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4.2 Economic Efficiency

4.2.1A project is ‘economically efficient’ if it offers net benefits to the NI economy. The economic efficiency criterion is satisfied by demonstrating that the benefits to NI from the proposal exceed the costs, taking account of all the costs and benefits arising, both quantified and unquantified. As indicated above, any significant impacts elsewhere in the UK should also be considered and weighed into the investment decision. Economic efficiency is normally tested by applying the standard steps of appraisal, as indicated in the Basic Steps table above.
4.2.2Accordingly, every proposal to provide assistance to the private, voluntary and community sectors should be subjected to an economic appraisal, with appropriate and proportionate effort, based on the general 10-step guidance in NIGEAE.
4.2.3Assistance is provided in various contexts and for numerous different reasons, for instance in pursuit of economic, social or environmental objectives. Thus the appraisal requirements can vary significantly from area to area, and the precise approach often needs to be tailored to suit the type of spending under consideration.
4.2.4For example, DETI has specific methods for assessing assistance to industry, tourism and research and development. Likewise, DARD has specific guidance on appraising assistance to the agricultural industry and other Departments have their own guidance suited to the types of assistance they offer.
4.2.5

For details of the methods used in particular programmes of assistance, the relevant Departmental economists should be consulted.

Displacement
4.2.6Displacement should be taken into account in economic appraisals for all types of financial assistance. Displacement is the degree to which an activity promoted by government policy is offset by reductions in activity elsewhere. Displacement reduces economic efficiency. A modest degree of displacement may be acceptable, but more substantial displacement may constitute grounds to refuse an application for assistance.
4.2.7For instance, this may be the case where a proposal appears likely to succeed largely by diverting business from other NI firms or service providers. To provide assistance in such circumstances can represent poor value for money and may result in a legal challenge by competitors whose businesses are threatened. Thus it is generally important to identify the potential for displacement and assess its impact. The assessment should focus on displacement within NI, but if there are likely to be important displacement effects elsewhere in the UK, these should also be identified and appraised.
4.2.8

Displacement may occur in the product, service or factor markets in which the applicant operates. For example, in a product or service market, assisting a firm to develop its business may cause a reduction in the business of other companies in the same sector; or development of community facilities may lead to a reduction in the use of other similar facilities in the surrounding area. Basic questions which appraisals should address regarding the product/service market include:

  1. Who are the applicant's competitors within Northern Ireland? (They may be other firms producing similar products, or other voluntary groups or community service providers producing similar facilities/services).
  2. Is the market growing, and what share of the business is the applicant likely to take?
  3. Is the applicant's proposal likely to have a significant impact on the business of particular competitors? Will it damage their viability or threaten closure?
  4. Are there likely to be any important displacement effects elsewhere in the UK?
4.2.9Displacement may also occur in the labour market. For example, an applicant's proposal may displace significant labour from other employers in NI labour markets. The level of displacement of an employment creation programme, or of individual proposals to safeguard jobs or that involve redundancy, should be assessed by examining the characteristics of the relevant jobs, in relation to the characteristics of the local labour market. Where potentially large changes to employment are in view, a thorough analysis of the local labour market may be required. If, however, only small changes in employment are likely, then a less detailed analysis may be more appropriate.
4.2.10When considering whether to offer assistance designed to safeguard employment in a particular firm, a basic consideration is whether the assistance is necessary to do this. The local labour market might also be analysed in terms of age, skills and experience of those whose jobs are being safeguarded, and how these compare with the characteristics of the unemployed, particularly the long term unemployed, and those who have recently found employment. The analysis might also assess the likelihood of new investment in the region in the event that the job losses occurred, accounting for the inflow onto the local labour market of labour with particular skills and experience.
4.2.11

Generally, displacement will tend to be greatest, and of most concern, under the following circumstances:-

