenance of assests is not the same as depreciation/depreciation; maintenance is the real use of

economic resources and its costs have to be included in the cost-benefit analysis.13HM Treasury. The Green Book. Appraisal and Evaluation in Central Government. Treasury Guidance. London. //

http://www.hm-treasury.gov.uk./media/3/F/green_book_260907.pdf


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Costs/ benefit Comments on inclusion/non-inclusion in the analysis

deviations from the equilibrium of economys competitiveness. This generally

happens due to additional taxes or regulation. For example, increased taxes oncertain goods or services create a situation when part of consumers buy less of

these goods or services than they would if the taxes were not raised. In otherwords, the deadweight loss (sometimes referred to as a surplus burden) meansthe loss in welfare due to behavioural changes caused by taxes. Theinclusion/non-inclusion of deadweight losses in the cost-benefit analysis shouldbe evaluated on a base-by-case basis. As a general rule, these costs should be

included in the analysis if they are sufficiently significant compared to the totalcosts and benefit of a decision and could impact the decision on the optimumalternative.

Behavioural effects Public interventions, particularly regulation, often have an effect on economicoperators behavioural changes. However, in many cases behavioural changescaused by a public intervention are difficult to interpret and quantify.Therefore, the inclusion of these changes in the cost-benefit analysis should be

considered on an individual case basis taking into account their importancewhen compared to the total costs/benefit of a decision and the impact on thedecisions as regards the optimum alternative.

Externalities A decision may also have an impact, either negative or positive, on persons

who are not directly relating to it. This is especially relevant in the case ofdecisions relating to the environment and health. The inclusion of externalitiesin the cost-benefit analysis should be considered on an individual case basis. As

a general rule, externalities should be included in the analysis if they arequantifiable and of sufficient significance to make an impact on the decision as

regards the optimum alternative. All assumptions relating to the assessment ofexternalities should be properly explained and justified. Non-quantifiableexternal effects must indicated and explained.

Transfer payments Transfer payments mean single-direction payments in exchange for which nogoods or services are provided. Such costs include social security benefits, old-

age and disability pensions, student grants, sickness benefits, etc.14

Thesepayments should notbe included in the cost-benefit analysis as they have animpact on the re-distribution of public welfare only, but do not themselvesimpact the costs/benefit on the entire economic scale.

2.4.3.2.Real and nominal valueThe costs and benefit of a decision should be evaluated at the real but not nominal value (i.e. the

cost of acquisition of a good or service). The influence of inflation should be respectivelyeliminated from the analysis. An exception is applied only where the price of a good or service is

expected to decrease/increase compared to the price of all the other products and services. In this

case a relative change should be evaluated and integrated into analysis. Below are presented

several examples of relative price changes:

high-tech products whose price is likely to drop (e.g. the most recent computer technologies);

high-tech products whose price is likely to grow (e.g. technologies in the area of health,

defence equipment);

limited natural resources (e.g. oil);

14Subsidies paid to exporters, farmers, producers. etc. shall not be considered to be transfer payments.


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wages and the price of other costs which are likely to increase more rapidly than the total rate

of inflation.

In summary, in carrying out the analysis, the price of goods or services should be considered as

constant within the entire period of decision implementation (i.e. regardless of the effect ofinflation), except for the cases when it is possible to reasonably foresee that the price will change

when compared to the price all the other goods/services.

2.4.3.3.Estimation of costs and benefit in monetary terms in the case of non-existance of market pricesThe costs and benefit of a decision should be calculated on the basis of real market prices.

However, in practice, situations are frequent when the market prices cannot be used for public

intervention assessment:

At the presence of market imperfectionsor due to States regulation the price of a good orservice does not always reflect its real value.For example, where a certain good is subsidised,

its price may be lower than the real value of resources necessary to produce it. In this case the

price of a good/service would be equal to the sum of the price of the good and the unit of

good/service in the amount of the subsidy. In the cases of taxation differences between

different alternatives at issue, when applying subsidies or in the cases of monopolistic pricing,

market prices should be corrected.

