Chapter 14 Social Cost Benefit Analysis
Short Description
"Projects" Prasanna Chandra...
Description
CHAPTER 14 SOCIAL SOCI AL COST BENEF BENEFIT IT ANAL ANALY YSIS
OUTLINE •
Rationale for SCBA
•
UNIDO approach
•
Net benefit in terms of economic (efficiency) prices
•
Savins impact an! its val"e
•
Income !istrib"tion impact
•
A!#"stment for merit an! !emerit oo!s
•
$ittle%&irrlees approach
•
Sha!o' prices
•
SCBA by financial instit"tions
•
"blic sector investment !ecisions in In!ia
Rationale for SCBA In SCBA the foc"s is on the social costs an! benefits of the pro#ect *hese often ten! to !iffer from the monetary costs an! benefits of the pro#ect *he principal so"rces of !iscrepancy are + &ar,et imperfections • • -.ternalities *a.es an! s"bsi!ies • • Concern for savins • Concern for re!istrib"tion • Μerit 'ants
UNIDO Approac Te UNIDO !eto" of pro#ect apprai$al in%ol%e$ fi%e $ta&e$'
/ Calc"lation of the financial profitability of the pro#ect meas"re! at mar,et prices 0 Obtainin the net benefit of the pro#ect meas"re! in terms of economic (efficiency) prices 1 A!#"stment for the impact of the pro#ect on savins an! investment 2 A!#"stment for the impact of the pro#ect on income !istrib"tion 3 A!#"stment for the impact of the pro#ect on merit oo!s an! !emerit oo!s 'hose social val"es !iffer from their economic val"es -ach stae of appraisal meas"res the !esirability of the pro#ect from a !ifferent anle
Net Benefit$ in Ter!$ of Econo!ic (Efficienc)* Price$ Sa"o+ Pricin& ' Ba$ic I$$,e$ • Choice of n"meraire • Concept of tra!ability • Concept of sha!o' prices • *a.es • Cons"mer 'illinness to pay
Sa"o+ Pricin& of Specific Re$o,rce$ • *ra!able inp"ts an! o"tp"ts • Non%tra!able inp"ts an! o"tp"ts • -.ternalities • $abo"r inp"ts • Capital inp"ts • 4orein e.chane
Ill,$tration resently5 a ferry service5 operate! privately5 is bein "se! to cross a river *he ferry operator chares Rs1 per person It costs him Rs0 per person 365666 persons "se the ferry service (*his means that the n"mber of persons crossin the river by ferry service thro"ho"t the year is 365666) *he overnment is consi!erin constr"ction of a bri!e over the river It is estimate! that after the bri!e is constr"cte! 05365666 persons 'ill cross the river on the bri!e *he bri!e is e.pecte! to cost Rs 1 million initially an! its ann"al maintenance cost 'o"l! be Rs /65666 It has an in!efinitely lon life Once the bri!e is constr"cte! the ferry operator is e.pecte! to close !o'n the ferry service an! sell the ferry boats for Rs/66566 Re7"ire! + Define the social costs an! benefits of constr"ctin the bri!e5 ass"min that the monetary fi"res iven in the problem represent economic val"es
Sol"tion +
*he social costs an! benefits of bri!e constr"ction may be !efine! as follo's+
Costs *hese consists of the follo'in+ / Constr"ction cost + Rs156665666 (*his is a one%shot cost) 0 &aintenance cost + Rs /65666 (*his is an ann"al cost) Benefits *hese consist of the follo'in + / 8al"e of ferries release! + Rs /665666 ( *his is one%shot benefit) 0 Savins in the cost of ferry operation+ Rs /665666 (*his is an ann"al benefit) 1 Increase in cons"mer satisfaction+ *his is e7"al to 'illinness to pay of 0665666 a!!itional persons 'ho are e.pecte! to "se the bri!e Since the first a!!itional person is 'illin to pay almost Rs 1 (the chare of the ferry operator) an! the late person is 'illin to pay almost nothin (there is no toll for "sin the bri!e) the averae 'illinness to pay of a!!itional "sers5 ass"min that the !eman! sche!"le is linear5 is Rs /36 So the 'illinness to pay of 0665666 a!!itional persons is is 0665666 . Rs /36 9 1665666
