PUBLIC INVESTMENT CRITERIA

Cost-Effectiveness Analysis
&
Cost-Benefit Analysis (CBA)
 INTRODUCTION
• Both cost-benefit analysis (CBA) and cost-effectiveness
analysis (CEA) are useful tools for program evaluation. Cost
- effectiveness analysis is a technique that relates the costs of
a program to its key outcomes or benefits.
• Cost-benefit analysis takes that process one step further,
attempting to compare costs with the monetary value of all
(or most) of a program’ s many benefits.
• These seemingly straightforward analyses can be applied
anytime before, after, or during a program implementation,
and they can greatly assist decision makers in assessing a
program’s efficiency.
• However, the process of conducting a CBA or CEA is much
more complicated than it may sound from a summary
description. 2
 INTRODUCTION
• In this lecture, we provide an overview of both
types of analyses, highlighting the inherent
challenges in estimating and calculating
program costs and benefits.
• We organize our discussion around practical
steps that are common to both tools,
highlighting differences as they arise. We
begin with a simple description of each
approach.

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 CEA
• Cost-effectiveness analysis seeks to identify and
place naira on the costs of a program.
• It then relates these costs to specific measures of
program effectiveness.
• Analysts can obtain a program ’ s cost-
effectiveness (CE) ratio by dividing costs by what
we term units of effectiveness :
• Cost-Effectiveness Ratio = Total Cost
Units of Effectiveness

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 CEA Contd.
• Units of effectiveness are simply a measure of any quantifiable
outcome central to the program ’s objectives.
• For example, a dropout prevention program in a high school
would likely consider the number of dropouts prevented to be
the most important outcome.
• For a policy mandating air bags in cars, the number of lives
saved would be an obvious unit of effectiveness.
• Using the formula just given and dividing costs by the number
of lives saved, you could calculate a cost- effectiveness ratio,
interpreted as “ naira per life saved.
• You could then compare this CE ratio to the CE ratios of other
transportation safety policies to determine which policy costs
less per unit of outcome (in this case lives saved).
• Although it is typical to focus on one primary outcome in
CEA, an analyst could compute cost-effectiveness ratios for
other outcomes of interest as well.
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 CBA
• Like cost-effectiveness analysis, cost-benefit
analysis also identifies and places naira values
on the costs of programs, but it goes further,
weighing those costs against the naira value of
program benefits.
• Typically, analysts subtract costs from benefits
to obtain the net benefits of the policy (if the
net benefits are negative, they are referred to as
net costs):
• Net Benefits = Total Benefits - Total Cost
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• In this lecture, we focus on social (or economic) cost- benefit and
cost-effectiveness analyses, rather than financial analyses.
• A social CEA or CBA takes into account the costs and benefits—
whether monetary or non-monetary— that accrue to everyone in
society.
• Any negative impacts of a program are treated as costs and added to
actual budgetary outlays in assessing the overall costs of a program,
whereas positive impacts are counted as benefits.
• To assess the value to society, the analyst would consider all the
costs and benefits that accrue to tax-payers, neighbors, participants,
competing organizations, or any number of other groups that are
affected by the program under study.
• In contrast a financial CEA or CBA considers only the monetary
costs and benefits accruing to a particular organization and simply
ignores the rest.
• Although such an approach is some- times useful for accounting and
budgeting purposes, it is less useful in assessing a program ’s
effectiveness.
• Nonetheless, the process we outline here can be easily applied to a
financial CBA or CEA: the only difference is that a narrower set of
costs and benefits is considered in the analysis.
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 Steps in Cost-Effectiveness and Cost-Benefit Analysis
1. Set the framework for the analysis
2. Decide whose costs and benefits should be recognized
3. Identify and categorize costs and benefits
4. Project costs and benefits over the life of the program,
if applicable
5. Monetize (place a naira value on) costs
6 Quantify benefits in terms of units of effectiveness (for
CEA), or monetize benefits (for CBA)
7. Discount costs and benefits to obtain present values
8. Compute a cost-effectiveness ratio (for CEA) or a net
present value (for CBA)
9. Perform sensitivity analysis
10. Make a recommendation where appropriate 8
• To illustrate these ten- step process, we
discuss the evaluation of a program aimed
at at-risk students and intended to reduce
the incidence of early high school dropouts.
• Indeed, this is often an important national
issue of governments in both developed and
developing countries across the globe.
• However, only the first three (3) will be
illustrated, you are encouraged to complete
through the evaluation on the subsequent
steps on your own.
• The knowledge gain in ECO 305 and 405
should be helpful and useful.
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Step 1: Set the Framework for the Analysis
• The first question is: Will you undertake a cost
- benefit analysis or a cost-effectiveness
analysis?
• This will depend on what you want to know.
Are you evaluating one program or comparing
two or more?
• Does the program have multiple objectives or
just one major focus? The next slide provides
an overview of the choice.

