Hands up if you’re a media commentator that has demanded the government undertake a cost benefit analysis (CBA) of the National Broadband Network?

Keep your hand up if you have any idea at all about how to actually do one?

If we were in a large hall right now filled with the nations media chirpers — there wouldn’t be a raised hand in the entire room. The reason for this is pretty simple — if you actually know how economic cost benefit analysis works, you understand that it is completely incapable of producing even a marginally meaningful result on a project such as the NBN.

Demands for a CBA on the NBN — as if it were some definitive document whose result is pivotal to the project’s implementation — speaks more to the ignorance of those making the demand than it does about anything actually related to the value, viability or otherwise of the NBN itself.

It’s not a matter of opinion, it’s a simple matter of methodology, and to understand why  we need to understand uncertainty.

There are two types of cost benefit analysis. The first is effectively an accounting exercise utilised by (usually) private firms where the *only* costs and benefits they are concerned about are their own. It’s a way to determine whether the benefits to the firm that would be delivered from a given investment over some specified period of time, would be greater than or less than the costs incurred by the firm from that investment over that time.

It estimates the net private benefit that a given investment opportunity would be expected to deliver and ignores the costs and benefits that people and organisations other than the firm would experience as a result of that investment choice.

A good example here is a private firm looking to build a shopping centre. If the benefits to the firm of building a new shopping centre outweigh the costs to the point where the rate of the return on that investment is larger than they could achieve by investing in some alternative — the new shopping centre would go ahead. But what doesn’t turn up in this sort of CBA are the benefits accrued by the *public* from the shopping centre (such as reduced travelling time to obtain goods and services as well as employment).

Nor do the costs borne by the public from the shopping centre turn up in this type of CBA such as increased traffic congestion around the shopping centre, increasing the  commuting time for those that have to drive past the new development on their way to work. The CBA for the firm is only interested in the costs and benefits that apply to the firm and not the costs and benefits that are externalised onto others.

Another issue that commonly arises with this type of firm level CBA is the length of the future time period over which all costs and benefits are measured. As a result of modern shareholder and broader market expectations having a larger focus on the relative short term performance of firms and their investment activity, what we find is that CBA analysis increasingly has to justify an investment over a much shorter period of time than it once did.

So an investment that might have run at a net loss for a decade before earning squillions from then on (earning a huge net private benefit over a long period of time), is harder to justify at the firm level these days (harder to justify to shareholders and the broader market) than an investment that is expected to run at a net loss for a much shorter period before earning substantially less than squillions from then on (turning a net private benefit quicker, but one which is smaller in magnitude than the longer term alternative).

As a result of this shorter term, firm level focus — firm level CBAs are generally time constrained, forced to use a shorter interval of time over which to judge any cost-benefit differential.

Some commentators are making the mistake of believing this type of CBA on the NBN is appropriate — they are wrong. The NBN is a piece of public policy, not an exercise in measuring private net benefit.