The Friction-Cost Method

Abstract

The friction-cost method has been put forward as an alternative to the human-capital method as it allows more realistic estimates of productivity costs to be calculated for use in economic evaluations. The possibility of replacement of (long-term) absentees is at the heart of the friction-cost method. It recognises that society will restore initial production levels after some period of adaptation, the length of which may depend on the availability of labour and, hence, on unemployment. The friction-cost method has received two main criticisms in the literature: (i) it has no theoretical underpinning; and (ii) it treats leisure time as having no value. We demonstrate in a simple 'theoretical' time-allocation model how time use shifts in the friction-cost method and that leisure is not treated as having no value. Rather, it is considered to be valued in terms of QALYs--as is normally the case in economic evaluation. The time-allocation model also demonstrates that when using the friction-cost or human-capital method the changes in the amount of unpaid work and leisure time need to be valued separately. Unpaid production losses from the previously unemployed may be larger than the gain in unpaid production gain of the absentee, resulting in a societal loss of unpaid work or the sacrifice of leisure in order to make up for lost unpaid work. These changes should be incorporated into economic analyses.