Assessing Risk and Uncertainty in Economic Development Projects

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Type: 
Best Practice
Background: 

When governmental organizations decide to undertake an economic development project, the goal is often to create sustainable improvements for the public. However, economic development projects can create substantial risks for governments, and for the public-at-large.  These risks often create the need for governments to either take a leadership role in the project, or to create incentives for others to participate in the project.  Regardless of the potential benefits that may result from a project, governments need to assess the risks related to any potential initiative.  The government must identify and evaluate risks, and determine whether or not these risks are acceptable, or if such risks can be mitigated.  The analysis must not only evaluate risks at the outset of a project, but also throughout a project’s duration.  Some risks may even continue far beyond a project’s completion.

Recommendation: 

Governments should recognize and evaluate risks related to participation in an economic development project before authorizing participation. A project should not be undertaken if risks are determined to not be acceptable, and cannot be mitigated to the point whereupon the project can proceed.  Risk assessment, assuming the project does proceed, should continue throughout the life of the project using a systematic approach.  This assessment should help the government determine when risks are reaching unacceptable levels, and provide guidance on how to control and mitigate such risk.

General Considerations Prior to Risk Analysis:

An organization embarking upon an economic development project should have already evaluated a number of factors, and made certain determinations, before the risk analysis can begin.  There are a number of GFOA Best Practices that address economic development, and each unit of government should determine which best apply to a contemplated project, and use these appropriate Best Practices for guidance.  Key factors and determinations include: 

  1. The government should have clearly established goals for the project and the role and level of involvement the governmental unit will take in the project. 
  2. The government should have identified the expertise required for the economic development project assessment.   The required expertise will depend upon the type of project, the scope of the project, the role of the government in the project, and available resources within the governmental entity.  The government must evaluate the skills necessary in all aspects of the project and determine which of those skill-sets are not already available within the organization.  Expertise required may include, but is not limited to: legal counsel; finance, accounting, and procurement expertise; construction and engineering specialists; demographic and statistical services; environmental experts, etc.
  3. The organization should have already assembled a leadership team to evaluate risks and uncertainty.  This team should be augmented with outside expertise to fill any identified skill-set gaps.  It is important to identify, organize and apply this necessary expertise, in order to properly evaluate all potential risks.  Ideally, this team will facilitate analysis and evaluate risks through a systematic approach focused on two primary aspects: risk severity and risk probability. The team will consider risk tolerance within the scope of the government’s economic development policy.

Identifying and Evaluating Risk and Uncertainty in Economic Development Projects:

Governments should consider that risks will vary depending upon a project’s type, and the level of the entity’s participation.  Risk can be avoided or mitigated even before the project begins if risks are properly identified and evaluated.  Accordingly, it is recommended that a project leadership team:

  1. Identify and evaluate potential risks that are inherent to economic development projects, including but not limited to: 
    1. Project Completion Risk: complete project failure; not achieving results within the intended timeframe or to the desired outcome; an external organization’s failure to perform.
    2. Financial Related Risks: revenues falling short; cost overruns; unexpected operational, maintenance or capital costs after project completion; debt limitations; and debt instruments.
    3. Regulatory/Legal Risks: jurisdictional authority; negative legal actions against the government related to a project; liability and insurance risks; legislation with potential adverse effects.
    4. Operational and Ancillary Risks: Negative environmental impacts; the displacement of other businesses or residences. 
  2. Utilize additional methods for identifying other risks related to the project. Methods may include: brainstorming; interviewing experienced team members, identifying stakeholders and subject matter experts (SME’s); root cause analysis; developing checklists based on historical knowledge or experience with past projects; analyzing the results of feasibility studies; completion of a Strengths, Weaknesses, Opportunities, & Threats  (SWOT) analysis. 
  3. Develop an analytical methodology to evaluate risk levels. Methods may include both informal and formal approaches.  Risk assessment methodologies can also include sensitivity analysis, modeling, matrices, or other methods.
  4. Determine the acceptable and unacceptable levels of risk the government is willing to take.  Unacceptable risks which cannot be mitigated to acceptable levels should help determine whether or not the project will move forward.  
  5. Evaluate the severity and probability of each risk identified with the project under consideration.  Each aspect should be rated from high to low in discernable increments, usually to at least four levels.  An analysis using this methodology might conclude that a moderately high severity with a low probability is acceptable, while a moderate severity with a moderate probability is not. 
  6. Determine if unacceptable risks can be mitigated to acceptable levels.
  7. Consider an aggregate evaluation of all identified risks, to determine whether or not to continue with consideration of a project.
  8. Establish methods and systems to monitor and analyze risk factors throughout the life of the project.  Notably, governments may incur costs or liabilities long after the project is completed.
Committee: 
Economic Development and Capital Planning
Approved by GFOA's Executive Board: 
September 2015
Applicable to Canadian Governments: