Rationale for SCBA

Market Imperfections. Externalities. Taxes and subsidies. Concern for savings. Concern for Redistribution. Merit Wants.

Market Imperfections
Rationing : It means control over the prices and distribution of a commodity. Prescription of minimum wage rates : In case of minimum wage rates the wages paid to the labourers are more than what the wages would be in a competitive labour market free from such wage legislation. Foreign exchange regulations : The official rate of foreign exchange is typically less than the rate that would prevail in the absence of foreign regulation.

Externalities
A project may have beneficial external effects, for e.g. a project may create certain infrastructure facilities like roads which benefit the neighbouring areas, or may have harmful external effects like it may create environmental pollution. Laying of irrigation canals - water for some, and disease for some Laying a bridge distances reduced, pollution, noise levels increasing etc

Taxes and subsidies

In case of monetary cost and benefit of a project, taxes and subsidies are to be considered because they are definite monetary gains decisions are taken on tax holidays and cash subsidies for a project. However, taxes and subsidies are ignored in case of SCBA because they are considered as transfer payments.

Concern for savings

In case of monetary cost benefit analysis a private firm is least concerned as to how its benefits are divided between consumption and savings From social point of view, there is a higher concern of society for saving and investment and this is reflected in SCBA where higher valuation is put on saving than on consumption.

Concern for Redistribution

While doing monetary cost and benefit analysis, a private firm is least concerned about how its benefits are being distributed among various groups of the society While doing SCBA, this factor is kept in mind because it is assumed that a rupee of benefit going to the poor section is considered more valuable than a rupee of benefit going to an affluent section.

Merit Wants
Merit Wants are not relevant from the private point of view Merit Wants are important from the social point of view. E.g. Governmnet may prefer to promote an Adult Education Programme even though they are of no benefit to the consumers in market, but from the point of view of the society they are important

APPROACHES to SCBA
UNIDO Approach L & M Approach Approach Adopted By Financial Institutions IDBI, IFCI, ICICI and state financial institutions

UNIDO Approach to SCBA:

UNIDO approach emerged in 1960s. This approach was initially articulated in the Guidelines for Project Evaluation which provides a special framework for SCBA, especially in developed countries.

UNIDO method of project appraisal involves five stages:

Calculation of the financial profitability of the project measured at market prices. Obtaining the net benefit of the project measured in terms if economic (shadow*) prices. Adjustment for the impact of the project on savings and investment. Adjustment for the impact of the project on income and distribution. Adjustment for the impact of the project on merit goods and demerit goods whose social values differ from their economic values. * explained in next slide

Shadow Prices
Capital Input - it comes from the denial of capital from the alternative project , its opportunity cost is the rate of return that would be earned from those alternative projects Foreign exchange - the UNIDO method uses domestic currency as the numeraire. So the foreign exchange impact of the project must be identified and valued. The real exchange rate a person is willing to pay to get necessary traded service/product

Shadow Prices
Externalities : The valuation of external effects is rather difficult because they are often intangible in nature and there is no market price, which can be used as a starting point. Labour inputs : The principle of shadow pricing may be applied to labour. When a project takes away labour from other employment, the shadow pricing of labour is equal to what other user of labour are willing to pay.

Each of the above stages helps in feasibility of the project from different angles. :
Stage 1- The measurement of financial profitability is similar to financial evaluation of the company. Stage 2- It is concerned with determination of net benefits of the project in terms of economic (efficiency) prices. It is also called as shadow prices. Stage 3 & 4- These stages are concerned with measuring the value of a project in terms of its contribution to savings and income redistribution. In order to make such assessment, the income gained or lost by individual groups in the society is measured. Stage 5 A merit good is one for which social value exceeds economic value. And a de merit good is one for which social value is less than economic value. The difference between social value and economic value has to be adjusted in the right direction.

Little-Mirrlees Approach
I.M.D Little and J.A Mirrlees have developed an approach to social cost benefit analysis which became popular as Little-Mirrlees approach (L-M approach).

