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ANNEX 2: AN ECONOMIC PERSPECTIVE

The optimal amount of commercial activity: balancing costs and benefits

1. The importance of bringing to the fore the often intangible nature of some of the costs and benefits is highlighted when one considers what the optimal level of commercial activity should be, or, which particular activity a school should choose when presented with a potential range of activities (which may include the null option of no activity.) From an economic perspective, the optimal level of commercial activity occurs at the point where the marginal benefit from commercial activity is equal to the marginal cost. Therefore any increase in activity beyond this point will result in the marginal costs exceeding the marginal benefit. This seemingly simple decision is rendered difficult when the intangible nature of some of the costs and benefits are taken into account.

2. For example, consider a school deciding whether to install a soft-drink vending machine. If the vending machine will simply cause pupils to purchase their drinks from the vending machine rather than from the local shop, such that their overall consumption of soft drinks remains unchanged, then there is no incremental change on some of the costs associated with drinking sugar-saturated soft drinks - the outcome on individual health and behaviour in the classroom would be the same whether the school had the vending machine or not. However, the school may not know what the consumption of soft-drinks currently is and thus may not know whether the installation will lead to an increase (simply observing how many cans are sold via the machine is not sufficient to know what the incremental increase is). Furthermore, it may be too costly for the school to engage in any research activity leading to more informed opinion on the likely outcomes. Thus, the effect of the vending machine, the incremental difference it could make, is difficult to observe.

3. Even if schools were able to precisely observe these effects, it is not always obvious as to whether the trade-off between costs and benefits is optimal. For example, if the vending machine is expected to lead to a marginal increase in poor classroom behaviour (say an extra one hour of classroom disruption over the entire year), is it optimal for the school to have the machine if it generates £100 income per annum? Or £1,000 or £100,000?

4. Given the uncertainty surrounding the effects of activities, the uncertainty over the value of these effects, and the costly nature in terms of time, effort and money of resolving this uncertainty, decision makers may adopt simplifying heuristics, or rules of thumb, in choosing which activities to accept. Whilst this is an entirely reasonable and rational approach, certain rules may systematically lead to sub-optimal outcomes. In other words, decision makers try to act rationally, but under conditions of uncertainty, may make systematic (and often entirely predictable) errors. For example, decision makers may systematically omit from their decision-making process, or underestimate, those costs and benefits which are difficult to observe or value. Supposing that the costs are typically more difficult to observe than the benefits (this is entirely plausible given that one of the benefits, revenue derived, is typically more easily observable and quantifiable than other benefits and costs), are there any predictable consequences for the outcomes and the probability of choosing the optimal commercial activity? Unsurprisingly there are; if costs are systematically undervalued relative to benefits, then the balance of costs and benefits will be skewed and there will be an oversupply of commercial activity (and vice versa).

5. Similarly, in choosing between commercial activities with different levels of observable and non-observable benefits and costs, selection will be biased towards those with the relatively more observable benefits and unobservable costs. For example, a school may choose to install a vending machine rather than run a book club, on the basis that the former raises significantly more income for the school. However, it is plausible that the higher unobserved benefits of the book club and the higher unobserved costs of the vending machine may combine to make the book club the optimal choice. These types of systematic errors made by decision makers may be thought of as market failure caused by information problems. Market failures such as these are often used as the motivation for government intervention and/or production of guidance.

6. Time cost is one element of the cost of commercial activity that is possibly easier to measure and value. Time devoted to certain tasks is measurable and may be reasonably converted to a monetary value using wage rates. When the time used to complete these tasks is undertaken by staff using their private hours indicates the burden of the cost has shifted to the teachers rather than falling on the school (although it is possible that these teachers will be unable to undertake some other school-related task, such as marking, which they would otherwise do out of school hours and thus the school has suffered some of the cost.) From a social perspective, when determining whether an activity is desirable or not for the stakeholders, one should incorporate all the costs regardless of where they fall. This means that if schools are making decisions on behalf of themselves, their staff and the community they serve, they should be including the cost of staff time consumed in their own private time as much as if it were consumed during school hours. Ignoring the efforts of staff in their own private time is one source of bias in measuring costs that could lead to skewed amounts and types of commercial activity being adopted.

7. The removal of 'unhealthy' vending machines and their replacement with 'healthy' machines could have a financial cost for the schools involved in terms of lost revenue. Nevertheless removal of the vending machines would be optimal if the loss in financial income was offset by the estimated monetary value of the increase in healthy outcomes for the pupils. Indeed, the success of the Hungry for Success initiative, which drew explicit attention to the role of vending machines and has influenced many school's policy on these machines, may be viewed as identifying exactly the type of market failure that leads to sub-optimal amounts and types of commercial activity. If the health costs of machines had been adequately taken in to the cost-benefit decisions taken by schools prior to the initiative, then the introduction of the initiative would have had a minimal impact on the decisions of schools. That significant amounts of schools have changed their policy on vending machines as a result of the initiative, indicates that they may have underestimated or ignored this cost in their original decisions. Thus Hungry for Success represents the type of government initiative/intervention that may be used to effectively redress biases in the amount and types of commercial activity engaged in by Scottish schools.

8. As section 4.51 has shown, interviewees in the current study felt that it was easier to identify the benefits rather than the costs associated with commercial activity. The extent to which this may have been a problem in the past has been illustrated by the example of the impact of the Hungry for Success. The extent to which this may be a problem in the present can be deduced by identifying any similar systematic deviations. Where decision makers feel benefits are easier to observe and incorporate in a decision making process, this implies that perhaps too much activity is taking place. However, by delving into the decision making processes used in practice by schools, it is clear that the majority of them are trying to avoid completely omitting costs they find difficult to measure. Examples include the dominance of ethical costs, which have not been given a monetary value, over all potential benefits. It appears as if current practice is partially geared towards making sure decision makers do not underestimate potential costs. The consequence of this approach is that they may systematically over-estimate costs.

9 Nevertheless, there are still examples of perhaps systematic errors in determining costs. Possibly the biggest bias is where schools appear to ignore staff time that occurs out of school hours. There appeared to be a tendency in some, though by no means all, decision making processes to exclude the time that teachers donated in their out-of-school hours to certain tasks. If schools are making decisions on behalf of the school, pupils and staff, then the costs of the time given by staff out of the school should not be excluded from decisions. Furthermore, even if schools are not making decisions on behalf of teachers, the commercial activity may limit the time teachers have to donate to other tasks which may benefit the school and so this opportunity cost should also be included in any decision.

10. Whilst recognising and making efforts to avoid omitting the cost consequences of activities, it was less obvious that decision makers were applying the same rigour to potentially omitted benefits. Though there is evidence to suggest that is not true in all cases. For example the promotion of fair-trade produce was argued to yield difficult to measure benefits in encouraging pupils to think about being ethical consumers that in excess of the additional obvious costs of the produce. There may, however, be instances in which potential benefits could be overlooked.

Displacing economic activity and pupil choice

11. Activity which may potentially be seen as highly inappropriate may appear less so, even beneficial, when considering whether the activity has displaced consumption rather than created it. Two examples from the case studies illustrate this. In one school, vans which sell chips had been invited on to the school premises. On face value and in light of the emphasis on healthy eating promoted by Hungry for Success, this would seem an inappropriate activity for the school to permit. However, the existing alternative was that these vans would congregate across a busy road from the school, inviting pupils to cross this road thus leading to obvious health and safety risks. Given that the school was unable to dissuade pupils from using this service, it was felt optimal to allow the vans on the premises. Any additional increase in consumption by marginal consumers ( e.g. pupils who would have been dissuaded by having to cross the road) is then more than offset by the reduction in safety concerns. In addition, the school took the opportunity to attempt to influence pupil choice away from chip vans by inviting a 'healthy-eating' van to occupy a prominent position with a seating area.

12. Similarly another school, which ran its own line of branded water and lower-fat crisps, attempted to displace consumption from less healthy traditional brands by chilling own-brand drinks and warming the traditionally-favoured soft drinks. If these actions have not created any additional consumption and have simply displaced activity, then there is no incremental cost to the activity, which highlights the importance of incorporating what would have been as well as what is happening into the decision-making process.

