What is Cost-Benefit Analysis?

Cost-Benefit Analysis (CBA) is one of the most widely used decision support tools in the UK. There are two types of CBA, private and social. Private CBA focuses only on costs and benefits to a business and is focussed on profit maximisation. In contrast, Social Cost-Benefit Analysis (SCBA) focuses on raising aggregate social welfare and is a requirement for many decisions in central government. This guidance note focuses on SCBA only.

How does it work?

It is used to compare two scenarios, one without the proposed change (POLICY OFF) and one with the proposed change (POLICY ON). Once the differences between these two scenarios have been ascertained, economic values are estimated for the differences. These include both costs and benefits. The project is desirable if the benefits of the proposed change from POLICY OFF to POLICY ON are greater than the costs.

What decisions is it used for?

It is best used to make decisions around specific proposals for investment projects or programmes, expenditure or legal regulations. When used for more strategic and less specific decision-making, the analysis can become intractable and the advantages of this approach diminish.

When is it used?

Government guidance calls for it to be used at every stage in the policy cycle, from the initial scoping phase, through to appraisal and evaluation. In practice its use in initial scoping and evaluation are limited, which reduces its potential to inform decisions. Also, a significant proportion of government spending is driven by politically decided targets rather than SCBA. SCBA is most use when applied to a specific and genuine decision which needs making, but outside government it (or parts of it) are sometimes used to make the case for a specific approach. SCBA’s high status has a decision support tool makes it useful in this way.

Incorporating an Ecosystems Approach into CBA

Ecosystem Services Framework. In principle, SCBA should include all the significant consequences of a decision, including those relating to environment change. This is because, unlike market indicators such as Gross Domestic Product (GDP), SCBA includes non-market effects that impact on welfare, such as air quality or the view of a landscape from the window. In practice, environmental impacts have not historically been included as routinely or effectively as other impacts, particularly market ones. This may be due to ignorance by the analyst that they may be significant enough effects to include or difficulties in quantifying the effect, which tend to marginalise impacts in SCBA. Government economists have been working to improve this situation and there is now guidance to screening for and including environmental impacts, which explicitly uses the Ecosystem Services Framework.

Ecosystem Approach. Using the Ecosystem Services Framework to include environmental change in SCBA is a big step forward, but it is not in itself enough to fully adopt the Ecosystem Approach (EA). This is because of the values and assumptions that are built into the SCBA methodology. For example, the Ecosystem Approach focuses on societal choice, whereas SCBA assumes the right decision is that which maximises the value to all the individuals added up, without further discussion or dialogue. Some economists are seeking to address this by using SCBA as input into a deliberative process. Another example is that the EA focuses on the importance of ecosystem functioning for sustainability. This is very difficult to include in SCBA due to the lack of certainty about the likelihood of environmental ‘tipping points’ and their causes and the inability of project-level tools to address strategic issues. Addressing the problem requires SCBA, and policy decisions, to be conducted in a ‘safe space’ delineated by an expert process, such as the being developed by the Natural Capital Committee. Finally, SCBA reduces the costs and benefits of future years by an agreed percentage per year, called the discount rate. The standard Treasury discount rate renders all but enormous impacts irrelevant after 25 years which is in tension with the Ecosystem Approach focus on long-term management. Testing the effect of alternative lower discount rates is therefore desirable and allowable according to Treasury guidance.

Case study - valuing the benefits of Torbay’s trees

One of the significant barriers to include ecosystem service benefits in SCBA is the difficulty of getting hold of a robust enough scientific quantification of the benefits to value. For urban trees new possibilities arose in this area with the development of the I-Tree software. This programme provides quantitative estimates of some services based on a sample of urban tree species and sizes. The Tree Officer at Torbay Borough Council was interested in using I-Tree to value these benefits in order to highlight the value of investment in urban trees. He teamed up with an arboriculturalist and they conducted a sample survey of Torbay’s trees to feed into the programme. A TABLES project team member then joined the team to ensure the economic analysis was robust.

The first challenge to address was that the I-Tree programme was parameterised for use in the US and we had to go through each ecosystem service to check which estimates would be sufficient reliable in the UK. This removed saved heating and cooling costs from our estimate and left us with only carbon storage and sequestration and air pollution removal. The programme also needed data on the normal air pollution level which is difficult to source and required some assumptions.

The second major challenge was that the programme not only produced quantitative estimates but also placed a dollar value on benefits, using a relatively crude method. Therefore for the analysis in Torbay physical estimates and UK standard practices were used, including values to produce a better (and higher) estimate of the value of trees. Finally, the programme encouraged the user to compare the costs of looking after the town’s tree stock in a year with the benefits in that year, a one year snapshot analysis. In terms of SCBA this is meaningless because it does not relate to an actual investment decision. To put this another way, the benefits in this year are based on investment over the last two hundred years and would flow whether any further investment was put in this year or not. An ideal SCBA would therefore compare scenarios from now with business as usual level of investment or enhanced investment. Unfortunately this was beyond the scope of the project, but instead indicative cost:benefit ratios were produced for individual trees. Finally, the results were offered with two discount rates to demonstrate their sensitivity to the rate chosen.

Having conducted the analysis, ensuring it was communicated properly was a challenge. The results showed low cost:benefit ratios for some trees, for example at standard discount rates the worst performing tree, a Cherry had a Cost:Benefit ratio of 1:0.01 and the best performing tree, an Oak, had a ratio of 1:0.21. It is important to remember that this was based on considering only two of the many ecosystem service benefits offered by the trees. In general terms the project achieved its institutional aim of highlighting benefits offered by trees that are not normally considered, and provided a methodology others could follow. Due to the difficulty in quantifying many of the benefits offered by trees however, SCBA by itself is not an ideal tool. Instead it should be expanded through deliberative or weighted consideration of other benefits, as in Multi-Criteria Decision Analysis.

The following principles of the Ecosystem Approach are evident (light green) or significant (dark green) within this tool: