Analysis Approaches to SCBA Two approaches for SCBA UNIDO Approach:- This approach is mainly based on publication of UNIDO ( United Nation Industrial Development Organisations) named Guide to Practical Project Appraisal in 1978. L-M Approach It involves five stages :
Calculation of financial profitability of the project, measured at the market prices of resources and output. Calculation of the net benefit of project measured in terms of economic prices. Some resources are priced at international prices and for others shadow prices are considered. Adjustment for the impact of the project on saving and investment. Adjustment for the impact of project on income distribution. Adjustment for the impact of project on merit goods and demerit goods whose social value differ from their economic values.
UNIDO Approach
Stage - 1 Calculation of financial profitability of the project a) A good technical and financial analysis must be done before a meaningful economic (social) evaluation can be made so as to determine financial profitability. b) Financial profitability is indicated by the Net Present Value (NPV) of the project, which is measured by taking into Account inputs (costs) and outputs (benefits) at market price. UNIDO Approach Stage - 2 Obtaining the net benefit of the project at economic (shadow) prices a) The commercial profitability analysis (calculated in stage 1) would be sufficient only if the Project is operated in Perfect market. Because, only in a perfect market, market prices can reflect the social value b) If the market is imperfect (most of the cases in reality), net benefit of the Project is determined by assigning shadow Prices to inputs and outputs. c) Therefore, developing shadow pries is very much vital. UNIDO Approach Stage - 2 Shadow prices reflect the real value of a resource (input or output) to society Shadow Prices are also referred as economic prices, economic / accounting efficiency prices etc Shadow prices can be defined as the value of the contribution to the country's basic socio- economic objectives made by any Marginal change in the availability of commodities (Output) or factor of production (input). Example: A project of power station may increase the production of electricity which contributes to one of the socio-economic Objectives of the country. Sources of shadow pricing Basis of valuation Increase/decrease total consumption Consumer willingness to pay Increase /decrease total production Cost of production Increase/decrease export or imports Foreign exchange value
Consumer Willingness to Pay (CWP) What a consumer wants to spend for a product or service The difference between CWP and actual payment is called consumer surplus Numeraire a)A unit of account in which the values of inputs and outputs are to be expressed. b)Numeraire is determined at Domestic currency ,rather than border price. Present value rather than future value, Because, "a bird in the hand is worth two in the bush' Constant price rather than current price
Taxes: If the project augments domestic production, taxes should be excluded if the project consumes existing fixed supply of non-traded inputs, tax should be included For fully traded goods, tax should be ignored Shadow Pricing of Resources Non-tradable Inputs and outputs
Shadow Price = Cost of production + Consumer willingness to pay Non tradable inputs and outputs -: a good is non-tradable if following conditions are satisfied -: If its CIF prices is greater than its domestic cost of production. Its FOB price is less than its domestic cost of production.
For traded goods the shadow price border price translated in domestic currency, at market exchange rate. For non-traded goods the shadow price is measured in terms of consumer willingness to pay or cost of production, depending on the impact of project on the rest of the economy.
Externalities -: since SCBA seeks to consider all cost and benefits, to whomsoever they may accrue external effects should also be taken into account. 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 as well, though labour is considered to be services. 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. The shadow prices associated with inducing additional production of workers consist of the marginal product of labour in previous employment plus certain other costs.
Capital input -: the shadow pricing in case of capital investment involves -: What is the value of physical assets? The value of physical assets is determined the way values of other resources are calculated. What is the opportunity cost of capital? The opportunity cost of capital depends on how the capital required for the project is generated. To the extent that it comes from additional savings its opportunity cost is measured by the consumption rate of interest.
UNIDO Approach - Stage 3 Adjustment for the impact of the project on Savings and investment : The purpose of this stage is to Determine the amount of income gained or lost because of the project by different income groups (such as business, government, workers, customers etc) Evaluate the net impact of these gains and losses on savings Measure the adjustment factor for savings and thus the adjusted values for savings impact Adjust the impact on savings to the net present value calculated in stage two. UNIDO Approach- Stage 3 Evaluation of the Net Impact on Savings Net savings Impact of the project = Yi MPSi o Here, Yi = change in income of group i as a result of the project o MPSi= Marginal Propensity to save a group i UNIDO Approach- Stage 3 Adjustment Factor for Savings (AFs) AFs measure the percentage by which the social value of investment of one Re. exceeds social value of consumption one rupee. AFs = (MPC x MPcap) - 1 ( CRI- MPcap) x MPS Here, MPC = Marginal Propensity to Consume MPS = Marginal Propensity to Saving MPcap = Marginal Productivity of Capital CRI = Consumption Rate of Interest (Social Discount Rate)
UNIDO Approach- Stage 4 Adjustment for the impact of the project on Income distribution Govt. considers a project as an investment for the redistribution of income in favour of economically weaker sections or economically backward regions This stage provides a value on the effects of a project on income distribution between rich and poor and among regions Distribution Adjustment Factor (Weight) is calculated and the impacts of the project on income distribution have been valued by multiplying the adjustment factor with the particular income of a group. This value will then be added to the net present value re-calculated in stage three to produce the social net present value of the project. UNIDO Approach- Stage 5 Adjustment for Merit and Demerit Goods : If there is no difference between the economic value of inputs and outputs and the social value of those, the UNIDO approach for project evaluation ends at stage four. In practical, there are some goods (merit goods), social value of which exceed the economic value (e.g oil, creation of employment etc) and also there are some goods (demerit goods), social value of which is less than their economic value (e.g., cigarette, alcohol, high -grade cosmetics etc) Adjustment to the NPV of stage 4 is required if there is any difference between the social and economic value UNIDO Approach- Stage 5 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 NPV of the project as calculated in stage four.