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Guide to Social Cost Benefit Analysis

Step 1: Define policy and counterfactual

  • The economic impact of a policy or project is measured against a "no decision" counterfactual. It is important to be clear as to what the counterfactual is.

8. Any policy or business process starts with defining a problem or opportunity and identifying the potential need for a project or regulatory proposal. This might be done, for example, in the context of the Strategic Assessment stage of the Better Business Case process. See page 44.

9. Having established the potential need for a policy, the next thing to do is to clearly define the policy, alternative solutions and the counterfactual. The counterfactual is the situation that would exist if the decision is not made, if the policy does not go ahead. It is sometimes described as the “do nothing” or as the “do minimum” scenario. It is important to characterise the counterfactual accurately and to use it consistently, as the benefits and costs of the policy alternatives are measured against the counterfactual. This is often not straightforward, in particular where the “do nothing” or the “do minimum” scenarios are likely to evolve over the evaluation period. In those situations it will be necessary to forecast the evolution of behaviour and technologies.

Example: Bridge over river

Suppose that the bridge costs $20 million, and that it will save travellers $25 million worth of travel time and vehicle operating costs, in present value terms. The bridge would appear to have benefits that exceed the costs. The net present value (NPV) of the bridge is $5 million.

But suppose that in the absence of a bridge being built, there is every expectation that a private ferry operator will start business. The cost is $10 million in present value terms, and the social benefits are $20 million in present value terms. The ferry operation has an NPV of $10 million.

Compared with the ferry operation, a bridge would cost $10 million more, and would produce $5 million more benefits. Against this counterfactual, the bridge has an NPV of -$5 million.

Against the “no bridge, no ferry” counterfactual, the bridge would seem worthwhile. But against the “ferry” counterfactual, the bridge is not.

Equivalently, the ferry could be presented to decision-makers as an alternative to the bridge. This would still show the ferry to be the better option, despite the fact that the bridge has greater total benefits.

10. As the example above suggests, it is good practice to consider several alternative options for solving a problem or achieving an objective. Each of these should be treated as a separate policy to be evaluated against the counterfactual.

11. Finding the best alternatives is an art rather than a science. It relies on creativity and innovative thinking, and should include the best from an economic perspective even if they are not consistent with decision-makers' objectives. It is important for decision-makers to know what alternative policies or solutions they are rejecting.

12. Whether a policy is a good one is often not known until the CBA has been carried out. In such cases, and where an apparently good option is found to be not good, it may be necessary to go back to the first step and define and analyse additional alternatives.

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