Dissertation. The concept of cost benefit analysis

Contents

TOC o “1-3” h z u HYPERLINK l “_Toc354472410” Summary PAGEREF _Toc354472410 h 1

HYPERLINK l “_Toc354472411” Introduction……… PAGEREF _Toc354472411 h 2

HYPERLINK l “_Toc354472412” Costs and Benefits PAGEREF _Toc354472412 h 3

HYPERLINK l “_Toc354472413” Risk and Uncertainty PAGEREF _Toc354472413 h 4

HYPERLINK l “_Toc354472414” Discount Rate PAGEREF _Toc354472414 h 5

HYPERLINK l “_Toc354472415” Empirical / Contextual literature review PAGEREF _Toc354472415 h 5

HYPERLINK l “_Toc354472416” Methodology PAGEREF _Toc354472416 h 9

HYPERLINK l “_Toc354472417” Conclusion PAGEREF _Toc354472417 h 13

HYPERLINK l “_Toc354472418” References PAGEREF _Toc354472418 h 16

SummaryWith the recent hosting of the London Olympics, and the speculation surrounding its costs and benefits, such a mega event may bring, or not as some sceptics argue. I see it only seems fit as to carry out a cost benefit analysis in order to come to a conclusion weather a large scale investment of this nature would be beneficial for any future countries wishing to taken on a financial burden of this nature. The motivation behind the choice of a cost benefit analysis is that this allows me to not only measure the implications of costs and benefits in monetary terms, it allows me to take into consideration non-monetary costs and benefits, which is key for any government making this sort of investment. As benefits can not only be measured in monetary terms, it also allows creating a degree of measurement for these non-monetary implications. Countries have various motivations in their efforts to gain an event of this stature, the belief that economic growth will be generated; a development of infrastructure can be attained through supporting developments and maybe even acceptance into the modern world for developing nations. Many a institutions and bodies who help promote the growth and generate forecast to highlight the potential benefits offered through various economic models, with somewhat unrealistic and exaggerated economic benefits. With previous host nations not obtaining anywhere near these speculations and the actual results being a lot less. What this cost benefit analysis will allow me to then do is measure the actual results of previous hosting, in a matter that can then express the true economic implications of event of this stature. This will ultimately then allow me to come to the conclusion based on factual economical evidence weather the Olympics is the economic stimulus the Olympic committee claim it to be, or whether it is really “fool’s gold” (Baade and Matheson, 2002)

IntroductionIn the last couple of years, the concepts of Olympic Games have come to be regarded as one of the most important mega-international sporting activities/events (Roche, 2000). The increasing number of nations and cities who are bidding to host these events as well as the increasing level of funds that are invested in these bids are indicative that local leaders do perceive that securing an Olympic event holds a great value in terms of the economic and social benefits via the accumulated investment that is initiated by staging such a mega event (Malfas et al,2004).In this paper, we aim at demystifying such a notion through an elaborate cost-benefit analysis of the London Olympic Games.

The concept of cost benefit analysis

By using a Cost Benefit Analysis what this allows is a decision maker such as the government, to list all the costs and benefits a project is going to effect and the different sectors in the economy this may affect. However not all cost and benefits are numerically measurable and these will have to be quantified to be able to carry out this process. Through a cost benefit analysis what this then allows us to bring is an estimation of the implications of hosting this event through a universal indicator. This instrument allows policy makers to then make a decision on whether or not to take a certain course of action, and if that course of action was too undergo, what the expected outcomes would then be.

