Approaches to Economic Analysis of Projects

MZUMBE UNIVERSITY

FACULTY OF SOCIAL SCIENCES

DEPARTMENT OF ECONOMICS

MSc. PROJECT PLANNING AND MANAGEMENT

ECONOMIC ANALYSIS OF PROJECTS (ECO 603)

2013/2014

TERM PAPER

STUDENT: RODRICK WILBROAD MUGISHAGWE

REG. NUMBER: MSC/PPM/MZC/030/T.13

INSTRUCTOR: DR. NGILANGWA

TASK: INDIVIDUAL ASSIGNMENT

TOPIC

DISCUSSION ON THE THREE MAIN APPROACHES TO ECONOMIC

ANALYSIS OF PROJECTS

SUBMISSION DATE: MAY 2014

LIST OF ABBREVIATIONS

C.I.F - Cost, Insurance and Freight

CBA - Cost Benefit Analysis

F.O.B - Free On Board

GNP - Gross National Product

L-M - Little – Mirrlees

NSB - Net Social Benefit

OER - Official Exchange Rate

SCBA - Social Cost Benefit Analysis

SER - Shadow Exchange Rate

S-VT - Squire and Van de Tak

UNIDO - United Nation Industrial Development Organization

TABLE OF CONTENTS

LIST OF ABBREVIATIONS..........................................................................................................i

1. INTRODUCTION.....................................................................................................................1

2. OBJECTIVES OF ECONOMIC ANALYSIS............................................................................1

3. METHODS OF ECONOMIC ANALYSIS................................................................................2

3.1. UNIDO APPROACH..........................................................................................................2

3.2. LITTLE – MIRRLEES METHOD......................................................................................6

3.3. SQUIRE AND VAN DE TAK (S-VT) APPROACH..........................................................7

4. RELATIONSHIPS BETWEEN APPROACHES OF ECONOMIC ANALYSIS.....................11

5. APPLICATIONS OF ECONOMIC APPRAISAL METHODS IN TANZANIA.........................................13

6. CONCLUSIONS......................................................................................................................15

REFERENCES.............................................................................................................................16

1. INTRODUCTION

Over the years there has been a general consensus among many international institutions,

academicians, politicians and economists that market prices, broadly defined, are not

reliable guides with which to evaluate social costs and benefits of projects. This

agreement is based on a generally accepted doctrine that any departure from the perfectly

competitive paradigm may cause prices to diverge from marginal cost. The theoretical

development of the literature on economic analysis model is based on the theory of

welfare economics, according to which the welfare of a society depends on the aggregate

individual utility levels of all members of that society. Economic analysis had, at first,

used for evaluating public investments in the decade of 1960s and 1970s. In those

decades, this model had got a good emphasis; because public investments in many

countries, especially in developing countries, were immensely increased. Of recent,

economic analysis is also becoming important for private project as more often there is a

possibility for this kind of projects to bring adverse impact to the society.

2. OBJECTIVES OF ECONOMIC ANALYSISThe objective of economic analysis to secure and achieve the value of money in

economic life by evaluating the costs and benefits of alternative economic choices and

selecting an alternative which offers the largest net benefit to the community. Therefore,

it can be said that the main focus of economic analysis is to determine:

1. Economic benefits of the project in terms of a price (shadow price) that reflect

social value.

2. The impact of the project on the level of savings and investments in the society.

3. The impact of the project on the distribution of income in the society.

4. The contribution of the project towards the fulfilment of certain merit wants (self-

sufficiency, employment etc).

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3. METHODS OF ECONOMIC ANALYSIS It may be noted, in this context, that the actual cost or revenues from the goods and/or

services to the organization do not necessarily reflect the monetary measurement of the

cost ant or benefit to the society. This is because these figures are grossly distorted on

account of restriction and controls imposed by the government. Hence a different

yardstick has to be used for evaluating a particular in terms of cost and sacrifice on the

part of the society. Such payments are easily valued at opportunity cost or shadow prices

to judge their real impact in terms of cost to society for the purpose of social cost benefit

evaluation. There are essentially three mainstream and complete works on project

appraisal and shadow pricing, advocated for use in developing countries. These are the

procedures suggested by Little & Mirrlees in 1969 and 1974, The UNIDO by Dasgupta,

Marglin and Sen in 1972 and Squire and Van de Tak in 1975.

