Assessing net community benefit in the Victorian planning system

Posted October 18, 2022

  • Local government
  • State government
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Statutory planning practice in Victoria has struggled with the concept of net community benefit since the advent of this term in the Victoria Planning Provisions in 1996. This paper explores the reasons for the continuing controversy surrounding how the idea of net community benefit might be applied in the planning system and proposes some ways forward.

Cost benefit analysis and net community benefit

Cost benefit analysis is the primary means by which economics as a discipline influences public policy. These days, no government initiative of any significance — be it a spending or regulatory measure — will be implemented without first being tested for economic efficiency.

The initiative in question will be deemed efficient if it improves community welfare compared to a base case where life goes on without the mooted project, spending program or regulation. Community welfare in this context is not a collectivist concept; it represents the sum of the individual preferences of each community member. Some individuals may place a high value on the benefit promised by the initiative — say, access to a new community facility such as a cycleway — while others may be indifferent as they don’t care for cycling as a transport or recreational option.

If an individual truly values the benefit on offer from the policy initiative, they are assumed to be willing to pay for it, regardless of whether access will be priced. Much of CBA practice is about estimating and aggregating what individuals are willing to pay for anticipated positive effects of a policy initiative.

Often these benefits have no market price, so economists have to resort to indirect measures of willingness to pay. Even when there is a market price, economists must investigate ‘consumer surplus’, the extra amount, over and above the market price, that some individuals would be willing to pay for the service or product. It is in the imputation of benefit value that much of the controversy in cost benefit analysis resides.

Resource and opportunity cost

As well as potentially delivering benefits valued by the community, implementing a new policy will come at a cost. Resources of land, labour, capital and environmental assets that, in the base case, could have been used to deliver other benefits will have to be diverted to the production of benefits promised by the initiative under consideration. These resources have an opportunity cost.

The resource costs of the policy are typically measured at the market price of the land, labour and capital deployed to policy implementation. Where non-priced environmental resources - like clean air and healthy streams — may be ‘consumed’ as part of the policy, value must again be determined based on willingness to pay in the community.

Cost benefit analysis identifies the additional costs incurred by the community in diverting from the base case towards the policy case and contemplates whether these are outweighed by the benefits gained in making the diversion. Often, the timing of costs and benefits will vary, requiring both streams to be expressed in ‘present value terms’. This brings into play another core concept in economics: the ‘social discount rate’.

Social discount rate

This is premised on the assumption that individuals and communities would need to be compensated if they are to be persuaded to defer enjoyment of the proceeds from using land, labour and capital from today to a future period.

To give up a $1 benefit today for a promised return in 5 years, the amount received in that future period would need to be greater than $1 to compensate for foregone interest, inflation and risk. In other words, a nominal $1 received in a future period has a lesser or ‘discounted’ value compared to a $1 received today. This discount can be expressed as an annual interest rate — that is, the amount by which the $ foregone today would need to accumulate in value to provide an amount at a future time which is on par with the current value in the eyes of the person who is making the investment.

Kaldor Hicks rule

Cost benefit analysis as applied in public policy cannot work without a further, more philosophical, concept known as the Kaldor Hicks rule. This provides licence to aggregate and compare costs and benefits across the community regardless of their incidence on individual members of that community.

With this rule in place, the efficiency test becomes one of whether those who gain in welfare from the policy initiative — estimated by their willingness to pay — could, in theory, compensate those who would suffer a loss of welfare and still be ‘in front’. This is known as ‘net community benefit’.

CBA requires rigour and discipline. As a tool in public policy practice for almost a century, conventions have developed to ensure comparability and accountability in these analyses. Nevertheless, it is clear there is considerable room for professional divergence on preferred methodologies. As with any other social science, the evolution of estimation theories and methodologies is governed by the scholarly peer review process.

Cost benefit analysis and regulatory impact assessment

CBA is routinely used in assessing the welfare impacts of all types of regulation other than planning. Across the nation, any policy change which is anticipated to have a significant impact on business and the community generally will typically be subject to a Regulatory Impact Assessment. Under these assessments, it needs to be demonstrated that the direct and indirect costs of compliance with the proposed regulation or policy will be outweighed by the benefits of regulation.

Federal and state governments have set up entire agencies, along with extensive assessment guidelines, for ensuring the appropriate review of new regulations. Notable examples include:

Indeed, Australia is considered an international leader in regulatory review and assessment, as assessed by the OECD.

Cost benefit analysis in planning

Before discussing how and why CBA and NCB might enter into planning deliberations, it is important to be clear about what we mean by the planning system.

Urban planning is a system of regulations on land use and development intended to optimise welfare in the city building process within sustainability limits. Regulation of land use and development through the planning system is necessary because of ‘market failure’, specifically, the presence of externalities, and natural monopoly in the provision of urban infrastructure.

The legislative architecture of urban planning typically involves three elements, all of which are evident in Victoria’s system:

  1. The plan making process, that is, the procedures that must be followed for land use and development policies and standards to become law
  2. The scope or substantive content of plans, that is, the adopted strategies and development standards pertaining to urban development; these may variously relate to the scope of development impact assessment, land release and infrastructure co-ordination strategies, built form rules and infrastructure funding mechanisms, to name a few, and
  3. The processes and procedures by which development consent decisions are made and reviewed.

Benefits of an effective urban planning system

An effective urban planning system would be expected to deliver, or contribute to, the following benefits:

  • Avoiding inter-property negative externalities: these typically include overshadowing, overlooking, noise intrusion and air pollution and other emissions which might unreasonably compromise the utility of neighbouring properties were a land use or development proposal for another property to proceed.
  • Creating and protecting positive externalities at the inter-property/precinct/neighbourhood scale: this pertains to neighbourhood character, heritage values, cultural values and other distinctive and appreciated features of a place that might be vulnerable to ‘inappropriate’ development.
  • Creating and protecting positive externalities at the suburb, town, metropolitan and regional scales: these externalities relate to the welfare gained by communities through a ‘designed’ versus a laissez-faire urban future. Examples include saved congestion and vehicular emissions by creating public transport-friendly and active transport-friendly urban forms, generating productivity gains by building clusters of related firms and producing vibrant town centres by managing retail and related flows into hierarchies of activity nodes.
  • Beneficially deploying the ‘city shaping’ power of major infrastructure investments (such inter-urban freeways and metropolitan rail), thereby increasing the flow of Wider Economic Benefits (WEBs) from such projects, including agglomeration-linked productivity gains.
  • Saving costs in providing lower order ‘structural’ and ‘follower’ urban infrastructure. These benefits include avoidance of wasted infrastructure capacity, or failure to provide infrastructure, when development takes an ad-hoc rather than orderly sequence in a given service corridor.
  • Conserving natural resources/protection from inappropriate development.

The benefits of sound urban planning are summarised in the following chart. The shaded values require reference to some form of designed future or vision for urban development. That is, they cannot be fully or even partially delivered through a case-by-case effects based regulatory regime.

SGS economics and planning assessing net community benefit paper diagram
SGS Economics and Planning

Divergent views about the scope of impacts

Practising planners and economists looking at the same evaluation exercise may follow different rules or conventions in deciding what impacts to count and how. A good example relates to the job impacts of development proposals. It is commonplace within a planner’s matrix evaluation to count the jobs generated by, say, a new supermarket development as a positive social impact of the proposal. Within an economist’s cost benefit analysis framework, these jobs would typically not be counted as a benefit partly because the supermarket may simply redistribute retail expenditure, and the jobs that go with it, from somewhere else close by. Thus, there is no net gain in employment across the district in question compared to what would have happened in the base case.

Moreover, employment is typically counted as a cost in cost benefit analysis because labour is being diverted away from some other productive use. For these reasons, economists will usually only count job creation as a benefit where the project in question is bringing labour into production which would have otherwise remained ‘idle’. This is counterintuitive for many planners, as evidenced by the routine citation of ‘jobs created’ as a benefit in matrix evaluations of development options.