When using a cost benefit analysis the procedure will either be used for an investment type decision, such as whether a particular event should go forward, or for a decision making process as to which path should be taken, for example to make a decision amongst numerous different options. If we were then to further take the Cost Benefit Analysis into an economic approach what we are then defining is the welfare and the affects the investment will have on these defined groups weather this be a nation or a particular demographic. Further implications and considerations of an economic cost benefit analysis would be that of the social effects on people, in terms of changing areas such as their standards of living, increase in happiness and so forth. What this the allowed was for a structure and analysis of the various aspects to take place which consist of the project that is going to take place, the people this may affect, the parameters such as costs and benefits, the risk and uncertainty, inflation, discount rates and so forth. (Snell, M. 1997, Frost, M.J 1975, Perkins, F 1994, Dasgupta, A.K, Pearce, D.W 1972 and Kendall, M.G, 1971)

Costs and BenefitsWhen it comes to the consideration of the costs and benefits of a project there are numerous areas to take into consideration this can consist of, the volume of products and services needed to carry out a task, the amount of space the project will take up and where this will be positioned, how will the people around be affected, what will the impact on the local economy be and finally who receives the benefits and who takes the cost. The largest and most apparent cost is going to be the various levels of construction that take place throughout a project.

Project costs are generally underestimated as people generally say the mostly likely value of a cost not the mean value that it could be, and construction costs are positively skewed which highlights that mean exceeds the mode which then shows that this highlights project costs are generally underestimated. This is very important when considering your estimates as this could be a value that alters on a large scale. Further areas come under what is known as the externalities which may be affected which come at a largely estimated value and they may be hard to measure this is due to the nature of the variable that may be trying to be measured, an example of this could consist of measuring a group of individuals happiness before and after the project. These are hard to create a comparable variable but economists do their best to try measure this by scaling ones happiness through different measurements such as how do they feel about the area they live in on a scale of 1-10. However these measurements are subject to anomalies due to a person’s mood on one particular day may vary to their net happiness, however through gaining a large enough collection of data a reliable average can be generated and used. (Kendall, M.G, 1971, Snell, M. 1997, Treasury Guidance 1997, Sassone, P.G and Schaffer, W.A 1978)

Several prospective studies on the exact economic impact of hosting various mega sport events have confirmed that indeed Olympics can create some level of economic prosperity. A series of ex-ante studies have indicated that there are positive income as well as employment effects and thus indicating that indeed the benefits could exceed the costs. Haxton (1999) notes that it is claimed that Olympic Games could be used by host cities in expanding their economies in relatively short periods of time. The outcome of these ex-ante studies cannot just be trusted. Most ex-ante studies are however noted to suggest that there is indeed a positive economic impact. These studies are noted by Sterken (2006) to somehow exaggerate the economic impacts of hosting an Olympic Games event. According to Baade and Matheson (2002), the ex-ante studies actually exaggerate the economic benefits by a factor of close to ten (10).This is because these studies are claimed to be overoptimistic in their analysis due to the numerous made in the process of estimation (Porter,1999).

In order to find out the cost benefits of hosting an Olympic game, ex-post studies were statistically analyzed with SPSS. A meta-analysis and a meta-regression analysis of the relatively accurate ex-post studies on Olympic Games spanning close to 10 years was conducted. As was the case in the work of van Ewjik (2010), no cases of ex-ante studies were applied in this analysis due to the fact that most of them lack a regression coefficient. Ex-post Olympic games studies are what were used in this study. Modelling of the mega events in these cases were carried out using data derived from ex-post Olympic studies.

Meta-Regression Analysis (MRA) process

Risk and UncertaintyWhat risk and uncertainty allows for is two separate things. Uncertainty covers the idea that the outcomes is probably unknown, undefined or non-consensus, whereas risk covers the probability of an outcome occurring which is either known or estimated the risk could be classified in areas such as what is the risk of a certain outcome occurring other than the one desired . In conjunction with a cost benefit analysis this risk and uncertainty gives the analysis more information in order to make estimates and decisions upon. Uncertainty can be measured through various measures such as a percentage. For example there is a 5% chance that the cost of the build will be 1.5 times the best estimate.