Where a good is not sold in the marketthe market price does not exist. For instance, there isno market price for clean air, saved lives, nature preservation, etc. The economic value of

such goods can be estimated using indirect value determination approachesfor instance, by

revealing relative preferences of individuals with respect to them, making a comparison withother similar goods with the market value. It is assumed that consumers can estimate the

significance of non-market goods for their welfare. For instance, a consumer wishing to live

in a cleaner environment may be willing to pay a certain amount of money for that. The

largest amount of money he would agree to pay expresses his willingness to pay and shows

how an individual estimates the improvement of environmental quality compared to other

goods and services he would acquire for the same amount. On the other hand, knowing about

the deterioration of environmental quality an individual can agree to a monetary

compensation of a certain amount, which, in his opinion, offsets the damage caused to his

welfare. The smallest amount an individual would agree to accept for negative consequences

is his willingness to accept a compensation. It shows how an individual estimates the

deterioration of quality in the context of other goods that can be acquired for money.

Willingness to pay for non-market goods or accept a compensation for negative consequences

differs between individuals. Therefore, in order to identify what impact on the welfare of the

whole society (in the opinion of society members themselves) was made by the change (e.g.

improvement or deterioration of environmental quality) it is necessary to aggregate the

willingness to pay for non-market goods or accept compensation for incurred damage of all

the individuals affected by the change. The aggregated willingness to pay or accept a

compensation reflects the estimation of the change in welfare in terms of money.


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Several methods used for the estimation of the price of non-market services/goods are

presented in Table 7. These methods can be divided in two groups: revealed preferencemethods and stated preference methods. Both groups of methods allow the identification ofindividuals willingness to pay for a non-market good/servicein one case this is done directly

(stated preference testing), in anotherindirectly (revealed preference testing).

Table 7 Estimation of costs and benefit in monetary terms in the case of a non-market price: methods

Revealed preference

testing

These are indirect methods for estimating the value of non-market goods.

These approaches imply that similar situations in which individuals madedecisions on making of a certain payment for the foreseen benefit areanalysed (e.g. farmers who contributed to flood-protection work in order tominimise flood risks to their farms). This allows a conclusion on how manyindividuals would agree to pay for the expected benefit of the decision to beadopted.

The two most frequent methods of revealed preference are the following:

Hedonic pricing. In applying this method, various characteristics ofmarket-traded goods/services are analysed in order to indirectlyestimate the value of non-market goods/services. For instance, the

value of a lake pier could be estimated by comparing the price of ahouse on a lake shore with the price of a similar house located

Example 4: willingness to pay and accept a compensation

The gain or loss of society relating to the changes of environmental quality can be evaluated intwo aspects:

Willingness to pay for the improved environmental cleanness (What amount of money wewould agree to pay for living in a cleaner environment?)

Willingness to accept a compensation for the refusal of improved environmental cleanness(what monetary compensation we would agree to accept for our refusal to live in a cleanerenvironment?)

Willingness to pay for the avoidance of deterioration of environmental quality (what amountof money we would agree to pay for the avoidance of deteriorarion of environhmentalquality?)

Willingnss to accept a compensation for the deterioration of environmental quality (whatmonetary compensation would we agree to accept for the deteriorated environmentalquality?).

The first and the fourth measures of economic value describe the in individuals (s) monetary budget, which, in theaspect of benefit (welfare) level, offsets (compensates) the change of environmental quality. The second and the thirdcases reflect the change in revenue which, in the aspect of benefit, corresponds to the change in environmentalquality. In other words, the first and the fourth cases concern either a decrease or increase in welfare in monetary

terms in exchange for improvement or deteriorartion of environmental quality. Thus, the estimation starting-point is

the original level of welfare (before the changes) of an individual. The second and the third cases concern an increaseor decrease of individuals budget instead of gain or loss in environmental quality. In this case the estimationstarting pointa new level of individuals welfare (after the changes).


