Social Cost Benefit Analysis

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 SCBA aids in evaluating individual projects Spell out broad national economic objectives Allocation of resources to various sectors SCBA is concerned with tactical decision

making within the framework of broad strategic choices defined by planning at the macro level.

Evaluation on the Basis of Benefits

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

Evaluation on the Basis of Costs

Project CostAssociated CostsReal & Nominal CostsPrimary or Direct Costs Indirect or Secondary Costs

Rationale for SCBA

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

Principles Sources Of Discrepancy (Details)

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

Rationing Prescription of minimum wage rates Foreign exchange regulation.

Approaches of SCBA

Two principle approach for SCBA:UNIDO ApproachLittle-Mirrlees Approach

UNIDO Approach

UNIDO method involves five stages:1. Calculation of financial profitability

measured at market prices

2. Obtaining the net benefit of the project measured in terms of economic (effective) prices

3. Adjustment for the impact of the project on savings & investment

4. Adjustment for the impact of the project on income distribution

5. Adjustment for the impact of the project on merit goods & demerit goods

Net Benefit in Terms of Economic (Efficiency) Prices

Also referred to as shadow pricesMarket 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

Shadow Pricing

Choice of Numeraire 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.

Concept of Tradability

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

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

Shadow Pricing Measurement

Sources of Shadow Pricing

Basis of shadow pricing

Increase/ decrease of consumption

Consumer Willingness to pay

Increase/ Decrease of production

Cost of production

Increase / Decrease of export / import

Foreign exchange value

Types of Project Product

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 & outputsExternalities

Externalities

Characteristics 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

Externalities

Examples of Beneficial External Effect: An oil company drilling in its own fields

may generate improve the transport system in that area

The approach roads built by a company may improve the transport system in that area

The training program of a firm may upgrade the skills of its workers thereby enhancing their earning power

Externalities

Can be measured by indirect means: What the neighboring oil fields would have

spent to obtain the information The value of better transport may be

estimated in terms of increased activities & benefits derived from these

Benefit from the training program may be estimated in terms of the increased earning power of workers

Example of Harmful external Effect

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 farmer’s holding in two adversely affecting his physical output

Harmful external Effect

Can be measured by indirect mean:Cost of pollution in terms of loss of

earnings as a result of damage to health & cost of time spent for coping

Cost of noise from difference in rentEffect of highway on consumer willingness

to pay for output

Measurement of the Impact on Distribution

Groups

UNIDO approach seeks to identify income gains & losses by the followings:

Project Other private business Govt. Workers Consumers External sector

Measure of Gain or Loss

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

Savings Impact & its Value

UNIDO method seeks to answer the following questions:

Given the income distribution impact of the project what would be its effects on savings?

What is the value of such savings to the society?

Impact on savings

=i i∑∆Y MPS

Where i ∆ Y= change in income of group i due to the project

i MPS= marginal propensity to save of group i

Income Distribution Impact

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

Adjustment for Merit & Demerit Goods

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