COST DRIVERSCOST DRIVERSThe budget is a plan that links The budget is a plan that links government services with their government services with their

financing. There are factors that financing. There are factors that powerfully influence the cost of powerfully influence the cost of

providing services and thus impact the providing services and thus impact the budget. These factors are often budget. These factors are often

referred to as referred to as budget driversbudget drivers. They . They include:include:

1. Prices1. Prices. . . .

All the inputs required to provide All the inputs required to provide services, including personnel, services, including personnel,

equipment, supplies etc., have prices equipment, supplies etc., have prices associated with them. Wages or associated with them. Wages or personnel costs are the personnel costs are the pricesprices

associated with hiring the people associated with hiring the people needed. Equipment and supplies also needed. Equipment and supplies also

have prices. Price changes change have prices. Price changes change budgets.budgets.

General increases in all prices General increases in all prices

= inflation= inflation

Changes in the price of a Changes in the price of a particular item, in relation to all particular item, in relation to all

others others

= relative prices = relative prices

Good budget planning accounts Good budget planning accounts for both kinds of price changes.for both kinds of price changes.

Inflation: a fact of life nearly Inflation: a fact of life nearly everywhere everywhere

Failure to budget for inflation Failure to budget for inflation probablyprobably means a budget reduction, because this means a budget reduction, because this year’s amount of money year’s amount of money generallygenerally cannot cannot purchase the same goods and services purchase the same goods and services that were purchased in the past year. that were purchased in the past year.

Inflation Adjustment?Inflation Adjustment?

If the government’s forecast projects If the government’s forecast projects inflation at 4 percent, we might simply inflation at 4 percent, we might simply increase an agency’s budget by this increase an agency’s budget by this amount automatically, amount automatically, if if we believe that we believe that the agency was properly funded the agency was properly funded andand that that it’s costs will rise by about the same it’s costs will rise by about the same amount as general inflation. amount as general inflation.

Inflation AdjustmentInflation Adjustment

But we might also propose a special index But we might also propose a special index for a sector. This might reflect relative for a sector. This might reflect relative prices for energy, housing, transport or prices for energy, housing, transport or health.health.These sectors might be growing in relative These sectors might be growing in relative price or even decreasing in relative price.price or even decreasing in relative price.An example could be that a new natural An example could be that a new natural gas field may start producing and lowering gas field may start producing and lowering energy prices. energy prices.

Particular PricesParticular Prices

While inflation is a very While inflation is a very important price factor, it important price factor, it must also be recognized must also be recognized that changes in particular that changes in particular prices can suddenly prices can suddenly modify a budget. This modify a budget. This happens when the price happens when the price of a particular item (such of a particular item (such as school text books or as school text books or energy) represents a energy) represents a significant share of a significant share of a spending unit’s total spending unit’s total costs.costs.

ExampleExample

A simple adjustment for A simple adjustment for inflation may not be inflation may not be sufficient for an sufficient for an organization, or a organization, or a country, where fuel country, where fuel constitutes a large share constitutes a large share of its overall costs. of its overall costs. Forecasts can be subject Forecasts can be subject to big errors. Fuel prices to big errors. Fuel prices are quite volatile.are quite volatile.

Oil in Euros and Dollars

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May-03 Jun-03 Jul-03 Aug-03 Sep-03 Oct-03 Nov-03 Dec-03 Jan-04 Feb-04 Mar-04

Fuel CostsFuel Costs

The previous slide showed the start of The previous slide showed the start of steep rises in fuel costs in 2004steep rises in fuel costs in 2004

Today, those prices are over $67 per Today, those prices are over $67 per barrel and unstablebarrel and unstable

These types of relative price changes will These types of relative price changes will have a tremendous effect on the cost of have a tremendous effect on the cost of public servicespublic services

2. Quantities2. Quantities. .

Quantity is the second major cost driver and Quantity is the second major cost driver and simply refers to the amount of services provided. simply refers to the amount of services provided.

OutputsOutputs

Such as the number Such as the number of children vaccinated of children vaccinated

Or the number of Or the number of students students

Or the number of Or the number of textbooks purchasedtextbooks purchased

Or the number of Or the number of teachers hiredteachers hired

Inputs Inputs

Such as the amount Such as the amount of vaccine needed of vaccine needed

Or the number of Or the number of textbooks required for textbooks required for each studenteach student

Or the number of Or the number of students per classstudents per class

WorkloadWorkloadAlways a quantity factorAlways a quantity factor

Workload Workload

Determining how changes in workload Determining how changes in workload relate to changes in costs and budgets is relate to changes in costs and budgets is not always straightforward. Budget not always straightforward. Budget organizations may be able to absorb organizations may be able to absorb additional work at little or no additional additional work at little or no additional cost. This may be because they are not cost. This may be because they are not currently using resources efficiently or currently using resources efficiently or because they have excess capacity, such because they have excess capacity, such as a new hospital with few patients and as a new hospital with few patients and empty beds. empty beds.

