PO 141: INTRODUCTION TO PUBLIC POLICY

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 promise is identical to giving you $1000 today

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 cost-benefit 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

PO 141: INTRODUCTION TO PUBLIC POLICY