3.1. UNIDO APPROACH UNIDO was designed by three economists Dasgupta, Marglin and Sen who come up with

useful publications dealing with the problem of measuring social costs and social

benefits. The UNIDO guidelines provide a comprehensive framework for appraisal of

projects and examine their desirability and merit by using different yardsticks in a step-

wise manner. The desirability is examined from various angles, such as the impact on;

financial profitability of utilization of domestic resources, savings and consumption

pattern, income distribution, and production of merit and demerit goods. These different

aspects are examined in five stages, each stage leading towards a social benefit-cost of

the project.

Stage one

Measures financial profitability from detailed integrated standard analytical tables

enumerating various costs and benefits at the market price and examines profit viability

from investors’ point of view. A good technical and financial analysis must be done

before a meaningful economic evaluation can be made. For this reason, financial

profitability is a prerequisite in all cases. Financial profitability produces an estimate of

the project’s financial profit or the net present value of the project when all inputs and

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outputs are measured at market prices. The first step in stage one is to complete standard

tables of income statement, balance-sheet and cash-flow. The financial income statement

is the central table in this analysis as it is used to record the inputs and outputs of the

project. Cash flow statement is also important here as the financial income statement only

shows the annual profit and disguise investment. The net cash flow is derived from the

financial income statement by standard accounting procedures and is equal to the gross

cash flow (operating profit before interest and taxes plus allowances for depreciation)

minus capital investments.

Net Present value of a Project is calculated as:

(3.1)

Where

Vt = Value of outputs at market price at time t

Ct = Value of inputs at market price at time t

K = Discount Rate

T = Lifetime of the project

I0 = Initial cost at the start of the project.

The project is viewed as financially feasible if NPV > 0.

Stage two

Stage two of the UNIDO approach adjusts the financial costs and benefits to various

distortions introduced by market imperfections by valuing costs and benefits or net

benefits in terms of economic efficiency or shadow prices. Market prices represent

shadow prices only under conditions of perfect markets which are almost invariably not

fulfilled in developing countries. Hence, there is a need for developing shadow prices and

measuring net economic benefit in terms of these prices. For shadow prices, it categorizes

project inputs and outputs into “traded”, “tradable” and “non-traded”. For traded and

tradable, the guidelines use the border prices as the relevant shadow prices, whereas non-

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traded inputs and outputs are broken down into their components and each tradable

subcomponent is valued at border prices, and so on. The residual non-traded components

of commodities are valued at domestic willingness to pay criterion and the labour is

valued at shadow wage rate.

Calculating Net-benefit of the project from social point of view by:

(3.2)

Where,

Vt = Shadow price of Benefit at time t

Ct = Shadow price of Operating Expenses at time t

K = Social Discount Rate

T = Lifetime of the project

I0 = Initial cost at the start of the project.

Stage three

Most of the developing countries face scarcity of capital. Hence, the governments of

these countries are concerned about the impact of a project on savings and its value

thereof. This stage designed to examine the impact of projects on savings and

consumption which are of vital consideration in the choice of alternative investments in

labour-intensive and capital-intensive projects. If saving is assigned great importance, as

should be the case in capital-scarce countries, this stage recommends the rate for

adjustment for savings by which the social value of a dollar investment exceeds its

consumption value.

(3.3)

Where, NS = Net savings impact of a project

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Δ Yi = change in income of group i as a result of the projectMPSi = marginal propensity to save of group i

Adjustment Factor for Savings (AFs)

AFs measure the percentage by which the social value of investment exceeds social value

of consumption.

(3.4)

Where,

MPC = Marginal Propensity to Consume

MPS = Marginal Propensity to Saving

MP = Marginal Productivity of Capital

CRI = Consumption Rate of Interest (social discount rate)

Stage four

Many governments regard redistribution in favour of economically weaker sections or

economically backward regions as a socially desirable objective. Due to practical

difficulties in pursuing the objective of redistribution entirely through the tax, subsidy,

and transfer measures of the government, investment projects are also considered as

investments for income redistribution and their contribution toward this goal is

considered in their evaluation this calls for suitably weighing the net gain or loss by each

group, measured earlier, to reflect the relative value of income for different groups and

summing them.