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elsewhere.

Travel cost analysis method. In applying this method individualswillingness to pay is estimated on the basis of the travel costsnecessary to reach a particular place. For instance, the value of a park

could be calculated as an amount of costs incurred by personstravelling to that park (including travel time). Nevertheless, such amethod of calculation can show only the minimum value of the park asit ignores the price the consumer would be willing to pay (consumersurplus).15

Stated preference testing The stated preference methodologies were developed taking into account the

weaknesses of revealed preference tests. In this case, in order to forecastconsumers behaviour with respect to non-market goods consumer surveysare carried out. The surveys evaluate individuals (i) willingness to pay fora

certain non-market good and/or (ii) willingness to accept a compensation fornegative consequences of initiative implementation.

Figure 5 presents the scheme of the process of intangibles estimation in terms of quantity.

15Consumer surplusthe value consumers receive over and above what they actually have to pay.


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Figure 5 Intangibles estimation scheme

Source: Adapted according to the Impact Appraisal Guidance of Great Britain16

16HM Treasury. The Green Book. Appraisal and Evaluation in Central Government. Treasury Guidance. London. //

http://www.hm-treasury.gov.uk./media/3/F/green_book_260907.pdf

Is the impact measureable

and quantifiable?

ANDDoes a market price exist?

Revealed preference methods applied:

Hedonic pricingTravel cost analysis

NO

Is estimation of costs and benefit

in monetary terms possible?

Stated preference methods applied:

Willingness to pay

Willingness to accept compensation

NO

Is estimation of costs and benefit

in terms of money possible?

To perform qualitative

assessment of intangibles

NO

To calculate benefit

and/or costs

YES

YES

YES


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Table 8 discusses certain cases of intangibles which are most frequently used during the public

intervention analysis.

Table 8 Estimation of costs and benefit in monetary terms in the cases of non-market price: examples

Value oftime

In ideal conditions, an individuals salary is a monetary unit of the stimation of histime. In simple economic models an individual chooses between leisure and workingdurations: whether to refuse a leisure hour and increase consumption (i.e. to receivemore consumption goods) by the quantity equal to his hourly pay or to reduce work(increase leisure time) by an hour and reduce consumption (i.e. to receive lessconsumption goods) by the quantity equal to his hourly pay. Therefore, in order toestimate the economy of time due to, for instance, improved transport system, thesalaries of persons using this transport system may be used.

For example, if a quicker underground or automation of the traffic lights systemreduced the time necessary to go to/from work by 30 minutes, and the salary is LTL10/hour, the value of time savings is LTL 5 per day. Upon calculating and summing upthe values of time saved by each person the total value of time saved over a time unit is

obtained.

Value of life

In order to evaluate decisions having an impact on the probability of death (e.g. in thearea of transport, public order and healthcare) two main methods can be applied.

Constructive methodit estimates what a person would have earned if he stayed

alive (until his/her standard age of death). This is done by extrapolating his/heremployment history, comparing it with the revenue history of other personsholding a similar position. The weakness of this method is that it does notdistinguish between a living duration and the related being alive. This is the reasonwhy, according to this method, upon retirement a persons life has a zero value as

there is no loss of revenue.

Revealed preference method (previously discussed in Table 7). This method

estimates the value of life by analysing how much additional revenue a personneeds in order the increase of probability of his death is compensated. This revenueis reflected by the market wage for more risky jobs. For instance, some professionshave a much higher probability of death than others. Persons in riskier jobsgenerally require compensations for additional risk. By selecting a riskieroccupation they show their agreement to a higher probability of death if this meanshigher revenue.

