Social Cost Benefit Analysis

SCBA also called economic analysis, is a methodology developed for evaluating investment projects from the point of view of the society as a whole. Used primarily for public investment q SCBA aids in evaluating individual projects q Spell out broad national economic objectives q Allocation of resources to various sectors q SCBA is concerned with tactical decision making within the framework of broad strategic choices defined by planning at the macro level.
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Evaluation on the Basis of Benefits

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Benefits refers to the addition to the flow of national output occurring from a project. Real & Nominal Benefits Direct & Indirect Benefits Tangible & Intangible Benefits

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Evaluation on the Basis of Costs

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Project Cost Associated Costs Real & Nominal Costs Primary or Direct Costs Indirect or Secondary Costs

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Rationale for SCBA

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In SCBA the focus is on the social costs & benefits of the project. These often tend to differ from the monetary costs & benefits of the project. The principles sources of discrepancy are: Market Imperfection Externalities Taxes & Subsidies Concern for Savings Concern for redistribution Merit Wants
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Principles Sources Of Discrepancy (Details)

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MARKET IMPERFECTION: Market prices reflect social values only under condition of perfect competition which are really realized in developing countries. COMMON SOURCES OF MARKET IMPERFECTION IN DEVELOPING COUNTRY

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Rationing Prescription of minimum wage rates Foreign exchange regulation.

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Approaches of SCBA
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Two principle approach for SCBA:

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UNIDO Approach Little-Mirrlees Approach

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UNIDO Approach
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UNIDO method involves five stages:

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3. 4. 5.

Calculation of financial profitability measured at market prices Obtaining the net benefit of the project measured in terms of economic (effective) prices Adjustment for the impact of the project on savings & investment Adjustment for the impact of the project on income distribution Adjustment for the impact of the project on merit goods & demerit goods
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Net Benefit in Terms of Economic (Efficiency) Prices

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Also referred to as shadow prices Market prices represent shadow prices only under conditions of perfect markets So, shadow prices need to be developed & economic benefit need to be measured in terms of these prices
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Shadow Pricing
Choice of Numeraire l The unit of account in which the value of inputs or outputs is expressed

What unit of currency (domestic or foreign)? Current values or constant values? With reference to which point- present or future? In terms of consumption or investment? With reference to which group?

UNIDO Numeraire: net present consumption in the hands of people at the base level of consumption in the private sector in terms of constant in domestic accounting unit. 5/30/12

Concept of Tradability
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For tradable goods, the international price is a measure of its opportunity cost to the country

Substitute import for domestic production & vice versa Substitute export for domestic consumption & vice versa

Hence, the international price, also referred to as the border price, represent the real value of the good in terms of economic efficiency
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Sources of Shadow Prices

UNIDO approach suggests three sources of shadow pricing: 1. Increase or decrease the total consumption in the economy 2. Decrease or increase production in the economy 3. Increase or decrease export or import

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Shadow Pricing Measurement

Sources of Shadow Pricing Basis of shadow pricing

Increase/ decrease of Consumer consumption Willingness to pay Increase/ Decrease of Cost of production production Increase / Decrease of Foreign exchange export / import value
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Types of Project Product

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Non tradable input & outputs: When import price is greater than its domestic cost of production & export price is less than its domestic cost of production. Tradable inputs & outputs Externalities
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Externalities
Characteristics
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It is not deliberately created by the project sponsor but is an incidental outcome of legitimate economic activity It is beyond the control of the persons who are affected by it, for better or for worse It is not traded in the market

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Externalities
Examples of Beneficial External Effect: l An oil company drilling in its own fields may generate improve the transport system in that area l The approach roads built by a company may improve the transport system in that area l The training program of a firm may upgrade the skills of its workers thereby enhancing their earning power
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Externalities
Can be measured by indirect means: l What the neighboring oil fields would have spent to obtain the information l The value of better transport may be estimated in terms of increased activities & benefits derived from these l Benefit from the training program may be estimated in terms of the increased earning power of workers
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Example of Harmful external Effect

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A factory may cause environmental pollution & people living adjacent to it may be exposed to health hazards Airport in a certain area may raise noise level considerably in the neighborhood A highway may cut a farmers holding in two adversely affecting his physical output

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Harmful external Effect

Can be measured by indirect mean: l Cost of pollution in terms of loss of earnings as a result of damage to health & cost of time spent for coping l Cost of noise from difference in rent l Effect of highway on consumer willingness to pay for output

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Measurement of the Impact on Distribution

Groups UNIDO approach seeks to identify income gains & losses by the followings: l Project l Other private business l Govt. l Workers l Consumers l External sector
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Measure of Gain or Loss

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Difference between the shadow price & the market price of each input or output

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Savings Impact & its Value

UNIDO method seeks to answer the following questions: l Given the income distribution impact of the project what would be its effects on savings? l What is the value of such savings to the society? Impact on savings =i iY MPS Where i Y= change in income of group i due to the project i MPS= marginal propensity to save of group i 5/30/12

Income Distribution Impact

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Can be determined directly by the planner For different income groups relative weights can be assigned Using elasticity of marginal utility of income wi=(b/Ci)n

Where Wi = Weight attached to income at Ci level b= base level of income that has a weight of I n = elasticity of the marginal utility of income

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Adjustment for Merit & Demerit Goods

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Adjusting for the difference between social value & economic value

Estimate the economic value Calculate the adjustment factor as the difference between the ratio of social value to economic utility Multiply the economic value by the adjustment factor to obtain the adjustment Add the adjustment to the net present value of the project

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