Through the estimation of risk and uncertainty through the creation of a cost of if the outcome would occur this enables precautions and so forth to be put in place to prevent a certain outcome from taking place. Using the previous example, the budget could then be raised, to further take into the consideration that the build may be slightly more, allowing the decision maker to not only make a more realistic decision based on the provided information. It also allows them to base their decisions on their desires as decision makers are risk averse, as they don’t want to be made a fool of if things go wrong. Their utility function is linear as they are just after a net benefit regardless of what that is. (Kendall, M.G, 1971, Snell, M. 1997 Brent, R.J 1998 and Irvin, G, 1978)

Discount RateInstead of using Inflation the discount rate is either used in conjunction or as an alternative, through using just the discount rate we can come to a similar estimation, without over complicating with further variables. What the discount rate allows us to do in a cost benefit analysis is take into consideration the future value and the present value, and with the discount rate come up with a single value that represents the whole time scale, as something that is worth £100 in one year may not be worth the same in future years to come. What this then allows on large scale projects that occur of numerous years is create a single value taking into consideration the changes that will occur. This is still only an estimate but what it does become is a more accurate one.

There are various ways to generate the discount rate; some may do it as a percentage, whilst others may use figures more specific to the project such as the marginal rate of return on investment. Ultimately what this allows for is a realistic estimate to be generated to try generating the most accurate cost benefit analysis possible. (Snell, M. 1997, Kendall, M.G, 1971, Sassone P.G and Schaffer W.A 1978)

Empirical / Contextual literature reviewCost

The various categories can then be broken down into the following context. Costs, in the context of the Olympics this will directly relate to the costs in monetary and non-monetary terms of holding such event.

Monetary

When considering the financial Implications of hosting the Olympics the upfront monetary aspect that any country whom has the desire to bid will be the bidding process itself. It can be a prime example of cost potential host countries will be implied before they are even given the benefit of hosting such a mega event.

Upon successful acceptance of the Olympic Games, governments will have further financial implications to consider, these can consist of the development of the necessary infrastructure, and firstly the development of stadiums would need to take place. If the host city does not have the capacity to cope with the influx of tourists, necessary areas such as transport, roads, accommodation and so forth need to be taken into the financial implications. A prime example of the monetary funds needed to just develop necessary facilities are apparent in the 1996 Olympics which where hosted in the city of Atlanta. This host city had already some of the required stadium facilities to host the Olympic and the renovation of these alongside development of a couple more resulting in an estimated expenditure of $600 Million (USD) according to Baade and Matheson, (2004) further studies by Baade (2006) of more recent Olympics put a monetary costs on the Greek Olympics held in Athens at a staggering $1 Billion (USD).

These costs than need be paid, the problem being is where is the money sourced, these funds are generally substituted from other areas of the economy who receive cuts. This then implies than other areas of expenditure and government spending are now worse off.

What other implications are their once the Olympics are over at the maintenance of these structures, this would be an on-going cost regardless of the structures use. These expansion of structures and industries during the Olympics can not only result in them having continually high maintenance costs afterward but the structures may be disused due to lack of demand.

Non-monetary

However people in the existing areas could be driven out of house and home, the implications behind this being the rise in prices and facilities in that area, the poor people who once lived there can no longer afford.

Benefits

When considering the Implications and the relatively large investment that is required of this nature it is ever apparent that benefits will be apparent, weather this consist in direct financial returns, or bring about other non-financial benefits from the long last affecting any large investment should uphold.

Monetary

Any large event of the stature is bound to bring about the obvious monetary benefits, as any investment is ideally going to result in a level of returns, with an increase in property value.

Non-monetary

In the form of non-monetary benefits areas can undergo regeneration, increasing demand. Host countries status can be brought forward on the global radar, for tourism, business and capabilities. Examples of this can be seen in one of the more recent Olympics in 2008 at Beijing, China. This host was shown to enlighten the world of its capacity to meet the demands of the modern world. Hoping to bring about “Cash and Prestige” as referred to by Greene. (2003)

A further example of benefits is the significant increase in public expenditure that can be seen for that local economy which may not be achieved other as we clearly saw in the example of the 2012 London, UK. Olympics which brought about the mass re-generation of area.

Alternative

So why not the Olympics, considering that the Olympics brings about benefits in more ways then one, the argument against this is that, this money could be better spent on other aspects that would yield better returns for that level of investment.