Unit costsUnit costs

Budget analysts often assume there is no Budget analysts often assume there is no excess capacity and that the cost of excess capacity and that the cost of absorbing additional workload is equal to absorbing additional workload is equal to the number of additional work units the number of additional work units multiplied by its unit cost. If unit cost multiplied by its unit cost. If unit cost information is not available, we often information is not available, we often simply assume that an increase (or simply assume that an increase (or decrease) in workload will increase (or decrease) in workload will increase (or decrease) activity costs proportionately. decrease) activity costs proportionately.

ExamplesExamples

We will need We will need approximately 1 new approximately 1 new grade school teacher for grade school teacher for every 35 students that every 35 students that enroll. If 105 new enroll. If 105 new students enroll, we will students enroll, we will need 3 new teachers.need 3 new teachers.But will a 10% increase in But will a 10% increase in students result in a 10% students result in a 10% increase in the cost of increase in the cost of operating a school? operating a school? Why?Why?

ExceptionsExceptions

While some costs, like the number of While some costs, like the number of teachers, classrooms and textbooks might teachers, classrooms and textbooks might be expected to increase proportionately be expected to increase proportionately with the number of students, other costs with the number of students, other costs such as those for central administration such as those for central administration may be relatively fixed. Making these may be relatively fixed. Making these kinds of adjustments will depend on the kinds of adjustments will depend on the quality of information available and the quality of information available and the good judgment of the analyst. good judgment of the analyst.

Good Judgment Makes Good Good Judgment Makes Good AnalystsAnalysts

Good judgment and experience is Good judgment and experience is particularly important when information is particularly important when information is weak. The experience or personal weak. The experience or personal knowledge of an analyst can “fill in the knowledge of an analyst can “fill in the blanks” in available data. Someone who blanks” in available data. Someone who has worked for years in education can has worked for years in education can make better estimates when school data is make better estimates when school data is not known or verified.not known or verified.

Assumptions Assumptions

When we estimate the budget implication When we estimate the budget implication for changes in workload, we almost always for changes in workload, we almost always assumeassume that services will continue to be that services will continue to be provided in the same way as they are provided in the same way as they are currently. This “current services” currently. This “current services” assumption does not imply that the current assumption does not imply that the current way of doing things is good or even way of doing things is good or even adequate. It can often be improved!adequate. It can often be improved!

3. Quality3. Quality. .

Generally, we can think of quality as a Generally, we can think of quality as a predetermined standard. In government, predetermined standard. In government, such standards are most often applied to such standards are most often applied to inputs, such as the student to teacher inputs, such as the student to teacher ratio. ratio.

QualityQuality

There is also increasing attention being There is also increasing attention being given to quality as measured by the final given to quality as measured by the final results of a budget activity. results of a budget activity.

For example, the percentage of school For example, the percentage of school children who are considered to be properly children who are considered to be properly educated could be determined by standard educated could be determined by standard achievement tests.achievement tests.

More Quality = More ResourcesMore Quality = More Resources

Increases in the quality of services will Increases in the quality of services will usually require additional resources.usually require additional resources.

Improving student performance, for Improving student performance, for example, may require additional funds to example, may require additional funds to reduce the student to teacher ratio by reduce the student to teacher ratio by hiring more teachers.hiring more teachers.

Improving computer courses may cost Improving computer courses may cost new equipment and specialized teachers. new equipment and specialized teachers.

Quality and ResourcesQuality and Resources

The important thing for a budget analyst is The important thing for a budget analyst is to think about exactly which additional to think about exactly which additional resources will be required to achieve the resources will be required to achieve the desired change in quality: desired change in quality:

More computers? Better tests? Different More computers? Better tests? Different kinds of teachers? New Textbooks? More kinds of teachers? New Textbooks? More hours in Class? More homework?hours in Class? More homework?

4. Technology4. Technology/Methodology/Methodology

What tools and methods do we use? What tools and methods do we use?

We could buy people or computers. And the We could buy people or computers. And the people may not work for government, but people may not work for government, but for a contractor with special teaching for a contractor with special teaching equipment. The computers could have equipment. The computers could have unique teaching programs; or programs unique teaching programs; or programs that we can buy from a store.that we can buy from a store.

Methodology/TechnologyMethodology/Technology

The The processprocess chosen will drive chosen will drive costs.costs.

For example, if we use distance For example, if we use distance learning, we will need many learning, we will need many fewer classrooms, but we will fewer classrooms, but we will also need specially trained also need specially trained instructors.instructors.

Methods/TechnologyMethods/Technology

Different methods or technology will Different methods or technology will normally change input costs and could normally change input costs and could also change the results we achieve.also change the results we achieve.

For example, distance learning methods For example, distance learning methods may allow may allow moremore students in students in severalseveral regions to take a course that was regions to take a course that was previously limited to one location. The previously limited to one location. The results of the course will be different.results of the course will be different.

SummarySummary

Drivers =Drivers =PricesPrices

QuantityQuantity

QualityQuality

TechnologyTechnology