The Knowledge Programme of the European Investment Bank Institute channels its research grants through different schemes, one of which is:

—	EIBURS, the EIB University Research Sponsorship Programme

EIBURS provides grants to university departments or research centres associated with universities in EU, candidate or potential candidate countries working on research topics of major interest to the Bank. EIBURS sponsorships, of up to EUR 100 000 per year for a period of three years, are awarded through a competitive process to interested university departments or research centres with recognised expertise in the selected area. Successful proposals entail the delivery of a variety of outputs that will be the subject of a contractual agreement with the European Investment Bank.

For the academic year 2018/2019, the EIBURS programme is seeking proposals on a new research theme:

1.   Background to the research topic

The EIB (‘the Bank’) appraises the socioeconomic viability of the projects it invests in mainly through Cost Benefit Analysis (CBA) (1). This technique could be portrayed as an extension of the business plan of an investment operation. The business plan focuses on the financial flows of a project. It looks at the financial, or cash, value of expenditures (costs) and revenues (benefits). If the latter are sufficiently higher than the former, the investment adds financial value and is therefore considered a desirable operation in financial terms.

CBA expands on this by broadening the definition of costs and benefits of the project, in two respects. First, it includes all costs and benefits, whether they take the form of financial flows or otherwise. Secondly, it accounts for costs that accrue to all members of society, rather than just those that accrue to the private investor.

This involves looking at many additional items beyond those included in a business plan. Perhaps the most well-known new item among these is ‘externalities’. These are costs or benefits that are not borne by the producers or users of a project, but rather by a third party. Externalities are referred to as positive or negative depending on whether they consist of a benefit or a cost to the third party. A common example of a positive externality consists of knowledge spill-over effects, where a project that invests in research in a given sector of the economy, produces knowledge that also improves productivity in other sectors of the economy. A typical example of a negative externality is environmental pollution. Externalities are therefore benefits or costs that accrue to parties outside the business plan, and which generally do not take the form of financial flows, although they may have financial implications for the third party. So, for example, a positive knowledge externality may lower operating costs in other industries.

Other items considered by CBA and not by the business plan are changes in the value for money (formally measured through the consumer surplus) offered to the consumer. The business plan measures the money element, but leaves out the value element. If a project increases the quality of a product which is nonetheless sold to the public at the same price as before the project, the business plan would ignore the benefit that takes the form of higher quality, and hence value, to the consumer. CBA seeks to capture this change in value. This time it is a benefit to one of the parties in the business plan (the customer), but which escapes the measure of benefit used in a business plan. A much used example is the value that travellers place on savings in travel time resulting from transport projects.

An implication of taking the perspective of all members of society is that CBA must look at certain financial flows differently than a business plan. So, a business plan would treat a subsidy in the same way as a benefit — a cash inflow into the project. CBA recognises that this type of benefit to the producer constitutes a cost to the taxpayer, and hence will treat the subsidy as a transfer from the taxpayer to the private promoter, neither a benefit nor a cost. Likewise, business plans would treat taxes paid as equivalent to a cost – a cash outflow from the project – whereas CBA would treat it as a transfer from the private sector to the State.

Critics of CBA often mention that the technique fails to capture all benefits and costs of a project. In particular, it is often criticised for leaving out what are known in the CBA literature as ‘indirect effects’. These are monetary benefits and costs that the project causes in other markets related to the project – the so-called ‘secondary markets.’ Such effects may be labelled differently in the economic impact literature. Indeed, addressing differences in terminology is part of the remit of the research project proposed here.

CBA methods classify secondary markets into complements and substitutes. A project that consists of improving the productivity of orange growing, thereby reducing the price of oranges, may benefit a complementary industry, such as that of packed orange juice. CBA would not look at the increased sales and profits of the packed orange juice market, thereby arguably leaving part of the benefits of the project out. At the same time, the lower price of oranges would harm the sales of apples, a substitute sector. The lower profits of apple growers are allegedly not looked at in CBA.

In fact, CBA captures all of these effects when the markets for complements and substitutes are undistorted (2). Admittedly markets are often distorted, so CBA risks leaving out some portion of these effects. The pragmatic approach taken in CBA practice is twofold. Firstly, the benefits and costs across the various substitute and complementary markets on aggregate will tend to cancel each other out. Secondly, a project which depends on benefits in secondary markets for its socioeconomic viability is generally a weak project: alternative projects and policies are likely to generate those benefits more effectively. Still, while such a pragmatic approach is generally deemed reasonable, there is certainly a potential flaw in CBA regarding indirect effects.

