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Canadian Cost-Benefit Analysis Guide: Regulatory Proposals (view source)
Revision as of 17:57, 22 July 2021
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</blockquote>The cost-of-illness method estimates the explicit market costs resulting from a change in the incidence of a given illness. It generally relies on direct costs such as medical treatment, rehabilitation, and accommodation. It does not account for indirect costs such as the loss of income or the loss of leisure time, let alone the cost of pain and suffering. Therefore, the reduction in medical costs incurred because of a health intervention should be considered a lower bound estimate of the WTP.
</blockquote>The cost-of-illness method estimates the explicit market costs resulting from a change in the incidence of a given illness. It generally relies on direct costs such as medical treatment, rehabilitation, and accommodation. It does not account for indirect costs such as the loss of income or the loss of leisure time, let alone the cost of pain and suffering. Therefore, the reduction in medical costs incurred because of a health intervention should be considered a lower bound estimate of the WTP.
===== Stated preference methods =====
===== C. Stated preference methods =====
Stated preference methods refer to a direct survey approach to estimating the value placed on non-market goods or services. They rely on information obtained through surveys rather than on the indirect valuation through revealed preference methods. This approach attempts to measure the WTP directly through surveys that ask respondents about their evaluation of changes in the level of environmental quality, health, and safety.
Stated preference methods refer to a direct survey approach to estimating the value placed on non-market goods or services. They rely on information obtained through surveys rather than on the indirect valuation through revealed preference methods. This approach attempts to measure the WTP directly through surveys that ask respondents about their evaluation of changes in the level of environmental quality, health, and safety.
In addition to contingent valuation, there has been a growing interest in conjoint analysis or choice modelling approaches. This technique is considered a family of survey-based methodologies for modelling preferences for goods where goods are expressed in terms of their attributes and the categories of these attributes. Respondents are asked to make a choice of a good based on the preferences for the types and levels of the attributes associated with the good. The amount of WTP can be estimated indirectly from the prices of the relevant attributes of the good being valued.<ref>Organisation for Economic Co-operation and Development, ''Cost-Benefit Analysis and the Environment: Recent Developments'', 2005, Chapter 9.</ref>
In addition to contingent valuation, there has been a growing interest in conjoint analysis or choice modelling approaches. This technique is considered a family of survey-based methodologies for modelling preferences for goods where goods are expressed in terms of their attributes and the categories of these attributes. Respondents are asked to make a choice of a good based on the preferences for the types and levels of the attributes associated with the good. The amount of WTP can be estimated indirectly from the prices of the relevant attributes of the good being valued.<ref>Organisation for Economic Co-operation and Development, ''Cost-Benefit Analysis and the Environment: Recent Developments'', 2005, Chapter 9.</ref>
===== Benefit transfer methods =====
===== D. Benefit transfer methods =====
The benefit transfer approach relies on information from existing studies that have applied these non-market methods of valuation. This is in fact using the value of a good or service in an existing study as a proxy for the value of the same good or service in another study.
The benefit transfer approach relies on information from existing studies that have applied these non-market methods of valuation. This is in fact using the value of a good or service in an existing study as a proxy for the value of the same good or service in another study.
The following example illustrates the development and assessment of a recent Canadian regulation to lower the sulphur content of gasoline.<ref>''The Canada Gazette'', Part II, Vol. 133, No. 13, ( June 23, 1999 ), ''Canadian Environmental Protection Act, Sulphur in Gasoline Regulations''.</ref>
The following example illustrates the development and assessment of a recent Canadian regulation to lower the sulphur content of gasoline.<ref>''The Canada Gazette'', Part II, Vol. 133, No. 13, ( June 23, 1999 ), ''Canadian Environmental Protection Act, Sulphur in Gasoline Regulations''.</ref>
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'''<big>Regulation Controlling Sulphur in Gasoline</big>'''
'''Issues and Objectives'''
*High sulphur levels in gasoline increase emissions of sulphur dioxide and sulphate particles from vehicles.
*Emissions of pollutants from vehicles cause considerable harm to the environment and to the health of Canadians.
*Canadian gasoline had an average sulphur content of 350 parts per million (ppm) in the late 1990s, one of the highest levels in the world. A policy or regulation was considered to protect the environment and the health of Canadians.
'''Alternative Options'''
* The baseline option: In recommending an appropriate policy or regulation to deal with the above problems, one needs to establish the baseline scenario over the policy period, say 20 years from 2001 to 2020, including the likely regulations of the sulphur content in gasoline in Europe and the United States, since those areas supplied some of the gasoline consumed in eastern and central Canada.
