PO 141 INTRODUCTION TO PUBLIC POLICY Summer I

PO 141: INTRODUCTION TO PUBLIC POLICY Summer I (2015) Claire Leavitt Boston University

TABLE OF CONTENTS • Cost-Benefit Analysis, Part I – Discount rates • Cost-Benefit Analysis, Part II – Assigning monetary value to intangibles • Program Evaluation – Natural experiments, non-randomized comparisons, time-series analysis, discontinuity designs • Policy Design: Q&A

COST-BENEFIT ANALYSIS The process by which the benefits of an action/policy are calculated and compared with the costs of that action Policymakers will take action if the benefits outweigh the costs (net benefit) Different from theoretical assessments of utility—all benefits and costs have to be monetized

COST-BENEFIT ANALYSIS Monetization: Converting the costs and benefits of multiple possible actions into a single unit of measurement (e. g. , dollars) Are there some things that should not be commodified (e. g. , human life, the human body)? Why?

COST-BENEFIT ANALYSIS Cost-benefit analysis requires accounting for the passage of time: “Policy X will cost $10 billion and generate $25 billion of economic output. ” What does “ 25 billion of output” down the line mean in today’s dollars?

COST-BENEFIT ANALYSIS Inflation: The increase in the price of basic commodities over time; the rate at which the value of a dollar decreases Interest rate: The percentage by which the value of your money appreciates after investment Or, the percentage of your loan that you will have to pay back as interest—the fee for borrowing the money in the first place)

COST-BENEFIT ANALYSIS Discount rate: The rate at which a sum of money appreciates in raw terms (but the money’s worth remains constant); thus, the discount rate represents what X dollars tomorrow are worth today In other words, what is the intrinsic value of a commodity or service or person? What is the principal value of a thing?

COST-BENEFIT ANALYSIS How to calculate a discount rate: Example: Joe now owes $50, 000 in student loans at 8% annual interest and he graduated four years ago. How much did he borrow at the time?

COST-BENEFIT ANALYSIS Discount rate versus interest rate: You deposit $1000 with a 10% (interest) rate of return; after one year, you receive $1100 You are promised $1100 in one year with a specified discount rate of 10%; that

COST-BENEFIT ANALYSIS How do policymakers use discount rates? A proposed project will cost $10 billion but lead to an estimated $25 billion in economic output over the next 10 years. Should you greenlight this project? What is the discount rate? Current interest rate =. 25%

COST-BENEFIT ANALYSIS A proposed project will cost $10 billion but lead to an estimated $25 billion in economic output over the next 10 years. Should you greenlight this project? Assuming a constant discount rate, you should greenlight this project

COST-BENEFIT ANALYSIS How are discount rates chosen? Businesses choose discount rates based upon estimated interest rates/ returns on capital But how do policymakers set a social discount rate—the “worth” of a future benefit in the present?

COST-BENEFIT ANALYSIS How do policymakers choose social discount rates? Rate of inflation? Federal interest rate? Zero percent? (particularly for intangibles) How long until the benefits of a policy kick in? How quickly can the policy (the investment in future benefits) start generating returns? How much will the world change? Will the expected benefits increase or decrease? How much do people value the health of the environment?

COST-BENEFIT ANALYSIS How to carry out a cost-benefit analysis: 1) How will the economic and social benefits of a policy be monetized? 2) What is the worth of these economic/ social benefits in today’s dollars? Set your social discount rate 3) Calculate the nominal value of the economic/social benefits in today’s money. Is it greater than the cost of the policy?

COST-BENEFIT ANALYSIS Some costs and benefits are easy to calculate— they have market prices. But some do not. How do we monetize social costs and benefits? How do we determine what something is “worth? ” What is a cleaner environment worth? What is 10 extra years of life worth? What is falling in love worth? What is happiness worth? What is righting a historical injustice worth? What is your time worth? Your labor?

KEY TERMS Willingness to pay: The idea that the true worth of a good is the highest price that someone is willing to pay for it The endowment effect: The idea that people want more money to give up/forgo something than they would have been willing to pay for that something in the first place Coffee mug experiment

KEY TERMS Shadow pricing: Factoring in opportunity cost to the “price” of something that has no clear market value What is the “shadow price” of dying at age 55? What would you have done with an extra 20 years? Contingent valuation: How much people say they are willing to pay for something, hypothetically

CONTINGENT VALUATION What are the problems with contingent valuation? Why can’t we trust what people say? Fundamental human irrationality Inability to assess future value systems Differences in absolute versus relative assessments Fraudulent/selfish impulses

KEY TERMS Revealed preferences: When values are assigned to costs and benefits inadvertently, through behavior Example—contingent valuation versus revealed preferences: The affirmative-action experiment Value of a statistical life: The monetary value assigned to a human life

VALUE OF A STATISTICAL LIFE How do policymakers assign values to human lives? Is monetization of humanity a necessary evil of policymaking? Are there some policies that are never ethically acceptable, even if they would lead to a net positive outcome? When does costbenefit analysis fail? The “lifeboat” parable “Just war” and humanitarian intervention Religious values

COST-BENEFIT ANALYSIS: EXAMPLES The 9/11 Victims’ Compensation Fund How were compensation awards determined? Reparations: Fair? Feasible? US government to black Americans German government to Israel German government to France and other Triple Alliance powers post-World War I When should governments compensate individuals for crimes perpetrated by the state?

POLICY EVALUATION Once policies are analyzed and implemented, how do we know if they’re effective? Analyze effects based on: Philosophical soundness Basic statistical and economic indicators Regression analysis Randomized controlled experiments Other types of experimental designs

NATURAL EXPERIMENTS A natural experiment can be conducted when an (unintentional) treatment is randomly applied naturally A policy is implemented for a group of people and not implemented for a group of people who are highly similar to the first group but for the fact that they did not receive the treatment School voucher lotteries

NON-RANDOMIZED COMPARISONS The treatment is not randomly applied, but both groups (the ones receiving the treatment and the ones who are not) are highly similar Example: Comparison of two elementary schools in similar neighborhoods with highly similar demographics; one school gets an after-school reading program and one does not

TIME-SERIES ANALYSIS Applies a treatment at some point in time and compares the outcomes before the treatment and after the treatment (longitudinal, or over time, comparisons) Example: Did the Family and Medical Leave Act (1993) improve productivity in the workplace?

MULTIPLE TIME-SERIES ANALYSIS What happens over time for Group A (before and after a treatment is applied)? Compare with: What happens to Group B over that same period of time (but Group B has not received the treatment). Example: Compare two similar countries; one implements Policy X, the other debates it but doesn’t implement it. Are outcomes different between countries?

DISCONTINUITY DESIGNS Do subjects who received a treatment by just clearing an arbitrary cutoff have better outcomes than subjects who just missed the cutoff for receiving the treatment? (I. e. , both groups of subjects are highly similar. ) Do people who took part in X prestigious program have better career outcomes (income, etc. ) than people who were wait-listed for the program?

ASSIGNMENT: POLICY DESIGN Ideas? Questions? Structure: A clearly delineated goal; Diagnosis of the problem (hurdles in front of your goal); Identification of the appropriate political institution for implementing the policy; Evaluation of alternative solutions and justification for the proposal you settle upon A plan for implementation/execution of the chosen policy