Value ofnatural

resources

One of the methods used to assess the environmental impact of a public initiative is a

contingent valuation method. This is a survey-based method intended for estimatingthe value of non-market goods. The aim of a survey or an interview is to find outrespondents willingness to pay for a public asset, how much an individual is willing topay for positive quantitative and qualitative changes of natural resources. During thesurvey a resident can be asked how he/she evaluates particular actions of the statepolicy aimed at the preservation or improvement of natural resources, or whether or nothe/she would be willing to additionally pay, in the form of taxes, for positivechanges. An individual can also be asked what amount would be sufficient to him torefuse a certain public asset.

Source: R.Kuodis. Lietuvai silytinaskat naudos analizs modelis.


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It is important to note that the aforementioned methods for estimating the value of public assets

without a market price require a lot of resources and therefore should be applied taking into

account the extent of the initiative impact, accessibility of information necessary for analysis and

the available resources. Furthermore, if the aforementioned methods do not lead to the estimation

of costs and benefit in terms of money with sufficient accuracy, such estimation may be

misleading rather than useful. In this case the recommendation is to carry out either a sensitivity

analysis for the main (critical) variables (for more information see chapter 2.4.6) or a qualitative

cost-benefit analysis.

2.4.3.4.Assessment of an administrative burdenAn administrative burden is an element of costs and therefore, where this relevant 17, should be

evaluated in terms of quantity during the assessment of the costs and benefits of a decision. The

administrative burden means the costs incurred by business operators, residents, state and

municipal institutions in performance of the statutory obligations18 to provide information to state

and municipal institutions and their authorised persons about their activities and products as well

as other statutory information19.

To estimate the administrative burden resulting from regulation in terms of quantity a special

methodology is designed the so-called standard cost model. It has received a wide applicationat EU level and within EU Member States. The model can be used for the assessment of a

particular legal act, a provision or a group of legal acts.

The administrative burden assessment consists of several main steps. In brief it can be stated the

first steps include identifying which legal norms lay down information obligations, what is their

nature and what actions are to be taken by business operators, citizens, state institutions or other

17i.e. where a decision provides for the establishment or change of the information obligation.

18Information obligations is a wide term it covers such actions as a duty to declare, register, apply for a licence, an

obligation to deliver reports, provide information to third parties (e.g. to indicate information on product labels),

certification of products or processes, inspections, etc.19 Order No 4-152 of the Minister for the Economy of the Republic of Lithuania of 2 May 2006 on the approval of the

Methodology for the determination and evaluation of an administrative burden on business.

Example 5: estimation of the price of saved life years

Robert E. Hall and Marc Lieberman48

presented systemised information on the costs for one saved

life in the U.S. by applying different instruments. In order to increase the number of saved lifeyears by one:

1. doctors advice to give up smoking to a smoking patient costs 150 US dollars;2. mammography for early breast cancer diagnosis (every 3 years, for women aged 50-64)

2 700 US dollars;3. heart transplantation157 821 US dollars;4. safety belts in school buses2 760 197 US dollars;5. anti-terrorist security measures at airportsaround 8 000 000 US dollars;6. ban on asbestos use in automatic transmissionsover 66 000 000 US dollars.Source: Robert E. Hall and Marc Lieberman (2005), Macroeconomics: Principles and Applications, South-


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entities in order to implement these requirements. Afterward, a quality assessment of the burden

is carried out.

Costs attributed to the administrative burden are the following:

time spent on implementation of the statutory information obligations;

other costs incurred during information obligation implementation.

In order to estimate the magnitude of administrative burden at enterprise, institutional or

personal level it is necessary to asses the hourly rate of work of a person carrying out the action

of information obligation implementation, the length of the working time spent for performing

information actions, related additional costs (e.g. transport, software acquisition costs, etc.) and

the frequency of carrying out the information obligation. Assessment of the total administrative

burden on astate, regional or sectoral scale takes into account the number of entities that must

implement the set information obligation.