Critics of CBA also point out that the expenditures associated with a project will trigger multiplier effects throughout the economy, generating profits, tax revenues and employment in other sectors. This effect goes beyond the effects of a project on substitute and complement markets just described, and relates to the actual money expenditures associated with the project. Critics of CBA propose economic impact assessment (EIA) as a complement to CBA, or even as an alternative. But the criticism is based on a misunderstanding of the different nature and objectives of CBA and EIA. CBA is an application of welfare economics to practical decision-making. It looks at all benefits and costs and measures whether one line of action adds value over the alternative line of action, thereby producing an improvement in social welfare. It is geared to decision-making and as such always compares two alternative lines of action in order to embed opportunity costs in the exercise. EIA measures only monetised variables and does not make reference to opportunity costs necessarily. It is primarily a measurement tool. It can be used for decision-making but has a narrower focus than required by welfare economics.

EIA is based on input-output tables, modelling the whole economy by measuring how expenditures in any one sector of the economy impinge upon expenditures in other sectors. It would seem therefore that EIA would address simultaneously the issues of indirect effects and multipliers. But EIA has three characteristics that make it unsuitable as a substitute or even a complement to CBA. These three shortcomings are addressed in turn.

The first of the three characteristics is that EIA assumes that investments are exogenous flows into the economy. This may be an acceptable assumption if one looks at how the project impacts on the economy, or how expenditures related to the project propagate through the economy. But it is not appropriate as a measure of whether the project adds value, i.e. of whether it is a better use of resources than the use that would be given to those resources in the absence of the project. Investment projects are hardly exogenous: they have to be financed by diverting resources from elsewhere in the economy.

Treating projects as endogenous would yield radically different results. At its simplest, the multiplier effects of the oranges project come at the expense of the multiplier effects that would take place in those other sectors where expenditure has to be reduced in order to divert resources to the oranges project.

The second of the three characteristics that distance EIA from CBA is that EIA assumes that prices do not change in the economy and that the availability of resources is virtually endless. EIA is constructed in such a way that, no matter how big a project is relative to the size of the economy, there will always be sufficient resources to implement it without altering prices through the economy. But, in reality, large projects do alter prices, and higher prices of, say, inputs, mean that production in other sectors needs to be cut back.

To address these first two shortcomings of EIA, the academic community has developed computable general equilibrium (CGE) models as a more advanced method of EIA. This technique is fairly elaborate and ultimately consists of modelling the whole economy, including also resource constraints. In so doing, CGE models address the two disadvantages of the traditional EIA discussed so far. Firstly, CGE acknowledges that resources dedicated to an investment project are not exogenous but come at the expense of an alternative use of resources. Secondly, they also address price changes (3). Not surprisingly, a common finding of empirical studies conducted with these models is that multiplier effects are substantially lower than those found by EIA. Moreover, CGE studies show that, depending on the productivity of different sectors and the resource constraints they face, the net effect of a project can be negative on the economy as a whole.

CGE therefore can be seen as a refinement of EIA. It also brings impact analysis closer to CBA. However, CGE still shares the third shortcoming of EIA when compared to CBA, namely that it focuses on flows related to monetary transactions – profits, taxes, salaries, etc. – ignoring many of the variables included in CBA, namely externalities, value for money, etc. This is because CGE studies, like EIA, were designed as a link between project or policy analysis and the macro-economy, the key indicator of macroeconomic performance being national income, or gross domestic product (GDP).

The shortcomings mentioned should not mask the facts that, firstly, CGE offers a richer description of the economy where the project operates and that, secondly, CGE techniques have grown in sophistication. Dynamic stochastic general equilibrium (DSGE) models address the dynamic behaviour of economies. Projects appraised by CBA can have lives of 20 years or longer, strengthening the relevance of the insights offered by dynamic models. So, for example, the outturns of projects that yield a technological shock to an economy are likely to be better understood through DSGE than through static modelling.

The purpose of this EIBURS proposal would be to address this third shortcoming so as to render the results of impact models compatible with those of CBA. The researchers would put forward the impact assessment method, among those currently used in empirical studies, that shows the best promise of compatibility with CBA, and work to determine that compatibility. This should help users of CBA globally, and the EIB in particular, investigate how accurate CBAs are as a measure to assess the full socioeconomic case for investment projects.

2.   Content of the research project

The research programme would consist of four tasks.

Task 1

The researchers would review the range of impact assessment methods that show the greatest promise of arriving at workable compatibility with CBA. A method should be chosen on the basis of the following criteria:

1.	most importantly, it must have a sound, well-developed, track record of empirical application;

2.	it must be of current relevance to the applied academic literature; and

3.	the researchers must be convinced of the prospects of establishing compatibility with CBA within the time and resource constraints posed by the research project.

Task 2

The second part would consist of developing two impact models that incorporate all the necessary conditions to make them compatible with the value added measures of CBA. One of the models would be for a relatively high-income, efficient, competitive regional economy in the EU. The other would be for a relatively low-income, uncompetitive, high-unemployment economy in the EU. The rationale for modelling two starkly different economies is for the analysis to shed light on whether significantly different results could be expected across types of economic conditions. Poorer regions tend to enjoy broader investment eligibilities from the public sector. It would be relevant to learn whether there are indications that appraisals in poorer regions would merit the extra expense of carrying out an impact study.

