Financial Analysis
Description
Financial Analysis gives an overview of the monetary effects of a policy for a specific actor.
Financial Analysis is the main tool which firms use to decide upon their investments. In most cases a Financial Analysis will not be the main evaluation tool that is used for government policies. More than as a separate evaluation tool, Financial Analysis will then be used as part of the other methodologies described below, to calculate part of the effects.
Advantages & drawbacks
The simplicity of Financial Analysis forms both its main advantage and its main drawback. Due to the standard accounting approach the methodology is clear and objective. The main drawback is that the methodology is very incomplete: only financial benefits and costs are taken into account and often only for one actor. Due to this incompleteness Financial Analysis is not accepted as a final evaluation methodology for large government projects. The assumption that only financial effects for specific firms are important is especially inappropriate for the space sector, which causes possibly large external and unquantifiable effects.
Input-Output Analysis
Description
Input-Output analysis (IO analysis) traces the effects of an investment throughout the economy by using detailed data on interactions between industries or sectors within the economy.
Multipliers show how an input change (i.e. an investment) affects total output. IO analysis is basically static and built around IO matrices: transaction tables in which the values of transactions between industries are specified. Various IO analyses have been carried out for the space sector in recent years (see FAA, 2010; Goss Gilroy Inc., 2010 and NASA 2009).
Advantages & drawbacks
The advantage of IO Analysis is that the ideas behind it are simple and the mathematics straightforward. A drawback of this methodology is that the data requirements are immense. In order to be able to single out values and multipliers for specific regions and industries, full transaction information for all the cells in the IO table is needed.
An important (and often implicit) assumption is that the production factors labour, capital and land are available. Since IO analysis assumes a fixed production structure, it does not allow the analysis of structural shifts in policies or technology. It assumes the economic system under study to be in an equilibrium state. Industries are supposed to have a (more or less) homogeneous output and a known, invariable production structure. Given the static nature of IO analysis, it only provides short term information. In order to incorporate long term effects, a series of IO analyses has to be implemented, which all have the same dimensions in regions and industries.
Finally, IO analysis does not take non-financial and unquantifiable effects into account.
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Computable General Equilibrium Analysis
Description
Computable General Equilibrium Analysis (CGE Analysis) is a methodology in which the effects of economic shocks or policy measures are calculated using a model which simulates the entire economy. CGE models include factor (capital, labour) and commodity markets and model the behaviour of production sectors, households and governments.
CGE models are often based on (aggregated) Input-Output tables. They estimate the same direct effects of policy measures as IO Analysis does. As opposed to IO analysis, GCE analysis also adjusts prices and wages. Prices and wages are adjusted until production and employment in the entire economy are in an equilibrium state. CGE analysis therefore is an economy wide impact analysis.
No studies were found that estimate the effects of space activities on the economy using GCE analysis. This probably has to do with the large data requirements and complexity of the methodology.
Advantages & drawbacks
The major advantage of CGE Analysis is that it yields results which take into account all indirect effects throughout the whole economy. Furthermore, CGE models are based both on a consistent theoretical model of the economy and on empirical data which describe national economies.
As GCE uses IO tables, the drawbacks with respect to the immense data needs of these tables also apply to GCE. Another drawback is that policies have to be large enough in order to show any impact on the economy. As space activities are relatively small compared to the size of the economy as a whole, this is again an important drawback in the context of this study.
The assumption that the economy will end up in an equilibrium is only valid for the long-term; in the short term markets are usually not in an equilibrium. Prices and wages do not adjust instantaneously to changes in the economy. Therefore markets can be out of equilibrium during an adjustment period. Moreover, there might be institutional or market barriers which limit the efficient functioning of markets.
Finally, CGE Analysis concentrates on direct and indirect effects; it does not take non-financial and unquantifiable effects into account. This is an important limitation in appraisal of space programmes, as these programmes are expected to yield important external and strategic benefits, which are not in the scope of CGE Analysis.
Cost Effectiveness Analysis
Description
Cost-Effectiveness Analysis (CEA) is a tool to compare different technological options or policy programmes which have identical objectives. It summarises the outcome of a comparison using a single quantifiable indicator. It also provides a measure of the effectiveness of an option. The objective itself is not assessed. Cost-Utility Analysis (CUA) is an extension to CEA, in the sense
that it uses a quality-adjusted indicator to describe the objective. One study by Mathematica (1972) was found that applied CEA with respect to space investments.
Advantages & drawbacks
CEA is simple and effective, and capable of taking all kinds of effects into account, quantifiable as well as unquantifiable effects. An advantage of cost-utility analysis over cost-effectiveness analysis is that a richer indicator can be used to determine a cost-effectiveness ratio which includes more than one objective. However, at the same time this has the drawback that the relative weight of the different objectives becomes obscured through the use of one single cost-utility measure.
The main limitations of CEA and CUA are that they do not take secondary or indirect effects into account. As the latter situation applies to space programmes, this is an important drawback in the present study. Another drawback of CEA is that only the cost-effectiveness is analysed, not the relevance of realising an objective.
Social Cost Benefit Analysis
12Description
In Social Cost Benefit Analysis (SCBA) all the costs and benefits of investments or policies are systematically evaluated and where possible monetised to make them comparable. In addition, SCBA provides an overall picture of how the effects are distributed among stakeholders13. In principle, SCBA has the ambition of including and monetising all the effects of a policy, including societal and environmental effects.