* Alternative options included a complete ban of sulphur in gasoline, harmonization of the sulphur content of gasoline with that of the United States, economic instruments, or other options requiring varying levels of low sulphur in gasoline to be implemented in phases. For example, one option considered was the maximum annual average level of sulphur for each refinery to be 30 ppm, with the level of sulphur never exceeding 80 ppm at any time during the year.
'''Cost-Benefit Analysis'''
* The analysis should be carried out in an incremental manner. That is, the incremental benefits and costs of each of the alternative options are estimated and compared to the baseline option. For the purpose of illustration, we use the above example as one of the alternative options.
* Benefits: These refer to health and environmental benefits that result from the reductions of the adverse environmental and health effects as compared to the base scenarios. These include the following:
** Reducing sulphur in gasoline over time would lower emissions of SO2 proportionally to the reductions in the fuel sulphur content, as well as reducing emissions of CO, NOx and VOCs. The Health and Environment Impact Assessment Panel estimated that over the 20-year period, there would be a reduction of approximately 2,100 premature deaths, 90,000 respiratory cases in children, 3,200,000 acute asthma symptom days, and other respiratory problems.
** These impacts can be quantified in monetary values associated with premature mortality and illness costs over the 20-year period, using the benefit transfer methods.
* Costs: These costs include compliance costs to refineries and independent suppliers, costs borne by consumers, and enforcement costs to governments:
** Canadian refineries were expected to incur $1.8 billion in capital expenditures and $119 million per annum in operating costs to produce low sulphur gasoline. Part of the costs was expected to be recovered by the refineries from their customers through an increase in the price of gasoline. The Panel estimated that about three to four refineries were expected to be shut down rather than making the necessary investment to produce 30 ppm gasoline. A typical refinery directly employed about 350 people (ranging from 100 to 800).
** Importers and blenders of gasoline would be affected by the regulation. As Europe was the main source of imported gasoline, the types of gasoline produced by European countries would have a direct impact on the cost to importers.
** There were compliance costs incurred by primary suppliers using a pool average, since they had to demonstrate that they must comply with the average, independent auditing records and reports. In addition, compliance must be met by all gasoline domestically produced or imported under a pool average that is subject to a never-to-be-exceeded cap of sulphur content.
** The cost passed on by refineries was assumed to be borne by consumers. There should be no double counting with the costs borne by the refinery industry.
** Administration and enforcement of the regulations by the government required a wide range of planned and ad hoc inspections, audits, samplings, analyses, investigations, and legal actions by Environment Canada.
** All costs should be quantified annually and measured in the resource costs rather than the financial costs.
** Net benefits: The annual net benefits were estimated over the 20-year period and discounted by the discount rate in order to derive the present value of the option under consideration.
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=== Cost-effectiveness analysis ===
When benefits cannot be expressed in monetary values in a meaningful way, a cost-effectiveness analysis (CEA) should be carried out to assist in making effective decisions. A CEA calculates cost-effectiveness ratios of different alternative policy options and then compares the resulting ratios so that the most efficient option is chosen. In a sense, a CEA ensures technical efficiency in the process of achieving a desired outcome.
The pure cost-effectiveness of a policy option is calculated by dividing the present value of total costs of the option by the present value of a non-monetary quantitative measure of the benefits it generates. The ratio is an estimate of the amount of costs incurred to achieve a unit of the outcome from a policy option. For example, in a health and safety scenario, what is the amount of costs expressed in Canadian dollars incurred in order to save a person's life? Presumably, there are alternative ways to save a life and what are their costs? The analysis does not evaluate benefits in monetized terms but is an attempt to find the least-cost option to achieve a desired quantitative outcome.
The cost-effectiveness analysis can be extended to more sophisticated and meaningful ways of measuring benefits. A quantitative measure can be made by constructing a composite index of two or more benefit categories, including quantity and quality. For example, the cost utility analysis (CUA) in healthcare uses the quality adjusted life years (QALYs) as a measure of benefits. The QALY measure integrates two dimensions of health improvement: One is the additional years of life (reduction in mortality) and the other is quality of life (morbidity) during these years. On the basis of the costs incurred, expressed in Canadian dollars, the decision maker would still choose the option with the least cost per QALY achieved by the program.<ref>See e.g. Viscusi, W. Kip, "The Value of Risks to Life and Health." In: ''Journal of Economic Literature'', Vol. XXXI, No. 4, December 1993 ; Garber, Alan M. and Charles Phelps, "Economic Foundations of Cost-effectiveness Analysis." In: ''Journal of Health Economics'', 16, 1997.</ref> Cost utility analysis attempts to include some of the benefits excluded from the pure CEA, hence moving it a step closer to a full cost-benefit analysis.
