PPA 691 – Seminar in Public Policy Analysis

Lectures 7 & 8 – Recommending Policy Actions.

Recommendation in Policy Analysis The policy-analytic procedure of

recommendation enables analysts to produce information about the likelihood that future courses of action will result in consequences that are valuable to some individual, group, or society as a whole.

Recommendation in Policy Analysis The procedure of recommendation involves

the transformation of information about policy futures into information about policy actions that will result in valued outcomes.

Policy recommendations are normative (advocative) rather than empirical (descriptive) or evaluative.

Recommendation in Policy Analysis Characteristics of advocative claims.

– Actionable: Advocative claims focus on actions that make be taken to resolve a policy problem.

– Prospective: Advocative claims occur prior to the time that actions are taken.

– Value laden: Advocative claims require both that actions have the predicted consequences, but also that those consequences have value for society.

– Ethically complex: Advocative claims can be intrinsic (valued as ends in themselves) or extrinsic (valued because they will produce some other value).

Recommendation in Policy Analysis Simple model of choice.

– Advocative claims are only possible when the analyst is confronted by a situation of choice between two or more alternatives.

– Simple model.• The definition of a problem requiring action.• The comparison of consequences of two or more

alternatives to resolve the problem.• The recommendation of the alternative that will

result in a preferred outcome.

Recommendation in Policy Analysis Simple model of choice.

Conditions for choice.– Single decision maker.

– Certainty.

– Immediacy of consequences.

A1 O1A2 O2O1 > O2

A1

Recommendation in Policy Analysis Complex model of choice.

– Conditions.• Multiple stakeholders.

• Uncertainty about outcomes.

• The passage of time between actions and consequences.

– Results.• Intransitivity of choice.

Recommendation in Policy Analysis Forms of rationality.

– Given the conditions of complex choice, there are multiple forms of rationality.

• Technical rationality.

• Economic rationality.

• Legal rationality.

• Social rationality.

• Substantive rationality.

Recommendation in Policy Analysis Rational-comprehensive theory.

– An individual or collective decision-maker must identify a policy problem on which there is a consensus among all relevant stakeholders.

– An individual or collective decision-maker must define and consistently rank all goals and objectives whose attainment would represent a resolution of the problem.

– An individual or collective decision-maker must identify all policy alternatives that may contribute to the attainment of each goal and objective.

Recommendation in Policy Analysis Rational-comprehensive theory.

– An individual or collective decision-maker must forecast all consequences that will result from the selection of each alternative.

– An individual or collective decision-maker must compare each alternative in terms of its consequences for the attainment of each goal and objective.

– An individual or collective decision-maker must choose that alternative that maximizes the attainment of objectives.

Recommendation in Policy Analysis Disjointed incremental theory.

– Consider only those objectives that differ incrementally from the status quo.

– Limit the number of consequences forecast for each alternative.

– Make mutual adjustments in goals and objectives, on the one hand, and alternatives on the other.

– Continuously reformulate problems – and hence goals, objectives, and alternatives – in the course of acquiring new information.

Recommendation in Policy Analysis Disjointed incremental theory.

– Analyze and evaluate alternatives in a sequence of steps, such that choices are continuously amended over time, rather than made at a single point in time.

– Continuously remedy existing social problems, rather than solve problems completely at one point in time.

– Share responsibilities for analysis and evaluation with many groups in society, so that the process of making choices is fragmented or disjointed.

Recommendation in Policy Analysis Arrow’s impossibility theorem.

– It is impossible for democratic decision makers in a democratic society to meet conditions of the rational comprehensive model.

• Individual choices cannot be aggregated through majority voting procedures to create a collective decision that will produce a single best solution for all parties.

The Voter’s ParadoxCOMMITTEE MEMBER PREFERENCE

Brown (criterion: risk) A (solar) preferred to B (coal)

B (coal) preferred to C (nuclear)

A (solar preferred to C (nuclear)

Jones (criterion: feasibility) B preferred to C

C preferred to A

B preferred to A

Smith (criterion: efficiency) C preferred to A

A preferred to B

C preferred to B

Majority (intransitive and cyclic) A preferred to B

B preferred to C

C preferred to A

Recommendation in Policy Analysis Arrow’s impossibility theorem.

– Reasonable conditions for democratic decision procedures.

• Nonrestriction of choices.

• Nonperversity of collective choice.

• Independence of irrelevant alternatives.

• Citizen’s sovereignty.

• Nondictatorship.

Recommendation in Policy Analysis Bounded rationality.

– Decision makers engage in satisficing behavior (identify courses of action that are “good enough.”).

• Consider the most evident alternatives that produce a reasonable increase in benefits.

Rationality as constrained maximization.– Rational choice within the boundaries of

constraint.

Recommendation in Policy Analysis Criteria for policy recommendation.

– Effectiveness – does a given alternative result in the achievement of a valued outcome (technical rationality).

– Efficiency – the amount of effort needed to produce a given level of effectiveness (economic rationality).

– Adequacy – the extent to which any given level of effectiveness satisfies the needs, values, or opportunities that gave rise to the problem.

