Unit costs – what do they mean?

Both the G8 Social Impact Investment Taskforce report and Impact Investing Australia’s report to the G8 have called for publication of unit costs of government services, in order to encourage social innovation and social investment. The assumption behind this seems to be that:

If people know the cost of delivering something, then
They might develop a preventative social program that allows these costs to be avoided, which
Saves the government money, and
Delivers better social outcomes for the population.

Well this may be true for things like employment services, where the government saves cash by not paying unemployment benefits. But you might not get a lot of enthusiasm from some other parts of government. And that’s because a reduction in demand for government services doesn’t necessarily mean that government saves money. In order for this to happen, costs must be able to be recouped i.e. they must be marginal, reflecting the additional cost to the system of more people requiring more services. Marginal costs represent what can be saved if this government service isn’t required. So it all depends on how government spending currently occurs.

Let’s take a look at types of unit costs and how they are calculated. And then see what this means using the reoffending unit cost examples from the NSW Government’s Office of Social Impact Investment:

Unit cost	How is it calculated	NSW example	What does it mean?	What’s it useful for?
Average operating cost	Divide entire budget, (including the cost of things like the head of the department and their staff) by service units e.g. total nights spent in custody in one year	It costs Corrective Services NSW $189 per day to keep an inmate in custody.	Savings may result in response to reduced demand if a prison or wing of a prison closes, but only if staff are sacked and the prison is not maintained.	Useful for governments to benchmark their costs against other governments or identify trends in their expenditure over time.
Cost of time and other items	Work out how much time is spent on something and the salaries of the people spending that time. Add in any incidentals like photocopying, petrol, travel.	It costs NSW Police $2,696 to finalise an offending event in court.	This represents time that could be spent on other tasks- If the number of crimes drops, Police are more likely to reallocate their time, than be sacked. Time, rather than money, is saved.	Useful for governments to analyse ways to better allocate human resources.
Capital expenditure	Look at budget for new buildings in response to increasing demand.	This was not a cost given by NSW Government, but new prisons can cost several hundred million.	If demand can be reduced by a certain proportion and maintained for a certain period of time, a new prison may be avoided and the amount budgeted for it maybe saved.	Useful for looking at long-term government budget allocations and thinking about the best ways to spend a given amount of money.
Marginal cost (sometimes referred to as cashable savings)	The cost of things purchased specifically for one more unit of service i.e. new trainers, toothbrush, appointments with psychologists, water for washing clothes, food for one more person.	It costs Corrective Services NSW $19 per day for every additional inmate in custody	Every time a unit of service is avoided, the government can avoid spending this much money.	Useful for people outside government to understand their potential impact on government expenditure.

If we assumed that cash recovered from NSW marginal costs were used to fund preventative services, we would:

take the $19 per day marginal cost
multiply it by the 49% of unsupervised parolees that reoffend within 12 months^[1]
multiply it by the average 1.8 proven offences they commit in within 12 months^[2]
multiply it by the 31% of those proven offences that are sentenced to prison^[3]
and multiply it by the 8 out of 12 months we expect these people to spend in prison from those sentencing (average sentence is 486 days^[4] and average time of entry during 12 months post-release is around four months after release^[5]).

Then we’d have $3.48 per person per day to spend on our services over the first 12 months. Not a lot.

This doesn’t mean that it’s not worth spending money on preventative services for people who are released from prison. It just means that we need to realise that this isn’t a ‘no brainer’ for government and that it’s a serious spending decision that has to be weighed up against other uses for the cash. It’s certainly not the hugely misleading ^[6] calculation put forward in the G8 Social Impact Investment Taskforce report:

“Say, for example, that a £10 million, five-year SIB for reducing recidivism delivers an 8% financial return and significant social impact by succeeding in rehabilitating 1,000 youth offenders, each of whom would have cost the UK government £21,268 a year. Using the Unit Cost Database gives a value for the social outcome in just the first year of £21 million, and an associated social return per annum of about 15% (internal rate of return) for the SIB” (p.16).

In order for unit costs to be useful, we need to be informative and realistic about what they represent. Marginal costs will reduce as demand falls. But people quoting average operating costs back to government as if they represent savings? Not so helpful.

[1] http://www.dpc.nsw.gov.au/__data/assets/pdf_file/0003/168339/Statement_of_Opportunities_2015_WEB.pdf p8

[2] http://www.dpc.nsw.gov.au/__data/assets/pdf_file/0003/168339/Statement_of_Opportunities_2015_WEB.pdf p8

[3] http://www.dpc.nsw.gov.au/__data/assets/pdf_file/0003/168339/Statement_of_Opportunities_2015_WEB.pdf p8

[4] http://www.bocsar.nsw.gov.au/agdbasev7wr/_assets/bocsar/m716854l11/nswcustodystatisticsdec2014.pdf p22

[5] http://www.dpc.nsw.gov.au/__data/assets/pdf_file/0006/168873/Market_Sounding_-_Reducing_reoffending_and_return_to_custody.pdf p12

[6] Six fallacies of this calculation can be read here http://www.themandarin.com.au/5274-will-publishing-unit-costs-lead-social-investment/