Some caveats are noted below for the measurement of the associated costs.
* The marginal cost-effectiveness should be calculated. It is the marginal or incremental cost-effectiveness of the policy that should be compared with the baseline cost-effectiveness scenario. The policy that has the lowest marginal cost per unit of effectiveness will be the most efficient way to use resources.
* The costs include all compliance costs incurred by the private sector and the administrative costs to governments. They should be based on the resource or opportunity costs, not just the financial costs of goods and services.
* The costs should be properly defined and measured in the calculation of cost-effectiveness.
* The costs incurred may be capital or operating expenditures that are spread over many years. Both the costs and benefits should be discounted to a common time period in order to make a comparison of alternative options. It should be noted that the benefits are measured in physical units instead of monetary values. The quantities over time of the measure of effectiveness should be discounted to the same date in time as the costs.
One should be aware of some of the shortcomings inherent in the cost-effectiveness approach. It is a poor measure of the consumers' willingness to pay principle because there is no monetary value placed on the benefits. Furthermore, in the calculation of cost-effectiveness, the numerator does not take into account the scale of alternative options. Nevertheless, the cost-effectiveness ratio is still a very useful criterion for selection of alternative regulatory options when the benefits cannot be monetized.
=== Impacts on stakeholders ===
There are various entities or stakeholders that can be affected by a specific policy. The assumptions used for the stakeholder analysis must be consistent with those of the cost-benefit analysis. The cost-benefit analysis begins with the identification of the direct effects and then adjusts various goods and services affected for a variety of distortions in the markets. Central to the stakeholder analysis is the need to identify the affected subpopulations, whether they are winners or losers, and how much they would gain or lose as a result of the implementation of the policy. Most stakeholders are concerned about their private costs and benefits. In order to monitor and enforce the policy, governments are expected to incur certain administrative costs that should be included as part of the economic cost for implementation of the regulatory policy.
One must ask, "Who are the winners and who are the losers under the policy?" and "By how much does each class of stakeholders gain or lose?" A stakeholder analysis attempts to allocate the net benefits or losses generated by the policy. The output of the stakeholder analysis contains critical information for decision makers, as it indicates which groups will be the net beneficiaries and which groups will be the net losers and by how much.
The stakeholder analysis may begin with the estimation of the change in compliance costs for the affected sector that can be attributed to a policy and then assess their impacts on the production costs of the sector. The analysis must also estimate the change in the prices consumers will pay for the goods and services affected and the effect of this on other related sectors. The following are kinds of impacts that are likely to occur and need to be assessed.
==== Impacts on industry ====
Many policies are intended to change the way something is produced, input used in the production, or the quantity of a product being produced. The focus of the analysis will initially be on the change in compliance costs for the affected sector or how compliance with the policy affects the production costs of the sector or the item, the nature of the firm's supply response to this change in cost, and its competitive position in comparison with its rivals. At the same time, it is important to estimate how the demand and supply of substitute or complementary goods and services respond to changes in the prices of the affected item. The ultimate impact is the measurement of the implementation of the policy on the financial profitability of the regulated firms and industry.
Policies can unintentionally create barriers to entry for other firms and may result in market concentration. They might also restrict the level of international competition. The economic consequences are lack of competition and less incentive for innovation, eventually leading to lower productivity and slower economic growth.
==== Impacts on employment ====
Regulations may impair the competitiveness of certain firms. Some firms may close as a result of extremely high compliance costs and low financial profitability. Such closures might have serious political ramifications for the region where the firm is located. This can vary from case to case. The analysis should examine the viability of the firms affected in terms of their profitability, liquidity, and cash flow It should assess the number of firms being affected in the industry and by region. Since jobs are one of the most important concerns for workers and politicians, the number of workers affected by the plant closures should be estimated.
That being said, it should be noted that the social loss or loss of private incomes as a result of plant closures should be carefully assessed and included as part of the stakeholder analysis. It should be measured by the earnings prior to the closure in excess of the economic opportunity cost of the laid-off workers. The opportunity cost of workers will vary by occupation, skill level, working environment, market condition, region, and unemployment insurance scheme.<ref>See e.g. Harberger, Arnold C., ''The Social Opportunity Cost of Labor: Problems of Concept and Measurement as Seen from a Canadian Perspective''. Report for the Canadian Immigration and Employment Commission Task Force on Labour Market Development, Ottawa 1980.</ref>
==== Impacts on consumers and individuals ====
An increase in compliance costs will likely affect the prices of goods or services in the regulated industry. The question is whether the increase in compliance costs will have direct impacts on the affected firms and, if positive, how and what portion of the compliance costs can be passed on to customers. It is a complicated question because one has to examine the demand and supply conditions in the affected markets. In these cases, the basic question is the nature of the competitive conditions within the country. The elasticities of supply and demand, as well as cross-price elasticities of demand for the goods and services affected, need to be used to measure the impacts on these markets.
