Assessing Risk and Uncertainty in Economic Development Projects (2011) (CEDCP) Background. Economic development projects have the potential to carry substantial risk and uncertainty. At times, the level of risk is one reason why projects need to be incentivized by a government. It is important to know how risk and uncertainty could affect expected results from the project and to identify the potential impacts on the government. An analysis of risk and uncertainty will provide key information to allow decision-makers to judge whether or not the project should proceed under the proposed terms. Such an analysis will also assist in negotiations and identification of terms that may mitigate risk or uncertainty for a government.
For many economic development projects, the ability to analyze risk and find ways to best mitigate it, identify potential conflicts of interest, and successfully negotiate related issues may be beyond the expertise of government staff. Proposer analysis requires knowledge of risk analysis, economic and fiscal impact assessment approaches, reasonable development assumptions, and current information on the overall economic development market and trends. Further, even if they have the expertise, government staff may not have access to or knowledge of relevant data. Conversely, developers will almost always have the expertise to mitigate their risk and potentially move it to the government. As a result, governments should consider the use of expert advisors when appropriate.
Recommendation. The Government Finance Officers Association (GFOA) recommends that governments considering proposed economic development projects incorporate an analysis of risk and uncertainty as part of their overall feasibility analysis of such projects. GFOA also recommends that governments identify the potential impact from identified risks and uncertainties on expected outcomes. Examples of risks and uncertainties related to economic development projects include:
- Risk and uncertainty associated with the market the project is attempting to capture
- Risk and uncertainty of government revenues from the project
- Risk and uncertainty associated with government costs and resource requirements
- Risk and uncertainty with regard to government financial and/or credit status and if a financial guarantee or credit enhancement is provided, e.g., a debt service guarantee or moral obligation.
- Risk and uncertainty that the project will be completed or built when or as anticipated
- Risk that other expected outcomes may not occur as anticipated and that governmental goals will not be achieved
- Risk and uncertainty of future legislative actions and regulatory change by any level of government that may adversely impact a project and its funding.
- Risk associated with a government’s ability to carry out its responsibilities with regard to and economic development program or project
As part of the analysis, the finance officers should use sensitivity analysis and other modeling techniques to determine the impact of uncertainty on likely outcomes. Sensitivity analysis will help a government evaluate how an economic development strategy or project will perform when key assumptions are varied, (e.g., different occupancy rates for a hotel). Sensitivity analysis can also help quantify and model the magnitude of this uncertainty. Sensitivity analysis should also be used to identify failure boundaries (the level for an assumption at which the project fails). These failure boundaries can then be analyzed as to what operating conditions would cause these boundaries to be reached.
If necessary expertise does not exist on staff, GFOA recommends that governments should retain contractual expertise to assist with risk and uncertainty identification, analysis, development of mitigation strategies, and subsequent negotiation of those mitigation strategies. It may also be appropriate for the proposed developer to reimburse the government for the cost of these experts as a normal component of the project’s submittal/development costs. Where external expertise is utilized, the finance officer should actively manage consultants engaged in risk and uncertainty analysis. The identification of risk and uncertainty and their evaluation is in part subjective and can be difficult to analyze. When there is subjectivity, the biases or preferences of experts as well as resource constraints (getting the work done within the contract price) could impact project results unless there is active governmental oversight. A government should carefully review proposed tasks and approach and continually review work in progress to help ensure the quality and validity of the final work product.
Approved by the GFOA’s Executive Board, October, 2011.