Vivid Thoughts: Revamping Government Appraisals for Levelling Up, Part 2
How the approach to appraisal can be improved.
In my first post, I provided my assessment of the drawbacks of the UK Government approach to undertaking economic appraisal, encapsulated in the Green Book. Today, I offer some thoughts on how HM Treasury could strengthen the guidelines it offers to civil servants preparing business cases for Government expenditure.
Part 2: How the approach to appraisal can be improved
Additionality: the unanswered question
The Green Book side-steps an understudied aspect of economic appraisals, which is the question of ‘additionality’. This seeks to understand whether the expected benefits are above those which would have occurred without intervention. It requires an assessment of deadweight – impacts which would have occurred anyway – and displacement – benefits which have come at the cost of others. Investment in R&D that would have proceeded even without a tax credit is deadweight; whilst a business relocating from one region to another to take advantage of new infrastructure is displaced. Whilst some relocation may be desirable to support Levelling Up, neither of these examples should lead to additional benefits in a social cost-benefit analysis. Government is paying out for no gains.
Adjustments for additionality are recommended by the Green Book, there is almost no data available on which to base these, in contrast, for example to the very good guidelines on cost overruns. Previous guidance from the Department for Communities and Local Government (now Housing, Communities and Local Government) took a fairly simple approach: new jobs should be assumed as additional for up to five years and then written off. We believe a more sophisticated approach, one which considers current and expected labour market conditions at the regional and sectoral level, would be useful to determine whether job creation is additional.
A data driven approach to additionality
One option would be to use Office for Budget Responsibility forecasts of both unemployment and the output gap (a measure of spare capacity) to favour programmes which support employment in periods of high unemployment or slack capacity. Further research into capacity at the sector level could generate a set of additionality adjustment factors, allowing a nuanced evaluation of supply chain impacts.
A review of local labour market statistics can be used to prioritise regeneration of economically disadvantaged areas. A big pool of local labour that is un- or under-employed creates the right conditions for high additionality, whereas a sector with a constrained supply of skills is more likely to lead to displacement. The Green Book should recommend a regional disaggregation of programmes to demonstrate whether they exacerbate regional inequalities or support the Government’s Levelling Up agenda.
Taking into account distributional effects
The recommendations above focus on additionality, but don’t yet address one of the other elephants in the Green Book room: equality. The Green Book seeks to maximise aggregate social value, but is silent on distribution. An additional £1 of income to the richest percentile is valued as much as £1 of income to the poorest percentile. We believe this needs addressing. If the Treasury can calculate a social time preference (how much we would need to be rewarded next year to give up £1 today) surely a social preference for equality can be developed. Indeed, such preferences are implicit in other evaluation criteria, such as those used under EU State Aid regulations to designate ‘disadvantaged areas’ which can offer additional government support to businesses that invest there. Progressive income tax rates strip 45p in every pound earned by individuals earning above £50,000 but 20p for those earning £12,500 to £50,000. A starting point would be an explicit weighting function based on income deciles which was consistent with income tax.
At the same time, better guidelines for considering a broader set of impacts should be developed. These might include valuations of contributions to the Sustainable Development Goals (particularly important for aid programmes), mandatory inclusion of environmental impacts with explicit carbon prices. The Department for Transport already provides a for framework for evaluating transport projects – WebTAG – which other departments should emulate.
Making it easier to learn from past experience
Finally, it is vital that HM Treasury puts more effort into evaluating, consolidating and disseminating historic business cases. Our experience is that advisors see the business case approval as a hurdle, which, once cleared, can be largely forgotten. Evaluation of whether funds achieve the impacts they were originally allocated against should be much more common, and the findings collated in an open library which provide inputs for future appraisals. Such evaluations should be used to update guidelines and parameters in the Green Book, which should become a living document. This can all be done at low cost but with huge benefits to policy teams.
All views are those of the author and do not necessarily represent the views of Vivid Economics.