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 Step 1 Key Issues: A. Deciding on Cost-Benefit or Cost-Effectiveness
Analysis
Cost-Benefit Analysis
• CBA is most useful when you are analyzing a single program or policy
to determine whether the program’s total benefits to society exceed the
costs or when you are comparing alternative programs to see which one
achieves the greatest benefit to society. The major difficulty with CBA
is that it is often difficult to place naira values on all (or most) costs and
benefits.
Cost-Effectiveness Analysis
• CEA is most useful when you know the outcome you desire and you
are determining which of a set of alternative programs or projects
achieves the greatest outcome for the costs. It is also useful in cases
where major outcomes are either intangible or otherwise difficult to
monetize. The major difficulty with CEA is that it provides no value for
the output, leaving that to the subjective judgment of the policymaker.
Recommendation
• Although some view CBA as a superior technique, it is difficult and
time consuming. CEA may provide a good starting point by requiring
the evaluator to identify the most important outcome and relate that
outcome to the dollars spent on the project.

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Step 1 Key Issues: B. The Status Quo
• No matter how many programs you are evaluating and
whether you choose CEA or CBA, the step-by-step
process outlined here is essentially the same.
• In considering each program or project, the analyst must
always start by describing the status quo: that is, the
state of the world in the absence of the program or
policy.
• This scenario sets the baseline for the analysis. The only
costs and benefits that should be considered in a CBA or
CEA are those that would occur over and above those
that would have occurred without any action (under the
status quo).
• These additional costs and benefits are known as the
marginal or incremental costs or benefits of a policy,
and these are what you seek to capture in your measures
of total costs, total benefits, and units of effectiveness.
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Step 1 Key Issues: C. Timing
• Both CBA and CEA can be performed at any point in the policymaking process.
• A CBA or CEA undertaken when a program is being considered is considered an
ex ante (or prospective ) analysis. This type of analysis is useful in considering
whether a program should be undertaken or in comparing alternative prospective
programs aimed at common policy objectives.
• If an analysis is done at some point during implementation, it is considered an in
medias res analysis (or current year or snapshot analysis). Such an analysis
provides data on whether the program’s current benefits are worth the costs.
• Finally, an ex post (or retrospective ) analysis provides decision makers with
total program costs and benefits upon the program ’ s completion, to assist them
in evaluating a program’ s overall success.
• Each of these types of analyses has its usefulness, peculiarities, and issues.
• For example, in an ex ante analysis, the estimation of costs and benefits is most
difficult because they have not yet occurred. In this case the analysis will require
a significant number of assumptions and may yield less accurate results.
• In contrast, in an ex post analysis costs and outcomes are largely known and can
often be estimated accurately.
• Nonetheless it can be difficult to deter- mine which costs and benefits to attribute
to the program because the observed outcomes may have been the result of
programs or events other than the one being analyzed
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Step 1 Illustration: Dropout Prevention Program
• In our illustration, we will examine a dropout prevention program that is currently
implemented in just one high school.
• Assume that you have been tasked with evaluating the program ’s effectiveness for
state policymakers interested in expanding it.
• The policymakers would like to know whether the costs of the program have been
worth the results and they may be considering alternative programs to achieve the
same objective.
• Because they will want to know both whether the program is better than nothing and
how it compares to other programs, both CEA and CBA will be useful. For purposes of
illustration, we will present both analyses.
• The dropout prevention program has involved the creation of a special academy aimed
at students at risk of dropping out.
• The academy has access to space, teachers, and equipment. In order to create the
program, a consultant was hired to train the teachers and provide a curriculum for the
academy.
• One full-time teacher was hired to manage the academy, and three other teachers were
paid extra compensation to work after school in the program.
• As an analyst you may be asked whether the current program —now completing its
fifth year— h as been worth the costs and whether it should be continued or expanded
to a larger group of high schools.
• In this example the status quo would be described simply as all regular high school
activities and programs that occurred before program implementation.
• Our analysis will thus count the incremental changes in costs, dropouts prevented, and
other benefits that can reasonably be attributed to the program.
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Step 1 Illustration: Dropout Prevention Program Contd.
Step 2: Decide Whose Costs and Benefits Should Be Recognized
• Almost every policy or program involves a broad range of stakeholders
and every cost or benefi t ultimately affects a particular group of
people.
• For public pro- grams, taxpayers may bear a large portion of the costs of
a program, while the benefits may be concentrated on a few select
groups (for example, program participants).
• In light of this, determining whose costs and benefits should count (or
who should have standing) is an important consideration in CEA and
CBA.
• In a social CEA or CBA the goal is to assess the impact of the policy on
society as a whole, so the analyst must include all members of the
relevant society in the analysis— one cannot simply pick and choose
which stakeholders within society deserve standing.
• The key issue then becomes how to define society . To maintain
objectivity, society must be defined on a geographical basis
• Typically, analysts choose to define society according to national, state,
county, or city borders, but other geographical distinctions are also
acceptable.
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 Step 2: Decide Whose Costs and Benefits Should Be Recognized
• Almost every policy or program involves a broad range of
stakeholders and every cost or benefit ultimately affects a
particular group of people.
• For public programs, taxpayers may bear a large portion of the
costs of a program, while the benefits may be concentrated on a
few select groups (for example, program participants). In light of
this, determining whose costs and benefits should count (or
who should have standing) is an important consideration in CEA
and CBA.
• In a social CEA or CBA the goal is to assess the impact of the
policy on society as a whole, so the analyst must include all
members of the relevant society in the analysis— one cannot
simply pick and choose which stakeholders within society
deserve standing.
• The key issue then becomes how to define society .
• To maintain objectivity, society must be defined on a
geographical basis.
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 Step 2 Key Issue: Whose Benefits and
Costs Count?
Analysis Scope
• A major issue for evaluators is determining the geographical scope of
the analysis, for example, should benefits and costs be aggregated at the
national or state level? The narrower the geographical scope, the fewer
costs and benefits will need to be counted.
• However, narrower geographical boundaries will miss any costs and
benefits that may spill over to neighboring jurisdictions. It is often useful
to identify these missing costs and benefits, even if you do not quantify
or place a dollar value on them.
• Sometimes spillovers, such as air and water pollution, have broad
negative impacts; at other times projects such as mass transit have
positive spillovers to neighboring jurisdictions and those benefits might
be used to argue for a subsidy or other assistance from that jurisdiction.
• Typically, analysts choose to define society according to national, state,
county, or city borders, but other geographical distinctions are also
acceptable
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 Step 2 Key Issue: Whose Benefits and
Costs Count?
Recommendation
• The analyst should base her definition of society on the
jurisdiction that will bear the brunt of the costs and receive
the majority of the benefits. This will be the primary
concern to the policymakers of that jurisdiction. However,
major spillovers (both costs and benefits) should at least be
recognized and explained in the analysis.
• Policymakers might want greater information on those that
are the most significant or that have political implications. If
spillovers are substantial, the most useful approach might
be to start with a broader geographical scope (for example,
statewide) then look at the subset of costs and benefits
accruing to smaller areas (for example, cities).