When more than two groups are involved, weights are calculated by the elasticity of

marginal utility of income. The marginal utility of income is the weight attached to an

income is:

(3.5)

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Where,

wi = weight of income at ci level

ci = level of income of group i

b = base level of income that has a weight of 1.00

n = elasticity of the marginal utility of income

Stage five

In stage five, the UNIDO analysis suggests a methodology for necessary adjustment of

the deviations in economic and social values and difference between the efficiency and

social value of project output, say, between good and bad or merit and demerit goods. It

has been claimed that the analysis of merit and demerit goods is not designed for “purists

in economics who think that economics should be devoid of political or subjective

judgements” (UNIDO 1978). The steps of adjustment procedure are:

• Estimating the present economic value

• Calculating the adjustment factor

• Multiplying the economic value by the adjustment factor to obtain the adjusted

value

• Adding or subtracting the adjusted value to or from the net present value of the

project as calculated in stage four.

The figure below illustrates the concept of the UNIDO shadow exchange rate. Suppose

trade distortions keep the domestic currency overvalued, so that OER is below the

equilibrium exchange rate E.

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The willingness-to-pay for foreign exchange at the margin is given by SER. This is the

price that people are willing to pay in order to acquire the foreign exchange with which to

buy imports or, alternatively, the foreign exchange that is made available from exports.

Given the SER, the benefit of any project under the UNIDO approach may be expressed

as follows:

NB = SER (X - M) – D (3.6)

Where NB = net benefitsSER = Shadow Exchange RateX = Export M = Import D = Value of domestic inputs

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3.2. LITTLE – MIRRLEES (L-M) METHOD

The core of this approach is that the social cost of using a resource in developing

countries differs widely from the price paid for it. Hence, it requires shadow prices to

denote the real value of a resource to society. L-M measures the cost and benefits in

terms of international or border prices because the border prices represent the correct

social opportunity costs or benefits of using or producing traded goods. L-M also

suggested an elaborate methodology for calculating shadow prices of non-tradable.

L-M believe that in all less developed countries, one of the major criteria for the choice

of a project should be its ability to generate savings and, hence, the L-M method suggests

the use of accounting rate of interests to calculate present worth of future annuities of

savings and consumption. The numeraire in the L-M system is defined as uncommitted

government income, which is expressed in terms of border prices by converting into

domestic currency at the official exchange rate (OER). Border or world prices are

preferred under the L-M methodology as they represent a set of opportunities open to a

developing country, given the availability of scarce foreign exchange resources. In this

perspective, traded goods are valued at border prices, with the accounting price of an

export equal to its f. o. b. price. The accounting price of an import is equal to its c.i.f.

value. Where additional exports or imports are likely to influence their respective prices,

the f.o.b. and c. i. f. prices are replaced by marginal export revenue and the marginal

import prices, respectively. The resources (inputs and outputs) of a project are classified

under L-M into mainly; Labour, traded goods and non-traded Goods. Therefore, to find

out the real value of these resources, L-M calculates the shadow wage rate (SWR),

shadow price of traded and non-traded goods.

The valuation of non-tradable at border prices in the L-M system requires a little more

ingenuity. Non-tradable are valued by decomposing their marginal cost of production into

primary domestic inputs (mainly labour), traded and non-tradable goods. Primary inputs

are then valued at their shadow prices; traded goods are valued at border prices; and non-

tradable goods are iteratively decomposed into the same three components until every

input of the non-tradable good is expressed in terms of primary inputs and/or tradable

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goods. This procedure is performed using input-output analysis. The net impact of a

project under the L-M procedure may be expressed as follows:

NB = (OER) (X - M) – αD (3.7)

Where NB = net benefits

OER = official exchange rate

X = export at f.o.b

M = import at c.i.f

D = value of domestic inputs

α = standard conversion factor.

The purpose of computing the shadow wage rate (SWR) is to determine the opportunity

cost of employing an additional worker in the project. For this reason we need determine

the value of the output foregone due to the use of a unit of labour and the cost of

additional consumption due to the transfer of labour. L-M suggests the following formula

for calculating the SWR.