-ea$,re!ent of te I!pact on Di$tri.,tion Staes three an! fo"r of the UNIDO metho! are concerne! 'ith meas"rin the val"e of a pro#ect in terms of its contrib"tion to savins an! income re!istrib"tion *o facilitate s"ch assessments5 'e m"st first meas"re the income aine! or lost by in!ivi!"al ro"ps 'ithin the society 4or income !istrib"tion analysis5 the society may be !ivi!e! into vario"s ro"ps *he UNIDO approach see,s to i!entify income ains an! losses by the follo'in+ • ro#ect • Other private b"siness • :overnment • ;or,ers • Cons"mers • -.ternal sector <
*he ain or loss to an in!ivi!"al ro"p 'ithin the society as a res"lt of the pro#ect is e7"al to the !ifference bet'een the sha!o' price an! the mar,et price of each inp"t or o"tp"t in the case of physical reso"rces or the !ifference bet'een the price pai! an! the val"e receive! in the case of financial transactions
Sa%in&$ I!pact an" it$ /al,e &ost of the !evelopin co"ntries face scarcity of capital =ence5 the overnments of these co"ntries are concerne! abo"t the impact of a pro#ect on savins an! its val"e thereof Stae three of the UNIDO metho!5 concerne! 'ith this5 see,s to ans'er the follo'in 7"estions+ • :iven the income !istrib"tion impact of the pro#ect
'hat 'o"l! be its effect on savins> • ;hat is the val"e of s"ch savins to the society>
I!pact on Sa%in&$ *he savins impact of a pro#ect is e7"al to+ ∑ ∆Υi &Si
;here ∆Υi 9 chane in income of ro"p i as a res"lt of the pro#ect &Si 9 marinal propensity to save of ro"p i -.ample As a res"lt of a pro#ect the income aine! ?lost by fo"r ro"ps is + :ro"p / 9 Rs /665666 :ro"p 0 9 Rs 36656665 :ro"p 1 9 %Rs0665666 an! :ro"p 2 9 %Rs 2665666 *he marinal propensity to save of these fo"r ro"ps is as follo's+ &S/ 9 6635 &S0 9 6/65 &S1 9 6065 an! &S2 9 626 *he impact on savins of the pro#ect is+ /665666 . 663 @ 3665666 . 6/6 0665666 . 606 2665666 . 626 9 % Rs/5235666
/al,e of Sa%in&$ r(/%a) I 9
(@,)
r(/%a)(/@ar) @
0
(/@,)
r(/%a)(/@ar) n%/ @@ (/@,)n
@
r(/%a) (/@,)
9 /%
(/@ar)
9
r(/%a) (,%ar)
(/@,)
;here I 9 social val"e of savins (investment) r 9 marinal pro!"ctivity of capital a 9 reinvestment rate on a!!itional income arisin from investment , 9 social !isco"nt rate
Inco!e Di$tri.,tion I!pact &any overnments rear! re!istrib"tion of income in favo"r of economically 'ea,er sections or economically bac,'ar! reions as a socially !esirable ob#ective D"e to practical !iffic"lties in p"rs"in the ob#ective of re!istrib"tion entirely thro"h the ta.5 s"bsi!y5 an! transfer meas"res of the overnment5 investment pro#ects are also consi!ere! as investments for income re!istrib"tion an! their contrib"tion to'ar! this oal is consi!ere! in their eval"ation *his calls for s"itably 'eihin the net ain or loss by each ro"p5 meas"re! earlier5 to reflect the relative val"e of income for !ifferent ro"ps an! s"mmin them
In eneral5 the 'eiht attache! to an income is iven by the form"la+ wi
b
n
ci
;here wi 9 'eiht attache! to income at ci level b 9 base level of income that has a 'eiht of / n 9 elasticity of the marinal "tility of income
A"#,$t!ent for -erit an" De!erit 0oo"$ In some cases5 the analysis has to be e.ten!e! beyon! stae fo"r to reflect the !ifference bet'een the economic val"e an! social val"e of reso"rces *he !ifference e.ists in the case of merit oo!s an! !emerit oo!s A merit oo! is one for 'hich the social val"e e.cee!s the economic val"e 4or e.ample5 a co"ntry may place a hiher social val"e than economic val"e on pro!"ction of oil beca"se it re!"ces !epen!ence on forein s"pplies *he concept of merit oo!s can be e.ten!e! to incl"!e a socially !esirable o"tcome li,e creation of employment In the absence of the pro#ect5 the overnment perhaps 'o"l! be 'illin to pay "nemployment compensation or provi!e mere ma,e%'or, #obs In case of a !emerit oo!5 the social val"e of the oo! is less than its economic val"e 4or e.ample5 a co"ntry may rear! alcoholic pro!"cts as havin a social val"e less than the economic val"e