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 Step 2 Illustration: Dropout
Prevention Program
• In the dropout prevention program, the state policymakers will likely
want to consider the costs and benefits from the state’ s perspective.
• The decision may also depend on who is paying for the policy. In this
case, we assume that the school district and state taxpayers foot the bill,
so a state- level perspective can again be justified.
• The analyst should therefore count all the costs and benefits of the
program that accrue to state residents.
• Defining society as the state will naturally include almost all
stakeholders, as few costs and benefits of one high school’ s program
are likely to spillover to neighboring states.
• Note, however, that if the school is near a state border causing costs
and benefits to spill over to other jurisdictions, or if the program is paid
for by federal taxpayers, the analyst might want to consider taking a
broader regional or national perspective, or at least to identify and
discuss the nature of the spillovers.
•
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 Step 3: Identify and Categorize Costs
and Benefits
• In conducting a cost-effectiveness or cost -
benefit analysis as part of a program evaluation,
the third step is to identify and categorize as
many of the known benefits and costs of the
program as possible.
• Even though all costs and benefits cannot be
known for certain, the analyst should make a
reasonable effort to identify those that will have
the most significant implications on the policy.
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Step 3: Identify and Categorize Costs and
Benefits Contd.
• When discussing costs and benefits it is common to
classify all negative impacts of a policy as costs and
all positive impacts as benefits, whether these occur
in implementation or as a consequence of a
particular policy.
• However, one could instead frame the analysis as
comparing inputs to outcomes. In this case both the
inputs and outcomes could be either positive or
negative, but the same process applies
• In identifying and classifying these costs and
benefits, we suggest using the framework of
Musgrave and Musgrave, (1989) as follows:
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Step 3: Identify and Categorize Costs and
Benefits Contd.
• Real Benefits and Costs Versus Transfers
Real benefits and costs represent net gains or losses
to society, whereas transfers merely alter the
distribution of resources within the society (again,
defined by geographical area). Real benefits include
dollars saved and dollars earned, lives saved and lives
enriched, increased earnings and decreased costs for
the taxpayers, and time saved and increased quality
of life. In contrast, some societal gains are directly
offset by other losses and are considered transfers.

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 Step 3: Identify and Categorize Costs
and Benefits Contd.
• Direct and Indirect Benefits and Costs
Direct benefits and costs are those that are closely
related to the primary objective of the project.
Direct costs include costs for such things as
personnel, facilities, equipment and material, and
administration. Indirect or secondary benefits and
costs are by-products, multipliers, spillovers, or
investment effects of the project or program. An
often-cited example of indirect benefits from space
exploration is the numerous spin-off technologies
benefiting other industries. Indirect costs are
unintended costs that occur as a result of an action.
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