SWR = m + (c′- c) + (1-1/s) (c-m) (3.8)

Where

SWR= Shadow wage rate

m = marginal productivity of the wage earner

c′= additional resources devoted to consumption

c = consumption of wage earner

1 = value of uncommitted resources

1/s = value of committed resources

Supporters of the L-M procedure favour it for its analysis of projects explicitly in terms

of scarce foreign exchange. As a result it allegedly offers a better reflection of trade

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efficiency of economic planning in developing countries. The reasoning is that the use of

border pries reflects a country's actual terms of trade.

3.3. SQUIRE AND VAN DE TAK (S-VT) APPROACH

This is the third methodology of appraisal, which draws heavily on the L-M and

incorporates certain aspects of the UNIDO assumption. It has two distinctive features.

One, it bases the economic evaluation on a consistent shadow pricing system, and, two, it

incorporates distributional considerations into the analysis. The S-VT procedure suggests

a two - step approach to the estimation of accounting prices. The first step involves the

derivation of efficiency prices, while the second step is concerned with the estimation of

social accounting prices.

Efficiency pricing

Efficiency accounting prices are those prices that are obtained on the sole basis of

resource allocation considerations. There are four implicit assumptions in the estimation

of efficiency prices. These are a) that the actual rate of growth in the economy is optimal

and desired savings is equal to desired investment b) the economy is not faced with a

foreign exchange constraint; c) the distribution between public and private sector

investments is optimal; and d) the distribution of income is optimal - i.e., an additional

unit of consumption is equally valuable to rich and poor. The net benefit of a project

is described by an equation similar to (3.7) above.

NB = OER’ (X – M) - ΣαkDk (3)

Where αk is the conversion factor for each particular group of inputs from domestic to

border prices, and Dk is composed of domestically-produced commodities that are close

substitutes to tradable goods as well as non-traded goods. The parameter α can be viewed

as the variable which translates the value of the whole basket of domestically produced

goods into border prices by adjusting distortions in each price. The border price

equivalent to the tradable component of Dk may be derived by allowing for tariffs and

other distortions. For the other non-tradable component of Dk, which consists of primary

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factor inputs, specific conversion factors αk are derived by considering the value of

output (in border prices) that is foregone by employing these inputs in a particular

project. The conversion factors of other non-tradable inputs, such as construction,

electricity etc, may be derived similarly by decomposing them into traded goods and

primary inputs, and evaluating them accordingly.

The standard conversion factor α in equation (2) is therefore a weighted average of the

specific conversion factors αk. They are weighted by their share of the total domestic

input given a particular project -i.e. α = Σαk/ΣDk. The fact that αk is in principle project-

specific constitutes a very significant deviation from the UNIDO approach in which the

SER is calculated on the basis of nationwide weights (the weight of tradables and non-

tradeables in the Gross National Product).

Social accounting pricing

Linn (1977) has argued that the contrast between efficiency and social pricing is not that

the former is value-free while the latter is value-laden. Rather it is a contrast between a

particular set of value judgements embodied in the efficiency approach on the one side,

and the more general framework of social analysis which permits systematic

consideration of value judgements, one of which is in fact the particular set embodied in

the efficiency approach. In this perspective the social pricing procedure suggested by S-

VT is designed to provide less extreme assumptions than those required under the

efficiency approach. The basic framework for social pricing in the S-VT system assumes

that at the margin all public sector income is invested and all private sector income is

consumed. If the net increase in private sector consumption arising from a particular

project is denoted by C and β is the consumption factor that translates the aggregate

consumption basket to border prices, then the amount that accrues to the public sector out

of net benefits is equivalent to (NB' - βC). This is also equal to the amount that is

available for public investment. If the goal of the government is to increase growth by

placing a premium on investment, the net social benefit (NSB) may be expressed as

follows:

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NSB = (NB' - βC) V + C (4)

Where V is the shadow price of public income/investment at border prices in terms of

private consumption at domestic prices.