Little-irrlee$ Approac *here is consi!erable similarity bet'een the UNIDO approach an! the $%& approach Both the approaches call for+ / Calc"latin acco"ntin (sha!o') prices partic"larly for forein e.chane savins an! "ns,ille! labo"r 0 Consi!erin the factor of e7"ity 1 Use of DC4 analysis Despite consi!erable similarities there are certain !ifferences approaches+
bet'een the t'o
/ *he UNIDO approach meas"res costs an! benefits in terms of !omestic r"pees 'hereas the $%& approach meas"res costs an! benefits in terms of international prices5 also referre! to as bor!er prices 0 *he UNIDO approach meas"res costs an! benefits in terms of cons"mption 'hereas the $%& approach meas"res costs an! benefits in terms of "ncommitte! social income 1 *he stae%by%stae analysis recommen!e! by the UNIDO approach foc"ses on efficiency5 savins5 an! re!istrib"tion consi!erations in !ifferent staes *he $%& approach5 ho'ever5 ten!s to vie' these consi!erations toether
Sa"o+ Price$ • *he o"tp"ts an! inp"ts of a pro#ect are classifie! into the follo'in cateories+ tra!e! oo!s an! services5 non%tra!e! oo!s an! services5 an! labo"r • *he sha!o' price of a tra!e! oo! is simply its bor!er price • *he sha!o' (or acco"ntin) price of a non%tra!e! item is !efine! in terms of marinal social cost an! marinal social benefit
U$e of Con%er$ion Factor$ I!eally5 the acco"ntin price of a non%tra!e! item is !efine! in terms of marinal social cost an! marinal social benefit In practice5 the calc"lation of marinal social cost an! marinal social benefit is often a !iffic"lt tas, As a practical e.pe!ient5 $%& s"est that the monetary cost of a non%tra!e!
item be bro,en !o'n into tra!able5labo"r5 an!
resi!"al components *he tra!able an! resi!"al components may be converte! into social cost by applyin s"itable social conversion factors the labo"r componentEs social cost can be obtaine! by "sin social 'ae rate
Sa"o+ 2a&e Rate *he sha!o' 'ae rate is an important b"t !iffic"lt%to%!etermine element in social cost benefit analysis It is a f"nction of several factors+ (i) the marinal pro!"ctivity of labo"r5 (ii) the cost associate! 'ith "rbanisation (cost of transport5"rban overhea!s5 etc)5 an! (iii) the cost of havin an a!!itional amo"nt committe! to cons"mption 'hen the cons"mption of the 'or,er increases as a res"lt of the hiher income he en#oys in "rban employment $%& s"est the follo'in form"la for calc"latin the sha!o' 'ae rate+ SWR 9 c’ /? s (c-m) ;here SWR 9 sha!o' 'ae rate c’ 9 a!!itional reso"rces !evote! to cons"mption / /s 9 val"e of a "nit of committe! reso"rce c 9 cons"mption of the 'ae earner m 9 marinal pro!"ct of the 'ae earner
Acco,ntin& Rate of Ret,rn *he acco"ntin rate of ret"rn (interest) is the rate "se! for !isco"ntin social profits In !eterminin the acco"ntin rate of ret"rn the follo'in consi!erations sho"l! be borne in min!+ • *he f"t"re social profit for all pro#ects m"st be !isco"nte! in the same 'ay • *he acco"ntin rate(s) of interest sho"l! be s"ch that all m"t"ally compatible pro#ects 'ith positive present social val"e can be "n!erta,en • *he acco"ntin rate of interest sho"l! maintain some ,in! of balance bet'een investment an! investible reso"rces+ too lo' an acco"ntin rate of interest 'o"l! lea! to over%investment 'ith inflationary effects an! too hih an acco"ntin rate of interest 'o"l! leave savins "n!er%"tilise! an! res"lt in
SCBA .) Financial In$tit,tion$ *he all In!ia term%len!in financial instit"tions5 IDBI5 I4CI5 an! ICICI (IDBI an! ICICI have no' become "niversal ban,s) appraise pro#ects primarily from the financial point of vie' =o'ever5 they also scr"tinise pro#ects from the larer social point of vie' ICICI 'as perhaps the first financial instit"tion to intro!"ce a system of economic analysis as !istinct from financial profitability analysis I4CI a!opte! a system of economic appraisal in /FGF 4inally5 IDBI also intro!"ce! a system for economic appraisal of pro#ects finance! by them *ho"h there are some minor variations5 the three instit"tions follo' essentially a similar approach 'hich is a simplifie! version of the $%& approach ;e shall !escribe the appraisal proce!"re follo'e! by IDBI IDBI5 in its economic appraisal of in!"strial pro#ects5 consi!ers three aspects+ • -conomic rate of ret"rn • -ffective rate of protection • Domestic reso"rce cost
