248 – Ranking environmental projects 14: Private costs
Episode 14 in this series on principles to follow when ranking environmental projects. It is about how to account for the costs that are borne by private individuals and businesses in the course of their participation in the project.
People or businesses who participate in environmental projects may bear costs. For example, people may contribute their time, their land, or other inputs to the project.
The question of whether and how to consider these costs when ranking projects is not as straightforward as for the other costs we’ve discussed.
First consider the case where private costs are contributed voluntarily. Just as I argued for leaving out private benefits (PD244), my advice is to leave out these voluntary private costs.
The reason is that, since people are doing it voluntarily, if they actually do it, it must be something they want to do. For them, personally, the private benefits (broadly defined) must be sufficient to outweigh the private costs. In other words, overall, there are no net private costs to include. If there were private net costs from participation (i.e. if private costs exceeded private benefits), then they would not participate, and no private costs would be incurred.
[Just to be clear, in those comments about the balance between private costs and private benefits, I don’t just mean private financial benefits and costs, but also all of the psychological and social benefits and costs that people get from contributing to an environmental project.]
Things are different, however, when the private costs are not borne voluntarily, but are imposed on people against their will, such as through enforcement of a regulation. In that case, it’s quite possible that private costs exceed private benefits and we have “compliance costs” that should be accounted for. My simple advice is to estimate them, discount them if necessary, and add them in to the denominator of the BCR, like this:
where E represents total compliance costs.
The compliance costs you need to estimate are the losses incurred by the relevant people, aggregated over the whole group of people, and aggregated over the relevant time frame (including discounting if the time frame is more than a few years).
Compliance costs may continue on longer than the initial project costs if people are required to continue doing something that they wouldn’t otherwise choose to do. Over what time frame should they be counted? See the next post on maintenance costs.
Compliance costs should be calculated as the change in private net benefits with and without the project. They should include any direct and indirect losses, and any offsetting benefits, if relevant. Estimating compliance costs can be quite challenging unless you have good survey information or an economic model to use, but it’s better to make an educated guess than to leave them out.
The advice to add compliance costs to the denominator is another case of weighing up the benefits of practical simplicity with the costs of an approximation. If you’re not a stickler or an enthusiast for theoretical detail, you might not want to bother with the rest of this post where I present my justification for this simple advice. If you are interested, read on.
As I’ve said before, putting costs in the denominator of the formula used to rank projects is the right approach when there is a limited pool of resources to be allocated amongst projects. The limited pool might be held within the organisation delivering the projects, or in a separate funding organisation.
On the other hand, if supply of a costly input is not in limited supply, then in principle its costs does not belong in the denominator. Rather, the cost should be subtracted from the numerator.
Given that, what should we do with compliance costs? Should they be added to the denominator or subtracted from the numerator? If there is effectively a constraint on the total level of compliance costs the community will bear, it is reasonable to add them to the denominator. (This approximates the effect of optimising for an additional constraint, just as it did for the organisation’s in-kind costs.)
If there is no such constraint, then in theory they should be subtracted from the numerator. But what if the numerator is not measured in dollars? I suppose you could apply a weight to the compliance costs (with another subjectively determined weight) and subtract the weighted cost, but I feel that’s likely to be even more of an approximation than adding them to the denominator, so I’d do the latter.
That leaves us with compliance costs being subtracted from the numerator only in the case where benefits are measured in dollars and there is no constraint on the level of compliance costs. However, if you’re dealing with a variety of different projects, including compliance costs differently in different cases might be more confusing than it’s worth. If we were to simplify the system by always adding compliance costs to the denominator, the error would usually be small, in my judgement. That’s why this is my “simple advice” on how to include compliance costs: add them to the denominator.
Pannell, D.J., Roberts, A.M., Park, G. and Alexander, J. (2013). Designing a practical and rigorous framework for comprehensive evaluation and prioritisation of environmental projects, Wildlife Research (forthcoming). Journal web page ♦ Pre-publication version at IDEAS