February 27, 2020
By: Doramas Jorge-Calderón
How much impact is your economic appraisal leaving out?” This is the perennial question that CBA practitioners face when putting forward their results of, normally, a poorly performing project. In investment appraisal, my area of work, the question is often decisive. I presume the same applies to CBA practice in policy appraisal.
The question is really intended to mean how much benefit is being left out. The party posing the question would normally then refer to multiplier effects, employment, indirect effects, etc. There is a presumption that what is left out will always contribute to improving the performance of the project. But whatever the motivations, the question is a fair one ‑ and one for which there is no straightforward answer.
The question in fact amalgamates a number of issues. CBA practitioners would know how to address concerns about multiplier effects and employment. But the Achilles heel lies with indirect effects through secondary markets. The off-the-shelf reply would be something along the lines of: “we are picking up the large majority of benefits and costs, and any additional benefits or costs left out roughly cancel out.” The CBA practitioner would deliver such answer expecting a degree of pragmatism in the recipient. But for recipients with a taste for accuracy, or with vested interests in the results of the appraisal, such an answer would rarely be satisfactory.
When performed in undistorted markets, the magnitudes measured by CBA for the primary market would include all of the value effects of the project on secondary markets (Just, et. al. 2005). That is, CBA produces a general equilibrium result. The problem is that, in practice, distorted markets are the norm rather than the exception. CBA does a good job of incorporating distortions on the primary market. For secondary markets, though, CBA practice tends only to account for the most obvious distortions. The less obvious indirect costs and benefits are usually ignored. That they cancel out is largely an assumption by convention. For large projects, with meaningful effects on secondary markets, this assumption could be a source of potentially significant error in the estimate of the societal value of a project.
Some administrations conduct CBA and computational general equilibrium (CGE) in parallel, particularly for large projects, raising a number of issues for evaluation (see, for example, Forsyth 2013). CGE provides a broader model of the economy, including distortions in what would be secondary markets in CBA appraisals. This would seem to address our question (formulated now more precisely as: how much benefit and cost is CBA leaving out through distortions in secondary markets?)
But CGE have not been designed to help in project conception or appraisal from a welfare perspective as CBA has. Instead, CGE can be understood as a sophisticated version of economic impact studies, conceived as a link between project or policy analysis and the macro-economy. The target result is usually income at the state, regional or national levels.
This creates two problems when trying to use CGE in conjunction with CBA. First, unlike CBA, CGE normally focuses on flows related to monetary transactions ‑profits, taxes, salaries, etc. It originally ignored many of the non-income variables included in CBA, such as externalities, consumer surplus, etc. Gradually, CGE models have been developed incorporating these variables, at least on a piecemeal basis (an example is Carbone and Smith, 2013). But that still leaves the second, more fundamental problem unresolved. CGE uses concepts that do not fit well with CBA: say, multipliers, induced income, etc. For CGE to shed light on our CBA question then we would have to design a CGE model that is coherent with the CBA framework. That is, that simultaneously addresses the two problems just mentioned.
This is the challenge that C-Bridge seeks to meet. C-Bridge is a research project jointly led by the University of Las Palmas de Gran Canaria Spain, and the Swedish University of Agricultural Sciences. The scientific committee, collaborators and consultants include a wider set of research institutions. The project is financed by the European Investment Bank Institute (EIB-I). The EIB is the project-financing arm of the EU, providing loans to investment projects that meet the policy objectives of the EU, such as improving infrastructure, research and countering climate change. The EIB-I is the arm of the EIB that funds academic research in fields that are of interest of the activities of the EIB.
C-Bridge kicked-off in January 2019 and is scheduled to last three years. More information on objectives and progress can be found on its website. During 2020 the research team will seek to produce the CBA-compatible CGE model. That is, the bulk of the methodological and modelling output is due to be produced over the course of the current year. During 2021, the model will run simulations for us to come up with a better sense of how much we are really leaving out in CBA.
Doramas Jorge-Calderón is an economist at the European Investment Bank (EIB), the project financing institution of the EU. He manages the C-Bridge project on behalf of the EIB Institute, the project sponsor. C-Bidge research is jointly led by Juan Luís Eugenio from the University of Las Palmas de Gran Canaria, Spain, and Bengt Kriström from the Swedish University of Agricultural Sciences.
- Carbone, J.C. and Smith, V.K. (2013) “Valuing nature in general equilibrium.” Journal of Environmental Economics and Management, 66 (1), pp.72-89.
- Forsyth. P. (2013) “Air Capacity for Sydney.” International Transport Forum. Discussion paper 2013-02. Paris: Organisation for Economic Cooperation and Development.
- Just, R.E., Hueth, D.L. and Schmitz, A. (2005) The Welfare Economics of Public Policy: A Practical Approach to Project and Policy Evaluation. Cheltenham: Edward Elgar.