• Fixed costs and variable effectiveness (type I, maximize effectiveness).

• Fixed effectiveness and variable costs (type II, minimize costs).• Variable costs and variable effectiveness (type III, efficiency).• Fixed costs and fixed effectiveness (type IV, do nothing).

Recommendation in Policy Analysis Criteria for policy recommendation.

– Equity – the distribution of effects and effort among different groups in society (legal and social rationality).

• Maximize individual welfare.• Protect minimum welfare.• Maximize net welfare.• Maximize redistributive welfare.

– Responsiveness – satisfies the needs, preferences, or values of particular groups.

– Appropriateness – the value or worth of a program’s objectives and the tenability of assumptions underlying these objectives.

Approaches to Recommendation

Public versus private choice.– Nature of public policy processes.

• Numerous stakeholders with conflicting values.

– Collective nature of public policy goals.• Multiple conflicting criteria for choice.

– Nature of public goods.• Specific, collective, and quasi-collective goods.

Supply and demand (market mechanisms).– Discuss.

Approaches to Recommendation

Public choice.– Problems with supply – demand models of

public policy.• Multiple legitimate stakeholders.

• Collective and quasi-collective goods.

• Limited comparability of income measures.

• Public responsibility for social costs and benefits.

Approaches to Recommendation

Benefit-cost analysis.– Characteristics.

• Measure all costs and benefits to society of a program including intangibles.

• Traditional benefit-cost analysis emphasizes economic rationality: net benefits are greater than zero and higher than alternative uses.

• Traditional benefit-cost analysis uses the private marketplace as the point of departure in recommending programs.

• Social benefit-cost analysis also measures redistributional benefits.

Approaches to Recommendation

Types of costs and benefits.– Inside versus outside costs and benefits.– Tangible versus intangible costs and benefits.– Direct versus indirect costs and benefits.– Net efficiency versus redistributional benefits.

Approaches to Recommendation Tasks in benefit-cost analysis.

– Problem structuring.– Specification of objectives.– Identification of alternative solutions.– Information search, analysis, and interpretation.– Identification of target groups and beneficiaries.– Estimation of costs and benefits.– Discounting of costs and benefits.– Estimation of risk and uncertainty.– Choice of decision criterion.– Recommendation.

Benefit-cost and Cost-effectiveness Analysis Benefit-cost analysis is an applied branch of

economics that attempts to assess service programs by determining whether the total societal welfare has increased (in aggregate more people have been made better off) because of the project or program.

Steps.– Determine the benefits of a proposed or existing

program and place a dollar value on those benefits.– Calculate the total costs of the program.– Compare the benefits and costs.

Benefit-cost and Cost-effectiveness Analysis Simple steps pose real challenge, especially

estimating intangible benefits. Procedure still useful in uncovering

assumptions and estimating value of intangibles.

Benefit-cost and Cost-effectiveness Analysis Cost-effectiveness analysis.

– The major costing alternative to benefit-cost analysis.• Relates the cost of a given alternative to specific measures of

program objectives.– For example, dollar per life saved on various highway

safety programs.

– Often the first step in a benefit-cost analysis.– Especially useful if analyst cannot quantify benefits, but

has fairly specific program objectives.– Key problem: situation where there are multiple benefits.

Results often very subjective.– 2nd key problem: does not produce a bottom line number.

Benefit-cost and Cost-effectiveness Analysis A private sector analogy.

– Benefit-cost analysis similar to financial analysis in private sector.

• Should the firm have done the project at all, i.E., Is the project producing a satisfactory rate of return?

• Public version: is the program a success, i.E., Has it improved social welfare?

• What other options are there for the use of the firm’s resources?

• Public version: should the program be continued when weighed against alternative uses for the government’s funds.

Benefit-cost and Cost-effectiveness Analysis A private sector analogy.

– Benefits and costs do not occur simultaneously in either private or public sector.

• R&D costs, marketing, capital investment, training.

• Government not priced, thus benefits are more broadly defined.

– Alternative uses of resources (opportunity costs).

Benefit-cost and Cost-effectiveness Analysis Benefit-cost illustration.

Costs

Year R & D Capital O & M Total Benefits1 $1500 $2000 $0 $3500 $0

2 500 2000 2000 4500 3500

3 2000 2500 4500 5500

4 2000 3000 5000 6500

5 2000 3500 5500 8500

Totals $2000 $10000 $11000 $23000 $24000

Year Benefit-Costs Present Value, Benefits-Costs (10%)1 ($3500) ($3500)

2 (1000) (909)

3 1000 826

4 1500 1127

5 3000 2049

Totals $1000 ($407)

Net Present Value @ 10% ($407)

Net Present Value @ 5% 219

Benefit-cost and Cost-effectiveness Analysis Formula for net present value.

Formula sensitive to choice of rate of return. Could also use return on investment.

– Discount rate that would make the present value zero.

12

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x

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r

CB

r

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CBCBNPV

Continuing or not continuing the project.