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

Both approaches call for: Calculating accounting (shadow) prices particularly for foreign exchange savings and unskilled labour. Use of DCF analysis.

Despite of the above similarities, there are some differences which are as follows:
UNIDO approach is limited to domestic boundaries (measures cost and benefits in terms of domestic rupees) where as L-M approach considers international aspects also (measures cost and benefit in terms of international/border prices). UNIDO approach measures cost and benefits in terms of consumption where as the L-M approach measures cost and benefits in terms of uncommitted social income. The UNIDO approach focuses on efficiency, savings and redistribution aspects in different stages. L-M approach tends to view these aspects together.

UNIDO Approach Stage Two (Contd.)

Obtaining Net benefit of the Project (An illustration) The Government of Bangladesh is considering a project which would supply water for irrigation, generate electricity and provide a measure of protection against floods. The project is expected to have a 25 year life time. The costs and benefits of the project are: COSTS: 1. Power equipment costing Tk. 30 crore. (Additional Information: This equipment can be exported at $ 4.5 million. The shadow price of per dollar is Tk. 70)
Cost Type Indigenous Power Equipment Nature One-Shot Private Angle (Market price) 30 crore Social Angle (Shadow Price) 31.5 crore

UNIDO Approach Stage Two (Contd.)

Obtaining Net benefit of the Project (An illustration) 2. 30,000 tones of cement produced indigenously are used in the project at a cost of Tk. 6,000. (Additional Information: However, one-half of the cement will come from additional domestic production which cost Tk. 5,000 per tone and one-half come from diversion from other consumers who are willing to pay Tk.6,500 for per ton.)
Cost Type Cement Nature One-Shot Private Angle (Market price) 18 crore Social Angle (Shadow Price) 17.25 crore

Obtaining Net benefit of the Project An illustration (contd.)

3. Other construction materials ( sand, bricks, steel etc.) cost 20 crore. (Additional Information: these materials comes from additional production, production cost of which is 15 crore.)
Cost Type
Other Materials

Nature
One-Shot

Private Angle (Market price)

20 crore

Social Angle (Shadow Price)

15 crore

Obtaining Net benefit of the Project An illustration (contd.)

4. Two million man days of unskilled labor for which the project committee decided to pay a daily wage of Tk. 100. (Additional Information: The shadow price of unskilled labor is 80 Tk. Per day)
Cost Type Nature Private Angle (Market price) 20 crore Social Angle (Shadow Price) 16 core

Unskilled Labor

One-Shot

Obtaining Net benefit of the Project An illustration (contd.) 5. Skilled labor costing Tk. 5 crore. ( However, this cost reflects what others are willing to pay for the skilled labor)
Cost Type Nature Private Angle (Market price)
5 crore

Social Angle (Shadow Price)

5 crore

Skilled labor

One-Shot

6. Operating & Maintenance cost of the project will be Tk.

7.5 crore annually. (However, the operating cost should be Tk. 6.5 crore from social view point)
Cost Type
Operating Cost

Nature
Annual

Private Angle
7.5 crore

Social Angle
6.5 crore

Obtaining Net benefit of the Project An illustration (contd.) Benefits: 1. 0.5 million acres of land will be irrigated. The Government will charge the water levy at Tk. 150 for per acre. (Additional Information: The value of additional output per acre due to the irrigation will be Tk. 500 per acre).
Benefit Type Nature Private Angle (Market price) 7.5 crore Social Angle (Shadow Price) 25 crore

Irrigation

Annual

2.

100 million units of electricity will be generated for domestic use. The electricity tariff will be charged at Tk. 1 per unit. (Additional Information: The consumers are willing to pay Tk. 1.5 for per unit of electricity).
Benefit Type
Electricity

Nature
Annual

Private Angle (Market price)

10 crore

Social Angle (Shadow Price)

15 crore

3.