If the compliance costs of the affected firms resulting from a policy are shifted forward to consumers and individuals or households, they should be properly assessed and quantified. For example, if the price of supplying electricity to households increases because of a regulation imposed on the sector, it would be important to assess the magnitude of the price change and how it affects the quantity of electricity demanded by households and how they are likely to react to this change in terms of consumption. In other cases, regulations may impact on the quality and availability of the goods and services consumers and households purchase.
The more the price of goods or services in the regulated sector is shifted forward, the greater the likelihood that the regulated firms will recover their initial compliance costs from their customers. The net impacts on the respective stakeholders should be properly assessed and double counting in terms of effects must be avoided.
==== Impacts on governments ====
A regulation may increase costs incurred by the government due to additional administration, monitoring, and enforcement. If the regulation has a significant impact on domestic demand or supply, it may also affect the tax revenues of governments. These impacts will usually affect the different levels of government differently and should be properly recorded as part of the stakeholder analysis.
==== Impacts on other stakeholders ====
Depending upon the types of policy, there can be different economic and social impacts on a variety of stakeholders. A stakeholder analysis first identifies the direct impact of a regulation and then analyzes the interactions between a regulated market and other related markets. For example, the production and prices of regulated industries can be affected by an environmental policy that requires additional investment in equipment to control emissions of pollutants. In the case of health and safety, a ban on a certain drug will create a change in prices that will set in motion a change in consumers' demand for substitute medications and the production of these substitutes. In the end, it seeks to allocate among stakeholders the net benefits or losses generated by a regulatory intervention.
The impacts of a policy can have significant implications for public entities and other non-profit organizations. These entities can include municipalities, universities, schools, hospitals, charities, and religious organizations. Since they are not profit-oriented, the decision-making criteria in terms of the volume of services they provide and the prices charged are somewhat different from those of profit-seeking enterprises. As compared to profit-oriented firms, such organizations often have relatively large political voices. An increase in compliance costs may lead to the reduction in the organizations' ability to continue to provide goods and services to the community.
Equity is frequently raised in the stakeholder analysis. There is no doubt that the impacts of policy actions on disadvantaged or vulnerable groups should be properly assessed and documented by analysts. However, incorporation of these impacts quantitatively into a cost-benefit analysis is nonetheless controversial.<ref>See e.g. Organisation for Economic Co-operation and Development, ''Cost-Benefit Analysis and Environment: Recent Developments'', 2005; and the European Commission, ''Impact Assessment Guidelines'', June 15, 2005 .</ref>
This reflects the complexity involved in trying to disentangle society's distributional preferences. Because of these important concerns, analysts should identify the impacts on disadvantaged groups. Decision makers will almost certainly use this information in conjunction with the efficiency measure as captured by the cost-benefit analysis to evaluate trade-offs between equity and efficiency.
In reality, efficiency will frequently not be the only criterion used to guide decision making. Decision makers may place great importance on society's distributional objectives. There may sometimes be a trade-off between efficiency and equity but not necessarily so. The issue is how far a cost-benefit test should be moderated in the light of equity and distributional considerations. For example, in the case of health care, decision makers may seek a balance between maximizing the overall benefits of health care interventions and directing interventions (and resources) toward certain groups such as low-income native communities.
In summary, the economic net benefits of a policy for society as a whole should be equal to the summation of the net benefits across all stakeholders. Therefore, the analysis is important to decision makers, as it lets them estimate the impact of a particular policy on specific segments of society and to predict which groups will be net beneficiaries and which groups will be net losers.
A recent study by Health Canada provides an example of a cost-benefit analysis and a stakeholder analysis of a regulation to address the public safety and health problems resulting from fires started by cigarettes.<ref>See ''The Canada Gazette'', Part II, Vol. 139, No. 13 ( June 29, 2005 ), ''Tobacco Act'', ''Cigarette Ignition Propsensity Regulations''; Industrial Economics, Incorporated, "Economic Evaluation of Health Canada's Regulatory Proposal for Reducing Fire Risk from Cigarettes." Paper prepared for the Economic Analysis and Evaluation Division, Healthy Environments and Consumer Safety Branch, Health Canada, March 2004 .</ref>
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