economic appraisals and lessons from governments appraisal of yf projects patrick bowes yorkshire forward

1. Economic Appraisals and Lessons from Governments Appraisal of YF Projects

3. A word on the RGF application form.... Clearly designed to help private sector organisations relate more easily to principles of Green Book – but a lot has been lost in translation. The benefits elements of a traditional CBA analysis are not addressed as clearly as normal Green Book guidance specifies – the form indicates that RGF projects do not need to show what it calls “...wider secondary benefits” to receive support. Whilst this may be true for smaller projects – this will not be the case for larger projects (key thresholds for large projects are typically £10 million and £20 million”). HMT are approver of last resort – even BIS operate to a delegation limit (£20 million) beyond which a project can not proceed without HMT approval (this has not changed with RGF).

4. Rationale To some extent the rationale in RGF could be taken as a given, but this does not remove the need to be very clear on the “market” or “Equity” rationale – especially for the larger projects. Lots of guidance around , YF guides the subject very well – need will need to be absolutely confident that you can persuasively demonstrate this – evidence is key. It is rare that you will be able to show “outright” market failure (even business support) – it is rare that an outright market exists (so be clear about the nature of the market imperfection) – look at the BIS 2009 additionality research.

5. Rationale cont..... BIS believe they have a good grasp (now) of the key arguments by type of scheme which are used and have formed a view about what this means for public sector intervention at the local level - look at: http://www.bis.gov.uk/assets/biscore/economics-and-statistics/docs/u/10-1226-understanding-local-growth - “Understanding Local Growth: Economics Paper No 7” This paper helpful in the sense that it confirms BIS economic development investment priorities locally as: tackling barriers to growth that the market will not address itself supporting investment that will have a long term impact on growth supporting the transition of areas with long term growth challenges to better reflect local demand BIS understand the rationale for certain types of schemes more readily than others – but transport schemes are likely create greatest challenge in accurately establishing “additionality”. Ideally the rationale should clearly be reflected in the scheme design – taking the time to iterate the design to better reflect an identified market or equity failure is preferable to “retrofitting” schemes. Our experience has shown it is better to establish rationale, headline options and formed view on economic benefits before detailed appraisal begins.

6. Options Need to show which options were considered and the process used to move from a “long list” to a “short list” of options – summarising this clearly and the criteria used will help you greatly. The “preferred option” and at least one other option need to have a full CBA undertaken – a full discounted NPV analysis over the same time frame (the life time of the project). It is essential that this is done as it is the only way to actually evidence that the preferred option delivers the best mix of benefit relative to cost.

7. Options cont..... Typically there are two ways you can express costs compared with economic benefit – CBA ratio and cost per job (both net). The do nothing position must also be covered – it is important to show that the investment will create more jobs (in the target area) than otherwise would be case – so the counterfactual position must evidenced.

8. Addionality..... The Yorkshire Forward guide covers this very well but when presenting to BIS it is important that you show clearly (for each short list option) the adjustments made with “Gross to net” cost per job on CBA ratio laid out with “netting off” percentages applied – remember they have and excellent frame of reference from: “BIS Occasional Paper No1: Research to improve the assessment of Additionality, October 2009” http://www.bis.gov.uk/files/file54063.pdf

9. Additionality cont....... All short list options should reflect and adjust for the following on “benefits” side of the CBA: Deadweight Displacement Leakage Substitution Multipliers

11. Additionality cont.... A word on “Multipliers”: In most cases multipliers are used to attribute the indirect benefits of direct jobs arising from the intervention. The typical approach to quantify these benefits is an “Input-Output” based econometric assessment – the Regional Econometric Model is such an example. Using the REM gives greater control and granularity for the CBA calculations and allows for: Accurate phasing of benefits tied to job creation over project life cycle Accurate control for the phasing in and out of construction sector jobs – meaning they can legitimately be included in the life time CBA. Using local or regional intelligence where such data shows higher retained economic effect than normal I-O relationship.

12. Addionality cont..... If you use the REM it has been specifically designed to address most aspects of additioanlity apart from substitution and “out of region” leakage. Based on BIS view of multiplier impact by type of intervention - sector and cluster interventions have the highest multipliers and skills projects the lowest (apart from higher level skills projects). Note: the netting of direct jobs will vary by sector – for instance retail sector jobs have the highest discount factor.