Econo!ic Rate of Ret,rn *he metho! follo'e! by IDBI to calc"late the economic rate of ret"rn may be !escribe! as a Hartial $ittle%&irrleesE metho! beca"se 'hile international prices are "se! for val"ation of tra!able inp"ts an! o"tp"ts5 $% & metho! is not follo'e! in its entirety *he sinificant elements of IDBIEs metho! are !escribe! belo'+ / International prices are rear!e! as the relevant economic prices an!5 hence5 it is necessary to s"bstit"te mar,et prices 'ith international prices for all non%labo"r inp"ts an! o"tp"ts 0 4or tra!able items5 'here international prices are !irectly available5 CI4 prices are "se! for inp"ts an! 4OB prices are "se! for o"tp"ts 1 4or tra!able items 'here international prices are not !irectly available an! for non%tra!able items (li,e electricity5 transportation5 etc)5 social conversion factors are "se! to convert act"al r"pee cost into social cost
Effecti%e Rate of Protection *ariffs5 import restrictions5 an! s"bsi!ies are "se! to enco"rae !omestic in!"stries an! protect them aainst international competition *he e.tent to 'hich a pro#ect is sheltere! is meas"re! by the -ffective Rate of rotection (-R) It is calc"late! as follo's+ 8al"e a!!e! at !omestic prices % 8al"e a!!e! at 'orl! prices 8al"e a!!e! at 'orl! prices *his ratio is m"ltiplie! by /66 to e.press the -R in percentae terms *he !ata re7"ire! for calc"latin the -R may be arrane! as follo's+ At !omestic prices A Sellin price B Inp"t cost+ *ra!e! Non%tra!e! C 8al"e a!!e!
At 'orl! prices
Do!e$tic Re$o,rce$ Co$t Domestic reso"rces cost (DRC) reflects the !omestic cost inc"rre! per "nit of forein e.chane save! or earne! 4inancial instit"tions "se the follo'in form"la to calc"late DRC A @ B @ C
DRC 9
. -.chane rate P (Q @ R @ S @ T )
;here A 9 ann"al chare on !omestic capital calc"late! at the rate of /6 percent B 9 ann"al !epreciation on !omestic capital assets (other than lan!) calc"late! at the rate of percent C 9 ann"al cost of non%tra!e! inp"ts P 9 sales realisation at international prices Q 9 ann"al chare on importe! capital assets at the rate of /6 percent R 9 ann"al !epreciation on importe! capital assets at the rate of percent S 9 ann"al cost of importe! inp"ts T 9 ann"al cost of !omestically proc"re!5 b"t tra!able inp"ts
P,.lic Sector In%e$t!ent Deci$ion$ in In"ia 8ery broa!ly the principal steps in the p"blic investment !ecision ma,in process in In!ia are as follo's+ /
*he lannin Commission form"lates the five%year plan in!icatin the broa! stratey of plannin5 the role of each sector5 the physical tarets to be achieve! by each sector5 an! the financial o"tlays to be ma!e available for the !evelopment of each sector
0
*he a!ministrative ministries !evelop sectoral plans It is in these plans that the pro#ects of the p"blic sector enterprises are i!entifie! *he i!entification of a pro#ect provi!es the reen sinal for the preparation of its feasibility report
1
*he concerne! p"blic sector enterprise prepares the feasibility report an! for'ar!s it to its a!ministrative ministry
2
*he a!ministrative ministry carries o"t a preliminary scr"tiny of the feasibility report an! sen!s copies of the same to the vario"s appraisin aencies5 namely5 the lannin Commission5 the Department of -conomic Affairs an! the lan 4inance Division of the 4inance &inistry5 an! the B"rea" of "blic -nterprises for their comments