Flood damages can be saved by Tk. 2 crore annually. However, the Government will not able to collect anything for this.
Benefit Type Nature Private Angle (Market price) Social Angle (Shadow Price)

Flood Relief

Annual

2 crore

Obtaining Net benefit of the Project An illustration (contd.) Cost & Benefit of the Project (at a glance) One-Shot cost:
Cost Type Private Angle (Market price) Social Angle (Shadow Price)

Power Equipment
Cement Other Materials Unskilled Labor Skilled Labor Total

30 crore
18 20 20 5 93 Crore

31.5 crore
17.25 15 16 5 84.75 Crore

Cost & Benefit of the Project (at a glance) (contd.)

Annual cost:
Cost Type Private Angle (Market price) Social Angle (Shadow Price)

Operating Cost
Total

7.5crore
7.5Crore

6.5 crore
6.5 Crore

Annual Benefit:
Benefit Type Private Angle (Market price) Social Angle (Shadow Price)

Irrigation

7.5 crore

25 crore

Electricity
Flood Relief Total

10 crore
17.5 Crore

15 crore
2 crore 42 Crore

A Comparative Illustration of UNIDO & L-M Approach

COSTS: 1. Power equipment costing Tk. 300 million. This equipment can be exported at $4.5 million. The shadow price of per dollar is Tk. 70.
Cost Type
Power Equipment

Nature
One-Shot

UNIDO Approach
Tk. 315 million

L-M Approach
$ 4.5 million

A Comparative Illustration of UNIDO & L-M Approach (contd.)

2. 30,000 tones of cement produced indigenously are used in the project at a cost of Tk. 6,000. One-third of the cement will come from additional domestic production which cost Tk. 5,000 per tone and Two-third will come from diversion from other consumers who are willing to pay Tk.6,500 for per ton. The shadow price of per dollar is Tk. 70.
Cost Type Cement Nature One-Shot UNIDO Approach Tk. 180 million L-M Approach $ 1.48 million

A Comparative Illustration of UNIDO & L-M Approach (contd.) 3. Other construction materials ( sand, bricks, steel etc.) cost 200 million. These materials comes from additional production, production cost of which is 150 million.
Cost Type Other Materials Nature One-Shot UNIDO Approach Tk. 150 million L-M Approach $ 2.14 million

4. Two million man days of unskilled labor for which the project committee decided to pay a daily wage of Tk. 100. The shadow price of unskilled labor is 80 Tk. Per day.
Cost Type Unskilled Labor Nature One-Shot UNIDO Approach Tk. 160 million L-M Approach $ 2.29 million

A Comparative Illustration of UNIDO & L-M Approach (contd.)

5. Skilled labor costing Tk. 5o million. However, this cost reflects what others are willing to pay for the skilled labor.
Cost Type Skilled Labor Nature One-Shot UNIDO Approach Tk. 50 million L-M Approach $ 0.71 million

6. Operating & Maintenance cost of the project will be Tk.

75 million annually. However, the operating cost should be Tk. 65 million from social view point.
Cost Type Operating Cost Nature Annual UNIDO Approach Tk. 65 million L-M Approach $ 0.93 million

A Comparative Illustration of UNIDO & L-M Approach (contd.)

Benefits: 1. 0.5 million acres of land will be irrigated. The Government will charge the water levy at Tk. 150 for per acre. The value of additional output per acre due to the irrigation will be Tk. 500 per acre.

Benefit Type Irrigation

Nature Annual

UNIDO Approach Tk. 250 million

L-M Approach $ 3.57 million

2.

100 million units of electricity will be generated for domestic use. The electricity tariff will be charged at Tk. 1 per unit. The consumers are willing to pay Tk. 1.5 for per unit of electricity.
Benefit Type
Electricity

Nature
Annual

UNIDO Approach
Tk. 150 million

L-M Approach
$ 2.14 million

3.

Flood damages can be saved by Tk. 20 million annually.

Benefit Type Flood Relief Nature Annual UNIDO Approach Tk. 20 million L-M Approach $ 0.29 million