To translate the analysis is from a unit of account in terms of private consumption into

the S-VT numeraire, equation (4) may be divided through by V such that:

NSB/V = NSB' = (NB' - βC (l – 1/Vβ) (5)

It is clear from the above expression that if public income is at a premium relative to

private consumption (i.e. Vβ > 1), then the NSB' < NB'. The estimation procedure

suggested by S-VT far the derivation of V is based on a comparison of the marginal

productivity of capital to the consumption rate of interest, which is defined as the

discount rate that translates future consumption into present value streams (see Lyn

Squire Land Herman G. van der Tak. (1975). S-T pp. 69).

The above analysis ignored distribution and the fact that Gross National Product growth

was possibly suboptimal. To incorporate these considerations into the analysis, the S-VT

approach assumes that the government values an additional unit of consumption accruing

to the poor as more valuable than the same unit accruing to the rich. This may be

represented by a system of consumption weights di for the ith income group, where

average income in the country is used as the basis of comparison. The consumption

weights are derived from a CES utility function from which the marginal utility function

at any level of consumption is derived as follows:

Uc = C-n (6)

Where C is the consumption level and n is the elasticity of marginal utility with respect

to consumption. In this formulation, the higher the level of n, the more "egalitartan" is the

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government's objective function, since a higher level of n indicates a higher rate of

diminishing marginal utility. The weights di are derived as follows:

di = Uc/UĈ - (Ĉ/C)n (7)

Where Ĉ is the average level of consumption. It should be noted that for Squire-Tak, the

utility function is equated with the objective function of the government. Consequently,

the distribution weights derived from the utility function would by definition express the

government's preferences for redistribution. (see Lyn Squire Land Herman G. van der

Tak. (1975).S - T pp. 63 - 66).

Incorporating the consumption weights into equation (4), the net social benefit of any

project will be;

NSB' = NB' - βCi (1 – di/Vβ) (8)

Equation 8 sums up the essence of social pricing under the S-VT approach. The first term

of the right-hand-side of the equation (NB') is simply the efficiency price, while the

second term on the same side of the equation βC (1 - di) captures the distributional

impact of the project. The latter impact measures the increase in private sector

consumption at the border prices (β) and the social benefit of additional consumption in

the private sector d/V.

At a consumption level di/Vβ - l, the distributional impact term disappears and the net

social benefit (NSB') of a project is exactly equal to the net efficiency benefit (NB'). This

is the so called critical consumption level, and it is the level at which the government

judges private sector consumption to be as valuable as public investment.

Another aspect of the critical consumption level is that it serves as a very valuable device

for cross - checking the estimates of what are otherwise very elusive concepts - i.e. the

value of public income V and the consumption distribution weight di. In fact, given the

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initial estimates of V and di, policymakers may compute independent estimates of the

critical consumption level by considering recent government policies (subsidies, income

taxes etc.) which may provide the informational input for its estimation.

4. RELATIONSHIPS BETWEEN APPROACHES OF ECONOMIC ANALYSIS

Similarities

There is a considerable similarity between the UNIDO approach and the L-M approach in

the following ways:

1. The mathematical formulation for L-M is identical to the UNIDO method except

for differences in assigning value to discount rates and accounting for

imperfections and other market failures and social considerations.

2. Both methods single out the values of foreign exchange, savings and unskilled

labour, as crucial sources of a distorted price mechanism.

3. Both go on to calculate accounting prices which will correct these distortions and

both carry out these corrections in an essentially similar manner.

4. Both advocate Discounted Cash Flow analysis and the use of Present Social

Values.

5. Both method works making explicit allowance for inequality and distributional

considerations in project choice through manipulation of the shadow wage.

Differences

The three approaches agree in principle but differ in emphasis and detail (Donahue,

1980). Some key methodological items and points of departure are:

1. Numeraire

L-M nominates their numeraire as Uncommitted Government Income measured in

terms of foreign exchange (Little & Mirrless, 1974). Dasgupta, Sen, and Marglin

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propose Aggregate Consumption for the UNIDO approach (Dasgupta, Sen, & Marglin,

1972) while S-VT suggests Uncommitted Public Income measured in terms of

Convertible Currency (Squire & Van der Tak, 1975).

2. Foreign Exchange

The UNIDO methodology uses a shadow exchange rate which functions as a correction

factor and sets the shadow prices of foreign commodities on par with the prices of

comparable domestic goods and services. The L-M system of shadow pricing values

project inputs and outputs at world prices. The S-VT approach also adopts this basic

strategy with only minor adjustments.

