Evaluating Investments – CBA or CGE? Evaluating Investments CBA or CGE? Peter Forsyth Peter Forsyth Monash University NZ Treasury Seminar easu y Se a September 6 2011 1
Problem Problem • CGE models are now used often to assess whether investments are assess whether investments are worthwhile • The traditional technique is to use CBA The traditional technique is to use CBA • But which should be used? • Which is correct? 2
• Both 3
Argument Argument • Properly specified, both should give the same answer – i e no inconsistency same answer – i.e. no inconsistency • But there are limitations with both techniques techniques • But these are complementary • Possible to use both to improve investment evaluation • (If that is what decision makers want) 4
Theme Theme • Recognising the different roles of the two two • Use the two to improve evaluation • Reconciling the two obtain consistent results 5
Agenda Agenda • Use of CGE in project and policy evaluation evaluation • Characteristics of CBA and CGE • Issues for analysis f • Integrating CGE and CBA- is there convergence? • Conclusions 6
Use of CGE in Project Evaluation Use of CGE in Project Evaluation 7
Literature Survey Literature Survey • Growing recognition that CBA and CGE are on about the same things g • Use of CGE to inform CBA (key shadow prices etc) • Critical discussion eg BTE 1999 • Texts eg Boardman et al 4 edn p124 g p • Recognition of the issue (eg Layman) • But no integrated or comprehensive discussion g p • We’re confused! 8
CGE as a Project Evaluation Technique CGE as a Project Evaluation Technique • CGE models are now used quite often as a way of evaluating investments g • Esp for large infrastructure projects • Melbourne CityLink, East West Transport Study Melbourne CityLink, East West Transport Study (Eddington) • Also, non infrastructure investments (Sydney ( y y Olympic Games 2000) 9
The Tandem Approach- Pedalling in Different Directions? • Often done alongside a CBA • CityLink, East West study, Melbourne CityLink East West study Melbourne Grand Prix • Two different assessments of the same ff f project • How comparable are they? • They may be close (identical), but not y y ( ), couched in the same terms 10
What’s Missing? What s Missing? • A common welfare measure e.g. • Melbourne East West Melbourne East West • CBA – Net Benefits $1.0bn • CGE • CGE (in 2031) (in 2031) $852bn GSP $852bn GSP • A good or bad project - what does this mean? • A good or bad project - what does this mean? • Results are not comparable • But this can be resolved we can get • But this can be resolved -we can get comparable welfare measures for both 11
On the Same Track On the Same Track • CGE and CBA can address the same evaluation problems • How much better off is the economy as a result of this project or policy? • Both have limitations and rely on approximations • • “Once the additional used to increase production and “Once the additional used to increase production and consumption are allowed for, CGE model results and CBA are speaking the same language. CGE modelling results can then be used to enhance the results of CBAs, lt th b d t h th lt f CBA rather than to be used as an alternative” Layman, 2004 (?) 12
Characteristics of the Techniques Characteristics of the Techniques 13
Relative Characteristics of CBA and CGE Relative Characteristics of CBA and CGE • CBA can measure all costs and benefits of a project • CGE constrained by the model, usually at a high level of aggregation • But details can be handled with sub models • • Many effects are location specific, eg noise, congestion – Many effects are location specific eg noise congestion difficult to handle in CGE • Externalities difficult to handle with CGE (Not always) • CBA is usually used as a partial equilibrium approach (Not always) • • CBA tends to have difficulty with macro effects (eg CBA tends to have difficulty with macro effects (eg stimulation of a state econ) 14
Con’t Con t • Difficult to handle distributional effects and measure incidence of changes in CBA • Upshot- take advantage of complementarities 15
Caution Caution • CBA and CGE are two approaches which are soundly based in theory • Other alternatives are not • Eg using Input/Output Impact analysis • • Guaranteed to produce very big “Benefits” Guaranteed to produce very big “Benefits” • Increasingly used to “sell” projects (Dwyer et al 2004) 16
CGE and IO CGE and IO • CGE an outgrowth of IO • CGE to answer the limitations of IO Should IO ever be used? • I In measuring – eg carbon footprint (a snapshot- not i b f t i t ( h t t estimation of impact) • In some regional analysis g y • When full CGE not available 17
Issues Issues 18
Issues Issues • Measuring welfare • Disaggregation and detail • CBA and PE • Externalities • U Unemployment l t • Macro effects • Wider economic benefits (Transport) Wider economic benefits (Transport) • Measuring key shadow prices • Misusing CGE • Data limitations and use of proxies 19
Welfare Measures Welfare Measures • Theory of welfare measurement for CBA well established • Many CGE users are very cavalier (this does not have to be so) be so) • Simply identify benefits with change in GDP, consumption • Are inputs to production free, as many implicitly argue? • Many CGE models have no explicit welfare criterion • B t But some do – straightforward to incorporate d t i htf d t i t 20
Proxy Measures? Proxy Measures? • GDP is a welfare measure - • But under extremely restricted assumptions • Generally a bad measure • Can develop acceptable proxy measures, allowing for costs of factor inputs costs of factor inputs • GNI (allowing for terms of trade effects), adjusted for cost of additional capital and labour • Suitable for marginal changes • “Avoiding the Manna from Heaven assumption” (Dixon) • C Can retro-fit a model which does not have an explicit t fit d l hi h d t h li it welfare measure 21
Rigorous Measures Rigorous Measures • Theory of welfare measure measurement is well developed • Consumers and producers surplus – properties well known • Multi product measures can be used (eg King equivalent Multi product measures can be used (eg King, equivalent gain) • Require info available in a CGE model (eg demand system) t ) • Can handle non marginal changes • Welfare measure can be as rigorous or casual as in CBA Welfare measure can be as rigorous or casual as in CBA 22
Measuring Welfare Measuring Welfare… • Essential if CGE and CBA results are to be compared and differences can be reconciled • Fundamentally not a difficult exercise • Theoretical basis is the same 23
An Aside An Aside… • This is true for all policy evaluations using CGE • Do need to have the correct welfare measures • (Often not the case in Australia, even though Australia relies heavily on CGE) 24
Disaggregation and Detail Disaggregation and Detail • CGE models are often at a high level of aggregation • Though not necessarily – detail can be brought in • Can expand the model to bring in the necessary detail • Eg, the model may have a “rail” sector- bet we can break it down to “rail and a “HST” sector it down to rail and a HST sector • And, indiv HSTs • Eg, develop a tourism specific model based on MMRF g Green (A state based model with a CO2 component) 25
CBA and Partial Equilibrium CBA and Partial Equilibrium • Most CBA studies are primarily PE • Little detail except for big distortions • Need not be • Ideally, CBA is a GE technique, capable of shedding light on indirect effects on indirect effects • GE theory for CBA- Dreze and Stern, Dinwiddy and Teal • But you need a way of measuring the GE effects y y g • I.e . a CGE model • Some GE impacts are potentially large 26
Externalities Externalities • In markets are not included in a CGE model, impacts will not be measured • But externalities will be left out – noise will not be measured • Can adjust for this- measure and add in the cost of noise Can adjust for this- measure and add in the cost of noise, just as for CBA • Don't need to include in the model-can retro fit 27
Incorporate Externalities? Incorporate Externalities? • Can include select externalities in a model • Eg, including CO2 in MMRF Green • Can then estimate the net effects on CO2 of a project, allowing for indirect effects • • Eg the effects on CO2 of a HST Eg the effects on CO2 of a HST • Direct effects easy to measure • But not the indirect effects • Could even be negative • Easy to assess using a CGE model 28
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