Problems

Revenues that are raised wont directly go to the direct economy, due to various factors such as, the event itself is held by large corporate bodies returns are taken and spread into these corporate bodies, therefore the local economy could not see a direct benefit. Furthermore jobs that may be created, would result in employees be obtained from the broader economy, what this then results in is the benefits once again been taken away from the economy who carried out the investment. These factors are once again clearly stated in Owen (2005) which are referred to as Leakages.

More problems consist of the people who predict the economic impacts, these people or bodies are general organisations that are going to directly benefit from these investments and commission these studies. The 2000 Olympic Games hosted in Sydney, Australia, predicted to create a $6.3 Billion impact, however this was merely a prediction and the actual impact resulted in about $6.5 Billion impact (Haynes,2011).

The more profound problem with these studies that try to predict the impact of hosting the Olympics, to sell the idea to potential host nations is the assumptions they use, and the assumptions they conveniently forget to put in. Mathesoon, (2006) highlights the way the economic impacts are produced. These consist of construction expenditure, number of visitors, average spend of these visitors and so forth. What Owen, (2005) then highlights is the underlying flaws in their predictions, which indicate the necessary assumptions that are left out. These consist of areas such as monies may be being spent by groups of individuals, this money may be money that they would have already spent in that economy, they simply are substituting it with the Olympics, therefore the Olympics doesn’t actual bring about a return on investment it simply substitutes the revenue streams from other sectors.

This then creates a problem in the local economy as expenditure patterns change; this would ultimately negatively affect the economy and starts creating the opposite which is the desires of such an investment. Further evidence of the academics that bring up this issue of the predictions are Baade and Matheson (2004), who comply with the factors that spending patterns may just change not increase.

From a consumer level this can be taken to a business level. In French and Disher (1997) they analysed the 1996 Olympics held in Atlanta, USA. What they found through evidence and reports from business close and far between the grounds of the Olympics that a drop in business occurred, in the time period of the Olympics, in comparison to prior weeks and the same time period from the previous year.

Further problems are the drop of in demand for these structures once the initial excitement and demand for the Olympics expires. Therefore with the previously mentioned stealing of revenues and capital from other markets, and drop off in use after the hosting of the event can clearly hold that the event of this nature does not bring about the desired implications.

MethodologyThe exact impacts of hosting any given Olympic Games are precisely difficult to estimate or measure (Rosenblum, 2009).These impacts are however normally measured within social, political and financial contexts. The main aim of this research is to explain the truthfulness or fallacies in the positive attributes of hosting Olympic Games. The supposed benefits of hosting Olympics were explored as well as whether the tangible costs of hosting Olympics are less or greater that the perceived tangible benefits. In order to answer my question of “What is the true cost of hosting the Olympics?” A cost benefit analysis was conducted following the lines of the previous structure mentioned in the theoretical framework and empirical review. This consisted of a breakdown of the various cost and benefits such as monetary and non-monetary turning the various aspects into a measurement that can be compared on a nominal level.

The sources from which we gathered the data was through bringing together various individual economic analysis of previous host Olympics with consistent and realistic values in a combination with government published data, to then form our own calculations incorporating the areas of risk, probability and uncertainty alongside with the discount rates. These were then used in the analysis with the countries previous estimations pre-hosting of the Olympics games, during Olympics and then followed by an analysis of post-Olympic games in order to conclude weather the countries that have hosted Olympic games have realistic expectations of the costs and benefits and ultimately weather it brings about a positive impact from an economic perspective. The paper will mainly focus on the analysis of the pre-Olympics, during-Olympics and post-Olympics activities at the 2012 London Olympics, among others, in an attempt to answer the research questions. Other examples that were used are the recent Olympic Games due to the vast nature of information which is also readily available.

The results of the cost benefits analysis would then help us in evaluating whether such a mega event should go forward, or for a decision making process as to which path should be taken, for example to make a decision amongst numerous different options. The main focus will however be on the perceived political, social and financial impact of Olympic Games on a host city. As noted earlier both perceived monetary and nonmonetary benefits of the Olympic Games were noted and then a final stance taken.