In SCBA, the willingness-to-pay of firms and households is estimated for each impact of the project or policy. This is done market-by-market, with special care to avoid double-counting. If possible, existing markets are used, where the willingness-to-pay can be observed from choices made by suppliers and customers. Often, economic methods are used which describe specific markets (transport, energy) or the economy as a whole (Computable General Equilibrium Analysis, Input-Output Analysis14). For impacts which are not related to markets, other methods such as surveys may be used. The value of impacts is calculated year-by-year, for a period of decades. The future costs and benefits are translated into present values using discounting.
A Cost Benefit Analysis (CBA) can be conducted at several levels of detail. Different extensions to the name Cost Benefit Analysis are used to point out the extensiveness of the analysis conducted; for example Cost Analysis, Indicative CBA and Quick Scan CBA. The most complete form is the Social Cost Benefit Analysis. This complete form is discussed in more detail in this section.
SCBA is based in economic science and is often used in practice. Several studies have applied SCBA to the space sector, most of which relate to GMES services (see Indra, 2004; Whitelaw, 2004; Whitelaw, Costa and Scott, 2004; Ecorys, 2004; AETS, 2005; ESYS, 2004; European Commission, 2009b; Booz & Co, 2011; PWC, 2001 and NATO Industrial Advisory Group,
12 This text is adapted from two SCBA manuals: Zerbe and Bellas (2006) and Eijgenraam et al. (2000).
13 Here, stakeholders are defined as actors with an interest in the space investment or its effects.
14 In this report, these economic modelling methods are also described as separate appraisal methods.
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2011). Almost all of these studies focus on the benefits to end-users and society in terms of cost-savings or additional production, without estimating the direct effects on the space sector.
External and non-quantifiable effects were often not included or only qualitatively addressed. In addition, costs of infrastructure were not always included. Input data mainly consisted of estimates on cost-savings and additional production.
Advantages & drawbacks
All relevant advantages and disadvantages of an investment project are recorded and quantified in the best possible way. By allocating a suitable monetary value to project effects wherever possible and then adding them up, it is possible to present information in a well-organised manner which facilitates a comprehensive assessment. Social cost-benefit analyses limit, wherever possible, the compilation of long lists of diverse advantages and disadvantages which complicate rather than simplify a comprehensive analysis of project effects.
A social cost-benefit analysis also has a disciplining effect because it prevents double-counting. It requires an adequate insight into the relationships among the various impacts. A cost-benefit analysis therefore makes demands on the research, not only on the analysis itself, but also on the underlying research projects. This reduces subsequent criticism.
It is not always possible to express all effects in monetary terms and add them up. External effects may be partly monetised, but for strategic effects this is very hard. This is a serious limitation in all monetary methodologies. Still, non-priced effects can often be reliably expressed in monetary terms. Effects which cannot be expressed in monetary terms must be weighed up in political-administrative terms against the sum of the effects which can be expressed in monetary terms.
Box 3.1 Limitations of SCBA
SCBA works well when costs and benefits are associated to existing markets. In such a case, consumers’ surplus and producers’ surplus normally give extremely accurate values. However, as we depart from existing markets, calculations become more difficult. There are several objections to the use of SCBA:
1. Problems in attaching valuations to costs and benefits, especially when departing from existing markets. Techniques such as contingent valuation are available, but not accepted as valid by all economists.
2. SCBA may not (explicitly) cover everyone affected (i.e. all third parties) – inevitably there are a huge number of potential “stakeholders” who stand to be affected (positively or negatively) by an investment decision. There is a risk that some groups might be left out of the decision process.
3. Distributional consequences. Costs and benefits mean different things to different income groups. Those receiving benefits and those burdened with the costs of a project may not be the same. Are the losers to be compensated? This equity issue is important to policy makers.
4. Social welfare is measured as the sum of the willingness-to-pay of individuals. This might not be an appropriate criterion in the eyes of policymakers.
Apart from these limitations, SCBA has important advantages (see the text of this section). Any assessment methodology which includes SCBA should take account of its limitations and try to correct for them.
Finally, social cost-benefit analysis may seem like a black box to non-economists. The fact that some benefits should be disregarded to prevent double-counting, is not always obvious to people who find it important to account for all the benefits.
Social Return on Investment
15Description
Social Return on Investment (SROI) can be seen as a special form of SCBA. The main difference between SROI and SCBA is the focus of SROI on societal and environmental impacts and the involvement of stakeholders. It overcomes the difficulties faced by SCBA in estimating societal and environmental impacts by focusing on the most important sources of value as defined by stakeholders. No studies were found in which SROI was applied to a case regarding space activities.
Advantages & drawbacks
The advantage of SROI is the emphasis on the embedding of the methodology in the decision making process which may lead to a wide basis for acceptance. Another advantage is that as many effects as possible are taken into account, with special attention for societal and environmental effects.
The downsides of SROI are that societal and environmental effects are difficult to monetize and might need subjective assumptions to include them in the analysis. The involvement of stakeholders and the special attention to societal and environmental effects also imposes risks of subjectivity. The interests of strong stakeholders might be over-emphasized while the interests of smaller or less organised stakeholders might be underexposed. Strategic input from stakeholders can be partially overcome by a correct set-up of the survey or interview.
For space investments, the inclusion of strategic effects in SROI is nearly impossible. In SROI, as opposed to SCBA, the base case is not explicitly defined which can cause problems calculating effects in later stages.