The researchers can either design the impact models from scratch or adapt existing models. They would be free to follow any of the two alternatives, so long as the alternative chosen does not compromise the central purpose of the research programme, which is compatibility with CBA.

Adapting impact models to CBA measures would involve working at two levels simultaneously: the ‘real’ and the ‘financial’ side of the economy. Many existing impact models lack a financial sector. Given, more generally, the assumptions made in CBA about the provenance of resources invested in the project and, more specifically, the fact that the EIB plays its role through the financial sector, the impact models developed would need to pay particular attention to the financial side.

On the ‘real’ side, impact models already measure variables like GDP, employment and trade balance. The main modifications envisaged would involve adding elements necessary to compute social benefit, including:

—	capturing changes in consumer surplus across the economy, and

—	incorporating measurement of positive and negative externalities, including also environmental externalities.

On the financial side, the models would accommodate alternative options for raising finance for a project, including:

—	direct taxation,

—	indirect taxation,

—	increase in private savings, and

—	debt raised from international capital markets (see, for example (4)).

A necessary ingredient of Task 2 will be to clarify differences in terminology between the two techniques. For example, CGE makes reference to ‘induced effects’, probably influenced by the terminology in EIA. Such effects do not necessarily have a direct equivalent in CBA, which may capture some elements of the CGE induced effects as indirect effects while treating other elements as multiplier effects, thereby ignoring them.

Task 3

The researchers then would simulate the effect of various types of capital investment project on each of the two economies. The number of projects to be simulated would be decided during the research project. The researchers would suggest the sectors to simulate and to be agreed with the EIB supervisor. Possible candidates include an infrastructure project, a large industrial project and a service sector project in an area such as education, leisure, etc. Each project would be simulated through alternative sources of finance.

Task 4

The researchers would finally assess the extent to which impact assessment results would differ from results conducted by a ‘typical CBA’. The ‘typical CBA’ would focus on the primary market and only on the most important secondary markets. The researchers will draw conclusions and issue recommendations regarding:

(i)	the circumstances under which project appraisals conducted with impact assessment methods are likely to yield results that differ significantly from those found by a CBA; and

(ii)	the circumstances under which the expense and time of commissioning an impact assessment would offer value for money when appraising a project.

3.   Interest of the research project to the EIB

The research topic is central to EIB financing activities. The EIB’s Statute specifies that the EIB should finance investment projects that increase economic productivity (Article 18, 1.b) (5). The Bank uses CBA as its central tool to measure the extent to which an investment increases economic productivity. The research project will contribute to testing the integrity of CBA and to assess whether there are circumstances under which it would be advisable to complement CBA with CGE.

4.   Contribution of the research project to academic research

The impact assessment models currently produced by academic researchers or commissioned by research institutes are improvements upon earlier impact methods. But the purpose of such models remains the same: to measure the net effect of a project or policy on national income, or GDP. National income is an incomplete measure of the output of a country, and hence an imperfect tool to measure total economic productivity, including a social welfare perspective, so that the models are not fully compatible with CBA. GDP measures leave out elements such as improvements in value for money (consumer surplus) and environmental externalities. By adapting impact methods to make them compatible with CBA, the output of the impact methods will become a better measure of the overall effect of an investment project on the productivity and welfare of an economy. Such impact methods could also be used in the appraisal of policies, and not only of investment projects.

To the knowledge of the proponent, such adaptation of impact methods to CBA is not available yet. The research project should therefore help develop new versions of economic models for the socioeconomic appraisal of projects and policies.

Proposals should be submitted in English by 15 April 2018 24:00 (CET). Proposals submitted after this date will not be considered. Proposals should be sent by email to:

Events.EIBInstitute@eib.org

For more exhaustive information on the EIBURS selection process and on the EIB Institute, please visit: http://institute.eib.org/

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(1)  European Investment Bank (2013), The Economic Appraisal of Transport Projects at the EIB. Luxembourg: European Investment Bank. (Available online: http://www.eib.org/infocentre/publications/all/economic-appraisal-of-investment-projects.htm).

(2)  Just, R.E., Hueth, D.L. and Schmitz, A. (2004), The Welfare Economics of Public Policy: A Practical Approach to Project and Policy Evaluation. Cheltenham: Edward Elgar.

(3)  Hosoe, N., Gasawa, K. and Hashimoto, H. (2010), Textbook of Computable General Equilibrium Modelling: Programming and Simulations. Basingstoke: Palgrave Macmillan.

(4)  Godley, W., and Marc L. (2007), Monetary Economics: An Integrated Approach to Credit, Money, Income, Production and Wealth. New York: Palgrave MacMillan.

(5)  Consolidated version of the Treaty on the Functioning of the European Union, Protocol (no 5) on the Statute of the European Investment Bank (OJ C 202, 7.6.2016, p. 251) (Available online: http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=celex:12016E/PRO/05).