  • the greater the existing excess capacity in the market;
  • the larger the increase in market output arising from the project;
  • the longer the excess capacity is expected to persist, that is, when it is structural rather than cyclical;
  • the greater the share of the market to be served by the project which otherwise would be served by other NI suppliers;
  • the newer and more efficient the capacity that will be displaced.
4.2.12Where displacement is expected to be small, it is normally enough to document its likely nature and extent. Where it is considered to be significant, the benefit stream in the relevant NPV calculation should be reduced accordingly, in order to provide a more meaningful calculation of the prospective stream of net benefits to the economy. It may be helpful to undertake the NPV calculation both with and without adjustment for displacement in such cases.
4.2.13Substitution is a particular form of displacement in the labour market which should be considered in relevant cases. It is the extent to which those who gain from a policy do so at the expense of an equivalent loss to others in the labour market. This may occur when a firm substitutes one activity for another similar activity to take advantage of government assistance. For example, if an incentive is given to employ long term unemployed workers, then a firm may substitute an applicant who is in long term unemployment for another applicant who is not, leading to no overall increase in employment.
4.2.14

In general, substitution is undesirable and should be minimised. For instance, if substitution is significant, the net exchequer cost of the programme may be unacceptably high. However, some substitution may be acceptable when the totality of a proposal is taken into account. In some cases it may even be desirable. Taking the previous example, redistribution of jobs may contribute to a specific policy aim, such as getting more of the long-term unemployed to work.

Competition Effect of Subsidies
4.2.15In December 2006 the Office for Fair Trading published specific Guidance on how to Assess the Competition Effects of Subsidies, which may be accessed via its Public Subsidies page. This guidance focuses on assessing the impact of displacement in cases where the government provides support, in the form of a subsidy, to firms engaged in the production of goods and services. A subsidy is defined in the OFT guidance as a “grant, soft-loan, loan guarantee, tax break or benefit in kind, granted through government resources that affects the costs of at least one recipient undertaking”.
4.2.16This guidance, which applies to subsidies of more than £500k to a firm with greater than 5-10% of the affected market, sets out a number of steps which must be undertaken to fully assess the likely impact of subsidies.
4.2.17

Should the results of this analysis indicate that the subsidy is likely to affect the competitiveness within markets these impacts must be included in the economic appraisal.  Combining the results of the competition assessment into the economic appraisal will allow one of four conclusions to be reached;

  • the subsidy is unlikely to distort competition significantly and the competition effects have no influence on the decision to proceed;
  • the subsidy is likely to give rise to significant distortions but can be redesigned to reduce these.  The redesigned subsidy would proceed if it is likely to give rise to benefits which exceed the costs;
  • the subsidy is likely to give rise to significant distortions that cannot be reduced further.  However the benefits of the subsidy outweigh its costs and therefore the subsidy is justified; or
  • the subsidy is likely to give rise to distortion to competition that outweigh the likely benefits and therefore the subsidy is not justified.

Regeneration
4.2.18

The following specific issues should be addressed in the appraisal and evaluation of regeneration projects:

  • The Rationale. This needs to make clear:
    • Who the intended beneficiaries of the project are;
    • What structural benefits are expected as a result of the project; and
    • The means by which these will be achieved.
  • The Objectives. The objectives of regeneration programmes are likely to include improvements in one or more of the following:
    • Labour supply and skills;
    • Quality of Life;
    • Physical Environment; and
    • Local business opportunities.
  • Outcomes. These should be identified with respect to the relevant intermediate objectives. Regeneration outcomes might include:
    • Reductions in crime;
    • Improvements in the capacity of community organisations; or
    • Increases in local income or employment.
  • Partnerships. Partnerships between the local community, business and government are important for the sustainability of regeneration projects and the well-being of local communities. Most local regeneration projects involve partnerships, and are likely to have some effect on existing institutional relationships. An appraisal should include a description of the partnership and, where possible,its expected impact on the area. The use of social capital indicators, such as those developed by DSD, may help to capture the value added of voluntary and community-based activity in addition to conventional performance indicators of economy, efficiency, equity and effectiveness.See Report on Research into Evaluating Community-Based and Voluntary Activity in Northern Ireland (DSD Voluntary and Community Unit, 2003).
  • Further information on social capital indicators can be accessed at Toolkit to Measure the Value of Added Voluntary and Community Based Activity.
4.2.19Government intervention in the economy is sometimes undertaken with an employment objective in mind. In other cases, although employment is often retained as a principal objective, the justification for intervention is more far-reaching and the objectives tend to be more broadly cast. This is typical of regeneration projects.
4.2.20Where programmes have multiple objectives, such as environmental improvements, these other additional benefits (and any associated costs) should be covered in the appraisal, together with employment impacts. The geographical focus of regeneration projects means that it can be important to assess displacement effects at both the local and regional levels, particularly if the programme or project is substantial.

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