3 *he AD of the lannin Commission carries o"t a !etaile! appraisal *he ob#ective of its appraisal is not only to s"est 'hether to accept or re#ect the pro#ect b"t also to s"est ho' it may be re%form"late! to enhance its technical5 financial5 commercial5 an! economic viability J *he Investment lannin Committee of the lannin Commission !isc"sses the appraisal note of the AD an! recommen!s to the IB the vie' of the lannin Commission on 'hether the pro#ect sho"l! be accepte!5 re#ecte!5 !eferre!5 reform"late!5 or re!esine! G *he IB consi!ers the (a) appraisal note of the AD alon 'ith the vie' of the plannin Commission5 (b) the comments of the B-5 (c) the comments of the plan finance !ivision of the ministry of finance5 an! (!) the note of the a!ministrative ministry If the IB clears the pro#ect5 it sen!s it to the cabinet for its approval *he cabinet enerally accepts the recommen!ation of the IB an! approves its implementation
SU--ARY
In SCBA the foc"s is on social costs an! benefits of a pro#ect *hese often ten! to !iffer from the costs inc"rre! in monetary terms an! benefits earne! in monetary terms by the pro#ect *he principal reasons for !iscrepancy are+ (i) mar,et imperfections5 (ii) e.ternalities5 (iii) ta.es5 (iv) concern for savins5 (v) concern for re!istrib"tion5 an! (iv) merit an! !emerit oo!s
*o'ar!s the en! of the si.ties an! early seventies t'o principal approaches for SCBA emere! + UNIDO approach an! $ittle% &irrlees approach
*he UNIDO metho! of pro#ect appraisal involves five staes+ (i) calc"lation of the financial profitability of the pro#ect meas"re! at mar,et prices (ii) obtainin the net benefit of the pro#ect meas"re! in terms of economic (efficiency) prices (iii) a!#"stment for the impact of the pro#ect on savins an! investment (iv) a!#"stment for the impact of the pro#ect on income re!istrib"tion an! (v) a!#"stment for the impact of the pro#ect on merit an! !emerit oo!s
As per the $%& approach5 the o"tp"ts an! inp"ts of a pro#ect are classifie! into the follo'in cateories+ (i) tra!e! oo!s an! services5 (ii) non%tra!e! oo!s an! services5 an! (iii) labo"r
*he sha!o' price of a tra!e! oo! is simply its bor!er price If a oo! is e.porte! its sha!o' price is its 4OB price an! if a oo! is importe! its sha!o' price is its CI4 price *he sha!o' prices for non%tra!e! items are !efine! in terms of marinal social cost an! marinal social benefit
*he $%& approach s"ests the follo'in form"la for calc"latin the sha!o' 'ae rate (S;R) SWR 9 c’ /? s (c-m)
;hile the all%In!ia term%len!in instit"tions IDBI5 I4CI5 an! ICICI% approach pro#ect proposals primarily from the financial point of vie'5 they also eval"ate them from the larer social point of vie'
*ho"h there are some minor variations5 the three instit"tions follo' essentially a similar approach 'hich is a simplifie! version of the $%& approach
IDBI5 the ape. term%len!in financial instit"tions5 consi!ers three aspects in its economic appraisal of in!"strial pro#ects+ economic rate of ret"rn5 effective rate of protection5 an! !omestic reso"rce cost
*he economic rate of ret"rn is simply the internal rate of ret"rn of the stream of social costs an! benefits
*he effective rate of protection is calc"late! as follo's+ 8al"e a!!e! at !omestic prices % 8al"e a!!e! at 'orl! prices 8al"e a!!e! at 'orl! prices
*ill the mi!!le of the si.ties the mechanism for appraisal an! selection of p"blic sector pro#ects 'as rather primitive *o improve the 7"ality of pro#ect plannin an! strenthen the p"blic investment !ecision ma,in process several steps 'ere ta,en+ creation of the B"rea" of "blic -nterprises establishment of the ro#ect Appraisal Division (AD) in the lannin Commission an! instit"tion of the "blic Investment Boar! (IB)
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