Undefined subsidiarity in planning deliberations

Cost benefits analyses are usually applied in line with protocols and guidelines established by state governments. Not surprisingly, these guidelines require the analysis to be conducted for the whole community aligned to state boundaries. This means that local benefits cannot be credited in a cost benefit analysis if they are offset by costs incurred outside of the local area and vice versa. This creates a perplexing situation for many planning assessments which are, in the main, focussed on a local community.

Scepticism over the achievability and desirability of monetising impacts

A defining characteristic of cost benefit analysis is that it seeks to express all impacts in dollar terms, as far as possible, by assessing willingness to pay via a range of well-rehearsed techniques. In terms of urban development propositions, cost benefits analyses have featured the valuation of a range of impacts which, at first glance, appear to be beyond monetisation. These include social capital enhancement, preservation of cultural heritage, preservation of sunshine to parks and improvements to public realm vibrancy.

Good cost benefit analysis practice compels the analyst to document their assumptions and workings to support third-party scrutiny. Nevertheless, implicit in observed practice rejects the idea that a dollar value can be placed on things treasured by the community which are ‘above the market’.

Reluctance in planning to separate efficiency and distributional questions

Because of the Kaldor Hicks ‘rule’, cost benefit analysis neatly separates the question of efficiency — that is, whether the project makes the community as a whole better off — from that of fairness — that is, are the costs and benefits equitably distributed across the various groups in the impacted community.
The standard economist’s defence of this separation is that policy makers should, first of all, be concerned with growing the welfare cake and, after that, devise appropriate taxation and compensation arrangements to ensure that the initiative in question is equitable. In observed planning practice, there is typically a reluctance to make this separation, partly because there are not the tools, within the planning regulation arena, to redress any adverse distributional impacts. In effect, planners are wont to apply the Pareto principle in preference to Kaldor Hicks in their assessments.

Final words

Unlike all other areas of public policy regulation, the making of statutory town plans and the determination of development consents are not required to operate within a net community benefit framework governed by cost benefit analysis. There appears to be no compelling justification for this. The explanation for the odd separation of planning regulation from all other forms of regulation judging net wellbeing and sustainability effects seems to be that planning legislation predates, by many decades, the advent of formal regulatory impact assessment.

The planning critique of cost benefit analysis, revolving around questions of separating distributional from efficiency issues, the invalidity of monetising certain impacts and lack of consensus in defining ‘community’ for evaluation purposes, amongst other issues, certainly has merit. However, these issues are not unique to planning policy and development approvals. They arise in other areas of public policy, where it is established practice to regard cost benefit analysis as one, albeit essential and nonnegotiable, input to the decision-making process.

In other areas of regulatory impact assessment, cost benefit analysis at least provides one common reference point around which the debate about the net community merit of a particular proposal may be judged. This is preferable to a situation where evaluation frameworks have to be relitigated on a case-by-case basis, as seems to be the situation with planning regulation.

There is a strong case for extending the regulatory impact assessment process in Victoria to include regulations, as recommended by the Legislative Council Environment and Planning Legislation Committee in its 2013 report. This is not to say that the process should replace existing review processes, such as Planning Panels, entirely. Rather, regulatory impact assessments (including CBAs) prepared in line with government guidelines should form one routine component of evaluating major plan making and development approval decisions.

The value of cost benefit analysis in a planning context is not that it provides a definitive answer for the proposition under evaluation. Instead, the principal contribution of cost benefit analysis is in providing a flexible but consistent framework for ordering the arguments for and against the planning change.

Undoubtedly, a conclusion on net community benefit based on the Kaldor Hicks principle — which largely sets aside distributional impacts and typically adopts a geographically large definition of ‘community’ — will not satisfy all parties to planning deliberation. However, it provides a starting point for a focussed discussion on what distributional impacts are acceptable or not, what scale of community should be applied and what impacts should be admitted in assessing net community benefit.

This article is an excerpt from a paper written by Dr Marcus Spiller. The paper represents the views and opinions of the author and may not represent the views of all team members at SGS Economics and Planning.

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