Explain how the government uses cost benefit analysis to allocate resources in transport and why this method of appraisal has some limitations.
Cost benefit analysis is a technique for assessing the monetary social costs and benefits of a capital investment project over a given time period. It is used to plan many different types of government investments and analyse whether they are worth the money spent on it. CBA includes calculating tangible costs and benefits, intangible costs and benefits (in other words externalities) and also discounting - a prediction of future costs and benefits.
Allocation of resources in the most effective way is the main aim in any economic process, including investments in transport. In this context allocating resources means spending a particular amount of money on improving the infrustructure. Exspenditure is based on a detailed analysis of costs and benefits, which helps to understand on what parts of work more money should be spent, how much to spend on insurance and security and also taking into account possible future changes and external effects on the infrastructure. The analysis is started with an appraisal of the project (should the government invest in transport development) and only after that an accounting of costs and benefits is started. The government counts all the tangible costs and benefits (labour costs, building and repairing costs, profits from developed transport\infrastructure), after that it counts possible negative and positive externalities (pollution, people living near roads etc) and compares them to determine the net social rate of return (on the subject whether the project is worth investing). After that they start discounting of future costs and benefits - how it will work in the future years, will the transport need improvement or reconstruction etc.
What are the possible limitations of CBA in transport?
- it is very difficult to value some externalities. How will a new road affect the enviroment? How much this effect will cost? Analytics may only guess basing on some trends or formulae, but there is no proof that their guess will be accurate.
- when doing CBA, all costs and benefits should be included for completing an accurate analysis, but it is impossible to include all the third parties into analysis. future events are unpredictable, therefore, cannot be included into the CBA.
- for some people a particular change in the infrastructure might be a benefit while for others it's a cost. some will recieve more benefits than others. how to compensate those who gain less?
- impossible to predict all the impacts on the enviroment and humans' lifes.