3. Investment and Consumption

Generally, for developing countries, CBA should favour projects that route a larger

portion of their benefits into investment rather than consumption (Donahue, 1980). All

the three methodologies provide the mechanics for expressing this priority in quantitative

terms.

4. Discounting

The discount rate is a crucial variable in cost benefit analysis. Dasgupta et al (1972)

UNIDO methodology uses a single rate, the social discount rate, for adjusting future

resource flows. It is fixed by political value judgment of society’s time preference, and

the priority of present versus future consumption (Donahue, 1980). Little and Mirrless

(1974) approach begins with a time preference rate, the consumption rate of interest.

They go on to develop an accounting rate of interest defined as the rate of fall in the value

of their numeraire, uncommitted income. Squire and van der Tak (1975) like LM start

from a time preference rate and then adjust it by the premium on public investment funds

and the marginal productivity of invested resources.

5. Political Context

CBA requires that social values be articulated and then translated into clear, quantified

parameters (Donahue, 1980). LM Approach propose a “Top-Down” mechanism where

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high level officials would specify priorities and commit them to numbers, which it would

then pass to project designers and evaluators (Little and Mirrless 1974). Dasgupta et al

(1972) (UNIDO approach) are skeptical of this strategy and propose a “Bottom-Up”

mechanism for setting weights. The key to this approach is a special sort of sensitivity

analysis, the testing of several alternative project designs in with different values for the

discount rate, distribution weights and so on. These alternatives would be submitted to

political decision makers who further test and refine them before they are eventually

used. The World Bank Approach uses a “Side-to-Side” approach to fixing values. The

weights and judgments are worked out collaboratively and reflect the objectives both of

the national government and the lending agency (Squire and van der Tak, 1975).

5. APPLICATIONS OF ECONOMIC APPRAISAL METHODS IN TANZANIAThe main goal of the three approaches of economic analysis L-M, UNIDO and S-VT

approaches of economic analysis is balancing equity and efficiency objectives from the

point of view of society. Developing countries are characterized by market imperfections,

externalities, taxes and subsidies, concern for savings, concern for redistribution, and

merit wants (Chandra 1995).

1. Market imperfections

The price system in developing countries especially Tanzania is heavily distorted by

government duties, subsidies, and restrictions, coupled typically with considerable over-

valuation of the countries’ currencies, which forms a poor starting-point for the relative

valuation of project inputs and outputs. From the social point of view, taxes and subsidies

are nothing but transfer payments. But in CBA, taxes and subsidies are treated as

monetary costs and benefits respectively. In addition, Market prices, the basis for cost

benefit analysis (CBA), do not reflect the social values under imperfect market

competition. Financial profitability as calculated in stage one of UNIDO approach would

be sufficient only if the project operated in perfect market. Only in a perfect market,

market prices can reflect the social value. But if the market is imperfect as it in

developing countries like Tanzania, net benefit of the project is determined by assigning

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shadow prices to inputs and outputs. Therefore, developing shadow prices is very much

vital as it reflects the real value of resources (input and output) to society.

2. Imperfect labour markets

Structural features of many developing economies such as the dualism between formal

and informal sectors, and the predominance of household enterprises in traditional

agriculture combined with policy distortions have important implications for labour

markets. In developing countries, there is often a high level of urban unemployment, and

also (arguably) of urban underemployment and of surplus labour in agriculture, which

raised complex questions about the effective opportunity-cost of unskilled labour and

hence about the appropriate shadow wage-rate for appraisers to use.

3. Savings and Investment

In SCBA, the division between benefits and consumption is relevant wherein higher

valuation is placed on savings. But in CBA such division is irrelevant. The prevailing

view that the rate of economic growth needed to be increased implies that the existing

rate of investment, and consequently of saving, is sub-optimal and that a policy is needed

to boost savings rates. Considering individually, these peculiarities can push project

choices in opposite directions. A presumed need to increase the savings rate could favour

capital-intensive methods because they would shift income toward corporations and

richer people higher saving-rates than the average. On the other hand, recognition that

market wage rates in the formal sector exceed the marginal opportunity-cost of labour

dictates greater labour-intensity than markets can signal out, which can shift disposable

income towards the poorer. By providing frameworks for quantifying these

considerations, the L-M and UNIDO approaches enables the poor and the rich to be

balanced against each other.