Several prospective studies on the exact economic impact of hosting various mega sport events have confirmed that indeed Olympics can create some level of economic prosperity. A series of ex-ante studies have indicated that there are positive income as well as employment effects and thus indicating that indeed the benefits could exceed the costs. Haxton (1999) notes that it is claimed that Olympic Games could be used by host cities in expanding their economies in relatively short periods of time. The outcome of these ex-ante studies cannot just be trusted. Most ex-ante studies are however noted to suggest that there is indeed a positive economic impact. These studies are noted by Sterken (2006) to somehow exaggerate the economic impacts of hosting an Olympic Games event. According to Baade and Matheson (2002), the ex-ante studies actually exaggerate the economic benefits by a factor of close to ten (10).This is because these studies are claimed to be overoptimistic in their analysis due to the process of estimation (Porter,1999).

In order to find out the cost benefits of hosting an Olympic game, ex-post studies were statistically analysed with SPSS. A meta-analysis and a meta-regression analysis of the relatively accurate ex-post studies on Olympic Games spanning close to 10 years was conducted. As was the case in the work of van Ewjik (2010), no cases of ex-ante studies were applied in this analysis due to the fact that most of them lack a regression coefficient. Ex-post Olympic games studies are what were used in this study. Modelling of the mega events in these cases were carried out using data derived from ex-post Olympic studies.

Results

Meta-Regression Analysis (MRA) process

This is a new form of meta-analysis that was developed in order to reduce cases of publication bias (Stanley and Jarrell ,1989).This process of meta-regression analysis began through the collection of the relevant articles from databases. The next step was the identification of the relevant characteristics and then appropriately coding them. This was the most time-consuming part of this research, specific summary statistics had to be chosen. Examples of these are t-values, elasticities and regression coefficients. This summary statistic where then transformed appropriately to a common metric. This made it possible to compare the various results obtained across literature on a common scale. In MRA, this common metric is regarded as the dependent variable. The choosing of the independent variable was the third step in MRA. According to Stanley (2001), the moderator variables or dependent variables are the most important study characteristics. These included the models used in the studies. It is not easy to code all characteristics. Therefore, only the most important ones should be coded. The fourth step was the explanation of the study-by-study variations in the literature of interest.

The collection of the relevant studies

Collection of the relevant literature/studies

For the process of collecting relevant studies to be successful, we had to rely mainly on the studies that were all relevant to the ex-post assessment of economic impact of various Olympic Games.

Coding of the various articles as well as choosing of the summary statistic

Most of the literature or studies that where found were mainly descriptive in nature. This means that they merely stressed the known facts about Olympics. Only 9 studies were used. These studies had the following characteristics;

They focused on at least one mega sporting event

They had an estimation of correlation or causation between factors as well as the economic impact of Olympic Games .

A summary statistic was then created. This is shown in the Table below;

Studies

Author(s) Year of publication Weighted t statistic Significant results

Hotchkiss, Moore And Zobay 2003 3.11 ✓

Ahmar 2008 0.04 X

Jasman and Meannig 2007 0.44 ✓

Kasimati 2006 0.21 X

Matheson and Baade 2002 5.4 X

Rose and Spiegel 2009 0.40 X

Tucker 2006 0.61 X

Sterken 2006 0.61 ✓

Feddersen and Maennig 2010 0.04 X

The moderator variable

The moderator variable was chosen at a geographical level (National or Metropolitan Statistical Area level). Geographical level is a crucial moderator variable that was represented in the MRA by special dummy variable GLi (Gli is 1 for national level and 0 for at an MSA level).The second moderator variable Ei was coined from the reality that the game could be hosted as multiple events or a single event (Ei is 1 if multiple and 0 if it is a single event).Degree of freedom was the last moderator variable. This was used for taking care of any empirical effects.This was denoted as DgroFre

The resulting regression model was as follows;

ti=β0+(β1*GLi)+(β2*Ei)+(β3*DgroFre+ui!)

In this model;

β0-error term found by the average of the t-statistics

β1- differences in weighted t-statistics between various studies focusing on national levels and MSA levels

β2- differences in weighted t-statistics between various studies focusing on multiple events and sing event mega events.