In Lithuania special methodologies have been developed for the estimation of the administrative

burden which are to be followed during assessment, i.e.:

The administrative burden on business entities shall be assessed in accordance with the

Methodology for the determination and estimation of an administrative burden on business

approved by Order No 4-152 of the Minister for the Economy of the Republic of Lithuania of

2 May 2006.

The administrative burden on the population shall be assessed in accordance with theMethodology for the determination and evaluation of an administrative burden on the citizens

of the Republic of Lithuania and other persons approved by Resolution No 213 of the

Government of the Republic of Lithuania of 23 February 2011.

In the course of preparation of this Guide the Ministry of the Interior of the Republic of

Lithuania was instructed to develop a special methodology for the estimation of an

administrative burden on state and municipal institutions.

A quantitative administrative burden estimation can be facilitated by special calculators. During

the preparation of this Methodological Guide the development of Lithuanias electronic database

of an administrative burden on business (calculator) was started. It is being developed on the

basis of the EU administrative burden calculatorStarter kit.

Formula for calculating the administrative burden

The annual administrative burden caused by a duty to provide data is calculated according to the

following general formula:

Administrative burden (AB) = P x Q

Where:

Pthe price of performing a standard information action (the hourly rate of work of the person carrying out

an information action multiplied by the working time (in hours) spent on the information action)

Q quantity (the number of entities carrying out an information action multiplied by the frequencyinformation action carried out within one ear


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2.4.4. Estimating and discounting cash flows2.4.4.1.Estimation of cash flows

Nearly every decision is relating to cash flows. The cash flows show how much money will be

received and spent during each period of decision implementation. This information serves as a

basis for a quantitative assessment.

Net cash flows are calculated by deducting cash ourflows from cash inflows.

Where cash inflows exceed cash outflows, a net cash flow is positive, where the received amount

of cash is below the spent one, a net cash flow is negative (see Example 6).

Net cash flows are calculated on a yearly basis for the entire period of implementation of the

decision in question. Where the implementation period of a decision is shorter than four years,

the forecasting ofmonthly cash flows is advisable.

2.4.4.2. DiscountingA traditional view is that in the more distant future costs or benefit are incurred or derived the

less relevant to us they are as most people would prefer receiving an asset of the same volume

and quality now but not after two or more years. Furthermore, according to the value for money

principle, a litas received after a year does not have the same value as a litas is worth today as a

Example 6: net cash flows

An institution plans to upgrade its fine accounting software for a total of LTL 10 million. After thesystem is upgraded, the current costs (IT staff, employee training) will increase by LTL 20 millioncompared to those before system upgrading. However, the new software should help to save costs

relating to the collection of fines as the controlling agencies will receive reliable information in atimely manner and the system will automatically send reminders to pay the fine, etc. Therefore, the

upgrading of the system is expected to result in savings of LTL 65 million per year. The upgradedsystem is planned to be used for three years and afterward to be upgraded again.

Net cash flow calculation

Year

0 1 2 3

Forecast cash inflows 0 65 65 65

Forecast cash outflows (-) 100 20 20 20

Forecast net cash flow -100 45 45 45

Net cash flow estimation formula

Net cash flow = Cash inflowsCash outflows


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litas received today can be invested and more than one litas received after a year. Respective

economic estimations reflect these preferences.

In many cases cash flows occur in different periods. Therefore, future inflows or future outflows

should be discounted.

A discount rate used for the assessment of a public decision is referred as a social discount rate.

In the assessment of long-term decisions the selection of a discount rate is essential: an initiative

which seems to be good applying a low discount rate may be bad at a higher discount rate.

Present value calculation

A discounted cash flow is obtained by multiplying the calculated net cash flows by the

discount factor:

Present value (PV) =ni

FVeFuturevalu

)1(

)(

or

nixFVeFuturevalu

)1(

1)(

where: idiscount rate;discount factor.

Before a study enabling the determination of the discount rate applicale to public decision-making iscarried out in Lithuania it advisable for this purpose to use the discount rate on eurobonds issued onbehalf of the State.