Benefit-cost and Cost-effectiveness Analysis

Costs

Year R & D Capital O & M Total Benefits6 $500 $400 $4500 $5400 $9000

7 400 5000 5400 8500

8 400 6000 6400 8500

9 400 7500 7900 8000

10 400 8000 8400 7500

Totals $500 $2000 $31000 $33500 $41500

Year Benefit-Costs Present Value, Benefits-Costs (10%)6 $3600 3600

7 3100 2818

8 2100 1736

9 100 75

10 (900) (615)

Totals $8000 $7614

Net Present Value @ 10% $7614

Net Present Value @ 5% $7803

Benefit-cost and Cost-effectiveness Analysis Total versus marginal benefits and costs.

– When considering the overall profitability of a project, an agency will consider the total costs involved in getting the project started through its operation’s cycle.

– But at any point in time, when an agency is continuing or discontinuing a project or program, it only considers the marginal costs or benefits.

– Definitions.• Marginal cost: incremental cost of producing one more unit of

output.• Marginal benefit: incremental benefit of that one unit of output.

– Public sector usually does not do it on the basis of a single unit, but what are the benefits being generated now versus the costs now?

Benefit-cost and Cost-effectiveness Analysis Public-private sector differences and

similarities.– Similarities – alternative uses for funds, one-

time costs, recurring costs, land, labor, capital.– Differences.

• Distributional considerations.

• Spillovers.

Framework for AnalysisBenefit Indicator Measure Dollar value Assumptions

Real

Direct

Tangible

Intangible

Indirect

Tangible

Intangible

Cost Indicator Measure Dollar value Assumptions

Real

Direct

Tangible

Intangible

Indirect

Tangible

Intangible

Transfers

Framework for Analysis

Real benefits and costs versus transfers.– Real: net gains and losses to society.– Transfers: merely alter the distribution of

resources in society.

Framework for Analysis

Direct and indirect benefits and costs.– Direct costs and benefits are closely related to

the primary objectives of the project.• Direct costs – personnel, facilities, equipment,

material, project administration.

– Indirect costs and benefits are byproducts, multipliers, spillovers, or investment effects.

• Indirect costs are unintended costs that result from government action.

• Indirect benefits might include benefits of space exploration.

Framework for Analysis

Tangible and intangible benefits and costs.– Tangible benefits and costs can be converted

readily into dollar figures.– Intangible benefits and costs are those things

that cannot be directly assigned an explicit price.

Determining the geographic scope of analysis.– Spillover effects may determine true

geographic jurisdiction.

Framework for Analysis (Agricultural Dam Example)Real Benefits Nature of Benefit/Cost

Direct

Tangible Increased farm output

New supply of water

Intangible Maintaining family farms

Indirect

Tangible Reduced soil erosion

Intangible Preservation of rural society

Real Costs

Direct

Tangible Construction material, labor, operations and maintenance, direct program supervision by agency

Intangible Loss of recreational value of land or river

Indirect

Tangible Administrative overhead of government

Diversion of water and its effects

Increased salinity

Intangible Loss of wilderness area

Transfers Relative improvement of profit for farm implement industry

General taxpayers may be subsidizing farmers.

Measuring Benefits

Evaluation problem difficult for government because of multiple benefits and intangibles.

Measuring Benefits

Sources of data.– Existing records and statistics kept by agency.– Feedback from clients.– Ratings by trained observers.– Experience of other governments or private or

nonprofit corporations.– Special data gathering.

Whenever possible analyst should use market value or willingness to pay.

Measuring Benefits

Valuing benefits.– Cost savings.– Time saved.– Lives saved.– Increased productivity or wages.– Recreational benefits.– Land values.– Alternatives to market prices.

See handout.

Measuring Costs

Cost categories.– One-time, fixed, or up-front costs.– Ongoing investment costs.– Recurring costs.– Compliance costs.– Mitigation measures.

Measuring Costs

Valuing indirect costs.– Flat overhead figure.

• Does the project actually costs increased administrative burden?

– Costs to the private sector.

– Valuing the use of capital.

– Valuing the damage effects of government programs.

– Other cost issues.• Sunk costs.

• Interest costs.

Analysis of Benefits and Costs

Framework.– Retrospective.– Snapshot.– Prospective.

Analysis of Benefits and Costs

Importance of using present value.– Choice of an appropriate discount rate.

• Private sector rate.

• Low social discount rate.

• Long-term treasury bill rates.

– Adjustment for inflation.

Analysis of Benefits and Costs

Presenting the results.– Net present value (B-C).– Benefit cost ratio (B/C).– Return on investment (discount rate to reduce

present value to zero). Appropriate perspective.

– Costs and benefits vary across stakeholders.– May conduct analyses from several

perspectives.

Analysis of Benefits and Costs

Sensitivity analysis.– Use spreadsheet analysis to vary the assumptions.

Intangibles.– Relate intangibles to dollar results: if there are net

costs, do the intangible benefits overcome the deficit?

Particular problems.– Equity concerns (weighting of values).

– Multiple causation and co-production problems.