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Demonstrating Performance: A Primer for Expenditure Reviews (June 2008)

Condition #4: Produced Cost Effectively and Efficiently

Type of Analysis Measurement of Benefits
Cost-Minimisation Benefits found to be equivalent
Cost-Effectiveness Physical units (e.g. life years gained)
Cost-Utility Healthy years (e.g. quality adjusted life years)
Cost-Benefit Monetary terms
Cost-effectiveness of PHARMAC investments each year, 1998/99 to 2004/05
Cost-effectiveness of PHARMAC investments each year, 1998/99 to 2004/05.

The Public Finance Act requires departments to identify measures that will be used to report cost-effectiveness. The way benefit is measured will favour different methods of economic analysis (right).

Economic analysis will show whether a given intervention is worth funding, and can show whether it better than other options. Measured regularly over time, economic ratios show how – or whether - overall efficiency and value have improved (right).

Economic measures must thus be reported if benefits and costs are linked in a robust way. When this is not possible, cost-effectiveness can be inferred by benchmarking or real price analysis (below), and proving that the intervention works as intended (see #5-7).

An efficient producer maintains or reduces prices, after inflation is allowed for. As efficiency improves real prices for homogenous inputs and outputs fall (and vice versa).

Real Price Per Unit of Output, 1995-2004
Real Price Per Unit of Output, 1995-2004.

Real price analysis requires time series information on price and volume for major:

  • outputs (eg, cases, passports, patients or children processed), and/or
  • assets (eg, km of road, classroom or prison bed built), and/or
  • inputs (eg, per cop, fireman or analyst).

A spreadsheet for exploring price and volume data is on the SSC’s Expenditure Review Portal[3]. The results on the right show periods when the agency showed it could manage costs downwards (green arrow), and periods when costs rose much faster than inflation.

Remember: a 1% price increase in major Votes costs ~$200 million, without adding value.

  • Good managers manage costs: look for efficient production and economies of scale.
  • Quality alone does not justify a price rise: improved results must also be shown.
  • Utilisation rates also reveal efficiency (eg, cases per worker; % houses occupied).
  • Inefficiency is implied by year end spends, and persistent or major under-spends.
  • Improved quality usually shows as step changes in prices, not slow upwards drift.

Cost-effectiveness cannot be inferred from efficiency data alone. Agencies must show that their major interventions are also effective (see Conditions #6 and #7, below).

Notes

  • [3]Treasury staff should read TSY #855600, which lists ‘tips & traps’ for using the spreadsheet.
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