Discount factor

Discountingmeans adjusting the future value for the current period. The present value of

future cash is determined by using a discount factor, i.e. the number which makes the

future inflows and outflows equal to the current inflows and outflows:

n

i

fctorDiscountfa

)1(

1)(

Where: idiscount rate; nyear.


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For the convenience of calculation, discount factors for a 30-year period at a discount rate of 1 %

to 10 % are presented in Annex 3 to this Methodological Guide.

2.4.5. Methods for assessing and comparing alternative optionsThe net present value method is most frequently used for the assessment and comparison of

alternative options for a decision. Other assessment methods that can be employed for assessing

alternative options for decisions: an internal rate of return, payback period and benefit/cost ratio.

In order to enhance the reliability of decision-making (particularly when assessing complicated

decisions), the recommendation is to use several assessment techniques: e.g. one main andanother ancillary technique. The methods of alternative assessment and comparison are in more

detail presented in further sections of the Guide.

2.4.5.1.Net present valueNet present value is one of the most important performance indicators of a decision alternative.The net present value (hereinafter referred to as the NPV) indicator is the sum of discounted cash

flows over the period of decision implementation/application.

Example 7: cash flow discounting

Proceeding with the illustration presented in example 6 the present value of cash flows iscalculated:

Calculation of the present value of cash flows

Year

0 1 2 3




Discount factor = 1/(1 + 10%)n 1.0000 0.9091 0.8264 0.7513Present value = Current value x Discountfactor -100 40.9 37.2 33.8

Net present value calculationThe NPV is calculated according to the formula:

n

nt

n

t

ti

CF

i

CF

i

CFxfCFNPV

)1(...

)1()1( 11

0

0

0

where: CFcash flows; fdiscount factor; idiscount rate; nthe last year of the period;

tthe number of years from the beginning of a decision.


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It should be noted that cash flows in the early years are usually negative and only become positive

after a certain period. As their value deceases with time, negative cash flows in the early years of

decisions existence are weighted more than the positive cash flows of the subsequent periods.

Therefore, accurate identification of the initial assumptions is needed when applying the NPV

method. The value of the discount factor (discount rate) and the choice of the time horizon arecrucial for the calculation of the NPV (see Figure 6).

Figure 6 Inter-dependence of net present value and discount rate

The NPV shows (measures) the benefit of an alternative (the improvement of societys wefare

resulting from the decision i.e. the added value created for society in terms of money),

calculated at the todays value of money. If the NPV is positive (>0), a decision is generating

the net benefit. The NPV allows a comparision of different afternatives of a decision and making

a decision on the most acceptable one.

In the case of projects of commercial nature the alternative with the highest NPV is generally

selected. However, in the case of public decisions when all incurred costs and derived benefits are

difficult to quantify. the NPV should be only one of the criteria for decision assessment,

alternative acceptance/rejection. In other words, a decision with the highest NPV indicator is

considered to be the most attractive if other conditions are equal. If alternatives differ in some

aspects, the NPV is not the only criterion to be followed in adopting a decision on the most

acceptable alternative. For instance, one of decisions (alternatives) may generate a noticeably

higher net intangible benefit. A negative (


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Example 8: net present value (NPV)

Proceeding with the illustration presented in example 6 the NPV is calculated:

Net present value calculation

Year 0 1 2 3




Discount factor = 1/(1 + 10%)n

1.0000 0.9091 0.8264 0.7513

Present value = Current value x Discount

factor

-100 40.9 37.2 33.8

Total present value (i.e. the NPV) -100 -59.1 -21.9 11.9


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2.4.5.2.Internal rate of returnAnother important indicator of decision assessment, based on the time value of money principle,

is the internal rate of return (IRR). The internal rate of return (IRR) indicator is particularlyuseful if the determination of the proper discount rate is difficult. IRR is a discount rate at the

presence of which the present values of expected payments (outflows) are equal to the present

values of expected inflows, i.e. the NPV of all net cash flows generated by a decision is equal to a

zero. In other words, t

methodological guide to social cost-benefit analysis

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