13. A quick spatial point of note on the BIS additionality research BIS found that sub-regionally (locally) deadweight was the most crucial variable to account for, then displacement and leakage were most significant considerations. On the “+” of additionality the typical multiplier was 1.25 (or 25%) across all scheme types. Deadweight and displacement rose marginally at regional level – but multiplier benefits rose markedly (across all scheme types) to 1.45 (45%).

14. Need and demand...... Whatever the rationale for your project you will need well evidenced primary data (page 6 of the Yorkshire Forward handbook summarises this well) to establish and confirm: The need to be addressed (especially if an equity failure is the rationale) within the target group, community or area. The specific dimensions or characteristics of the market failure you are addressing.

15. Need and demand cont....... Take the time to consider how you will address and evidence that public sector intervention will drive growth (beyond an econometric assessment of the direct and indirect benefit arsing from job creation). For instance establishing that significant latent demand exists and would be unlocked by the investment will improve your business case and plays directly into RGF scheme priorities (also BIS Economics Paper No 7) – also a good way of articulating catalystic indirect benefits. Such evidence can clearly help with mixed use property schemes – especially office schemes. Regional growth – good quality primary research particularly on latent demand or unmet demand will help “demonstrate” that the investment will drive growth at the regional level and contextualise your economic case (layering quantitative and qualitative evidence will help).

16. VFM....... BIS Additionality paper did not touch VFM – but they emphasised that there is no simple relationship between additionality and VFM. It is clear that in RGF that “cost is king”, but is not yet clear what compromises they will make (a very cheap scheme but low additionality) – some of the large scheme will test them (especially transport schemes). CBA ratio – as a rule thumb a CBA ratio of in excess of 10:1 would be regarded as passable, anything beyond 15:1 as good, 20:1 as strong and over 30:1 exceptional (life-time CBA notation).

17. Hints and tips...... Demonstrate that the investment is delivering a higher trend rate in growth and jobs than would otherwise have been the case – in many instances the local baseline (from REM) would be the “do nothing option” reference point to help you accurately establish this. Show how the project will contribute to both local and regional growth – in the past BIS HAVE BEEN PREOCCUPIED WITH ESTABLISING A PROJECTS CONTRIBUTION TO REGIONAL GROWTH (AND QUITE RIGHTLY BASED ON THEIR ADDITIONALITY EVIDENCE – REMEMBER THE MULIPLIER EXAMPLE). Establish need or demand conclusively with clear evidence and undertake primary research to establish latent demand. Nesting projects – especially transport schemes – within wider schemes will help in attributing direct and indirect benefits – but clearly establish the dependency (in the rationale and reflected in the options treatment) to strengthen your business case. Demonstrating market failure is dependent on the quality of primary intelligence you can marshal to show why the market is not working efficiently – if have you clear evidence that the market is not working efficiently this will really help (quantitative as well qualitative).

18. More hints.... Do not rely on econometric data alone in helping show the GVA or employment impact (especially at regional level) – well marshalled evidence of latent demand can be equally as powerful. IDAB is the main decision making vehicle BIS will use to advise the RGF panel. IDAB membership has not changed significantly since their new role. Talk to the BIS economists early – communicating your ideas and approach (especially for the large projects) will help “Avoid” any surprises.

19. The key question..... Does the short list of LCR round one projects (in each case) clearly demonstrate that they will contribute to a higher rate of private sector employment growth than otherwise would be the case and that the rationale for intervention clearly establishes (and evidences) that this could not be achieved without the public sector. Similarly with long list and round two submissions – take the time to ask these questions.

20. Further sources...... RDA Evaluation at - http://www.bis.gov.uk/files/file54095.pdf Local growth evidence base and rationale for public sector intervention - http://www.bis.gov.uk/assets/biscore/economics-and-statistics/docs/u/10-1226-understanding-local-growth BIS have a separate and well worked rational for inward investment interventions (this is still extant) and can be found at - http://www.bis.gov.uk/files/file32297.pdf Additionality guide at – http://www.bis.gov.uk/files/file54063.pdf Green Book at (has been tweaked slightly re-launched in August – it is easier to navigate and has clearer case studies) http://www.hm-treasury.gov.uk/d/green_book_complete.pdf