β3- measures the amount of change should DgroFre change with 1

Results of MRA

REGRESSION RESULTS(DEPENDENT VARIABLE Fi) Independent variables Coefficients Coefficients

β0 0.91 2.02

(0.941) (1.726)

β1 1.54 2.02

( 1.456) ( 1.914)

β2 1.60 1.26

(0.900) (1.243)

β3 0.00009

(1.434)

RSquare 0.350 0.611

N 9 9

*=significant at the 0.01 level,**=significantatthe 0.05 level These outcomes indicate that the choice of geographical location and the level or amount of event has a large economic effect if the event is more localised (MRA).The positive correlation between the degree of freedom and the average or weighted t-statistic indicates that an empirical effect exists. This should further be investigated.

Analysis

The data collected supports the thesis that hosting an Olympic event has both its setbacks and benefits though the costs for hosting the event outweigh the perceived benefits. Proponents of the games argue that the capital expenditures of the event have long-term benefits and call for its inclusion in the Olympics total costs. Despite several benefits realised from bidding the games, game-period as well as post-Olympic events, there are critics of the event who argue that event often realise no profits at all (Fleischer & Daniel, 2002). In spite of the various negativity surrounding the London 2012 Olympics Games, this analysis presents findings that the cost of the Olympics were less that the benefits realised by the British government.

The recently concluded 2012 London Olympics led to the creation of more than 50,000 new jobs in the in the Lower Lea Valley area while motivating an additional 20,000 Londoners to move to their previous jobs. The costs related to this venture were approximately £11 million used in funding employment initiatives, training programs among London’s 33 boroughs. However, critics of the Olympics argue that this initiate was possible even without hosting the event since foreign prior to the event move into nearby towns while driving locals to rural areas rendering them jobless. This led to creation of a great opportunity for inward investment and exports of British goods and services though the value to the economy of such an image is not possible to quantify.

However, the huge costs incurred by the Olympics committee were for site preparation and transport infrastructure. This cost approximately £2 billion while the Olympics Village cost about £500m, but despite its re-usability, it is impossible to recoup the capital invested in the facility. In addition, the stadia and other venue costs necessary for hosting the event were at the tune of £1.1 billion. This was due to the use of existing venues such as Wimbledon, Wembley and the O2 Arena, and most of the construction work was complete way before the event and were under budget.

In addition, the event increased tourist revenue which stood at approximately £2 billion prior, during and after the event. The event attracted tourists from across the globe some participants others spectators; and it is approximated the tourism spending during the 2012 London Olympic event increased. Nonetheless, a survey conducted by ETOA dismissed this claim, citing how Sydney and Athens made similar claims that failed to work out. The revenues earned from tourism was used in regenerating some parts of London that has needed such investment for decades and would have cost about £2-3 billion pounds to achieve. The regeneration was subsidised by the private sector with a lot of investment emanating from inward investment through IOC grants and sponsorship from international corporations. This gave Britain a chance to demonstrate that it is a modern, efficient and multi-cultural nation, able to handle logistical, social and engineering problems.

Residency in villages nearby the London Olympics zone increased due to the establishment of more than 40,000 new homes in the zone, half of them in the Olympic village and others around the Olympics Park. This led to the increased employment rates in the surrounding areas and helped regenerate East London. This had the effect of increasing jobs for the locals though construction of new housing in the country could have been possible without the London games and with less capital invested. In addition to the 9,000 new homes built directly in the Olympic park alone, new hospitals, family health services and other community facilities were built to support them. This commitment helped transform the heart of East London, and sped up the process. However, this could have occurred despite the Olympics and thus cannot be traced as a direct benefit of the Games. On the other hand, the construction of the Olympic village led to demolishment of other houses as well which diminished the short-term benefits (Burton, 2003).

Additionally, the other cost of the 2012 Olympics was security. It is approximated that more than £900 million was used for arranging VIP security as well as the security of all the individuals present at the event. Since much of this was funded via wage payments, a significant chunk of this investment ended back in the pocket of the UK Treasury as