4. Income distribution

Income in developing countries is unevenly distributed and was and direct redistribution

considered difficult. This could be taken to imply that extra consumption for poorer

people should have a higher priority in the assessment of projects than extra consumption

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for richer people. In social cost benefit analysis (SCBA), the distribution of benefits is

very much concerning issue where commercial private firm does not bother about it.

Government considers a project as an investment for the redistribution of income in

favour of economically weakens sections or economically backward regions. This stage

provides a value on the effects of a project on income distribution between rich & poor

and among regions.

5. Externalities

A project may have beneficial or harmful external effects that are considered in SCBA

analysis. An externality is an external effect either beneficial or harmful causes from a

project which is not deliberately created by the project sponsors but is an incidental

outcome beyond the control of the persons who are benefited or affected by it not traded

in the market place. Although valuation of an external effect is difficult as are often

intangible in nature and there is no market price, shadow pricing of externalities may be

made indirect. Example of External Effects:A project of planting trees for commercial

purpose may give protection to the environment against the increasing global warmth.

People may be affected by erosion and flood conditions brought about by changes to the

river which result from the construction activities of a bridge. The harmful effect of

bridge may be measured by the consumer willingness to pay for the output of the people

which has been reduced due to the bridge. The cost of pollution may be estimated in

terms of loss of earnings as a result of damage to health caused by it.

6. CONCLUSIONS

Economic analysis aids in evaluating individual projects within the planning framework

which spells out national economic objectives and broad allocation of resources to

various sectors. It is also an important tool for analyzing a project to reflect its positive

and negative impact on the society. Today, economic analysis has expanded to evaluation

of private projects as they are much more responsible for good and bad effects on the

society. Economic analysis differs from financial analysis in the sense that it avoids

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market price and adopts shadow price to value the inputs and outputs of a project.

UNIDO approach & L-M approach for economic analysis of a project are not widely

used by private sectors. The logic behind the appraisal criterion is to select those projects

for which the country’s resources are more appropriate. Thus, the decisions regarding

capital allocation should be taken with regard to Rule Utilitarian approach i.e.

maximizing benefits to people (various stakeholders) at large as businesses cannot strive

on profit motives for long term. It is high time that businesses should align their strategies

in line with the needs of the community in order to foster long term sustainability of the

business. It should be noted that the choice of the numeraire does not make any real

difference in the analysis from an economic or mathematical viewpoint as long as

consistency is maintained throughout the analysis.

These methods of cost-benefit analysis are broadly similar in principle, in procedure, and-

most economists agree in the guidance they are likely to give on accepting, rejecting, or

modifying a project. All seek to establish the net benefit promised by a given project

design. Benefits are defined by reference to development objectives and are balanced

against opportunity costs. Each methodology assumes economic distortions, disequilibria,

and other malfunctions-problems serious enough to warrant the substantial effort that

shadow pricing requires. Equally important is the argument that projects-shaped, when

appropriate, by shadow prices-are more promising instruments for encouraging

investment or equity than direct fiscal measures. Finally, the methodologies share the

same mechanics of discounting and summarizing, and the power of each is enhanced by

sensitivity analysis.

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REFERENCESBelli Pedro, (2001), Economic Analysis Of Investment Operations: Analytical Tools And

Practical Applications.

Belli Pedro. (1996). Is economic analysis of Project Still Useful? The World Bank

Operations Policy Department. Policy Research Working Paper No. 1689.

Lal, D. (1974). Methods of Project Analysis, (Balt. John Hopkins University Press).

Linn, J. (1977). Economic & Social Analysis of Projects: A case Study of Ivory Coast.

(Wash. D. C. World Bank Staff Working Paper No. 253).

Little. I.M.D., and J.A. Mirrlees. (1974). Project Appraisal and Planning For Developing,

Countries (London: Heineman Educational Books Ltd.).

Lyn Squire Land Herman G. van der Tak. (1975). Economic Analysis of Projects.

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London

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