13. These examples also highlight the role of pupil choice and the limitations this places on the ability of schools to control behaviour. In the chip van example above, the school may have ideally wished to eliminate this option from the pupils' list of options; however, the reality is that schools may have a limited ability to do so. In most cases, local shops will be in convenient reach for pupils determined to consume goods schools would not want consumed. In some cases, it will be possible to limit choice, for example switching off vending machines at times when pupils are required to remain on the school premises.

14. The 2 examples above show how schools, rather than attempting to restrict choice, have instead attempted to influence pupil choice. In the case of the own-brand water, the school has identified a key factor in pupil choice, the coldness of the drinks and by warming the traditional soft drinks, has reduced the benefit to the individual and made them less appealing relative to the healthier options. This is an economically sophisticated approach, recognising that pupil choice is a function of the mix of product characteristics - price; taste; coldness; convenience; healthiness. The school has identified which characteristics are amenable to manipulation (in this case coldness) and set them to suppress demand for the good they would like pupils to consume less of. They may also attempt to educate pupils to incorporate a characteristic of the product that they had systematically omitted, in this case the healthiness of the product.

15. In the case of the healthy eating van, the school has created another option to compete with the chip vans and, by providing a seating area and prime location, the school has again sought to influence those factors which may underlie pupil choice. In schools which promote fair trade produce, pupils are asked to consider what factors they should consider when buying produce and whether they would be happy paying slightly more for a good if they were assured the additional money would benefit others.

Summary

• The conditions would appear to be in place to cause an information-led market failure in determining the optimal amount and types of commercial activity occurring in schools. Specifically, the main information problems affecting decisions are:
• 1. Inability to observe the incremental effects, specifically identifying the difference between displaced and new consumption.
  2. A number of difficult to observe or value benefits and costs, leading to a potential tendency to make decisions on a limited subset of observable outcomes (such as income generated)
  3. An uncertainty about what costs should be incorporated. For example a tendency to treat volunteered time as costless.
• The expected consequences of these problems are an under-supply of activities which have relatively high difficult-to-observe benefits and an over-supply of activities which have relatively high difficult-to-observe costs. Similarly, activities which displace consumption may be confused for activities which create consumption and, if it is consumption of an economic 'bad' ( e.g. chips or sugary drinks), this may lead to an under-supply of these activities.
• Systematically ignoring costs, such as volunteered teacher time, leads to an over-supply. Volunteered teacher time should be included in the decision making process as, even if the school does not wish to take into account a cost to teachers, it may represent an opportunity cost to the school in that the teacher may not volunteer that same time to do something else for the school.
• If the information problems are too costly to be resolved by individual schools, then government guidance can be used as a means to address these problems. The classic example is given by the Hungry for Success initiative, which has addressed the issue of schools systematically ignoring the health and behaviour costs of increasing consumption of fizzy drinks. Many schools and local authorities have reported removing vending machines, or changing their contents, as a result of this advice. If such advice were redundant and schools had adequately considered the difficult-to-observe costs, then the effect of guidance would have been negligible.
• The research has also identified the role of pupil choice in consumption choices. Schools may only be able to marginally influence the set of options that the pupils may choose from. Banning some options from school premises may have little effect if the pupils are able to purchase these products elsewhere, i.e. displacement working in the other direction. The research has highlighted a number of schools that, rather than restricting choice, have sought to influence the factors that pupils incorporate into their decision-making process; by educating pupils about the factors they should incorporate (healthiness of product) and/or by manipulating those factors (convenience, coldness of drinks, etc.)
• Thus, there exists a role for intervention guidance which can serve as good practice in aiding decision makers acting under conditions of uncertainty. This will not lead to perfect decisions, but can help decision makers avoid making systematic errors. The guidance should also be geared towards improving the decision-making process rather than simply identifying which activities should or should not be permitted. Inviting chip vans on to school premises initially seems a dubious move, but, when realising the decision makers have very strong grounds to believe it has displaced, rather than created, consumption and, in addition, has reduced an important safety cost as well as providing an opportunity to push for consumption of a healthier good, the decision looks justified. Thus, guidance can provide sensible decision rules which can be applied in local conditions to make optimal outcomes more likely.

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