UNIT - IV

SCBA – called Economic analysis (benefit to society)

-Evaluation of project from society (economy point of
view)
-SCBA – tool for analyzing appraising evaluating public
investment.
-To linked extend for public, quasi, semi quasi which may
have national concerns
-SCBA concerned with – cost (who will bear, bought to
whom)
-These differ from monetary cost (price) & benefits of
project.
-Social cost – Cost by economic agent home by society at
large. 1
Social Benefit – includes benefit that particular org. will
yield through the production of goods/ products/
services.
Market Imperfections: (Not perfect free competitor, Mkt
force – Demand and support

- Mkt price under imperfect Mkt condition cannot show

social values.
Common imperfections
a. Rationing – Min wage – FE sequation infletion
(support inelastic)
b. Large projects (in small economies) yield significant
(flyover – traffic Jam – fuel saving – menlal agency)
2
c. Evaluation – by pass road (township) / Express way
d. Taxes & Subsidies – are gain from monetary point of
view. (but social point of view (people’s money spent
on people)
e. Concern for saving (concern between consumption
& Saving in poor economies, rupee saved is more
valuable than a rupee benefit consumes. Thus there
is a higher valuation on saving than consumption.
f. Concern for Redistribution Private firm will not
bothered how the benefit will redistributed. Societies
concern about redistribution of benefit across different
groups i.e. rupee benefit to a poor is more valuable
than to affluent.
g. Merit Wants (Adult education Mid day meals/ health.
3
Need for Social Cost benefic Analysis
1. Set of Objectives

- Public planner looks for benefit to society

Private looks for – Revenue/ Profit
- Private looks expanding sales / Volume or asset base
(purpose of satisfying these is simple)
- But task of meeting diverse objective of national
interest i.e. employment generation, improving
consumption pattern, GNP/ GDP , saving are dfficult
- Planner to compare benefit today with future at the
cost incurred today

4
2. Difference between commercial calculation &
SCBA there is multiplicity of objectives in SCBA
Entrepreneur – may also have several objectives ↑
Profit ↑ Sales ↑ Asset base
But SCBA enlarging national interest , employment,
GNP equals distribution of income.
3. Choice of Parameters
Private – rate of interest (cost of money)
Public sector projects - large projects, longer
gestation period
- Choice of rate of return to discount future benefits
represents compromise of different interests
One to compare value of benefits today to that of
benefits of future at today’s cost.
5
 Approaches to SCBA
1. UNIDO (United Nations Industrial
Development Organization)
2. LM Approach (Little Mirrlees Approach)

1. UNIDO :
- First guide lines of project evaluation
framed in 1972
- Guidelines to practical Project Appraisal
1978

6
 Under UNIDO Method of Project Appraisal
(five stages are involved)
1. Calculating Financial profitability at Mkt. prices.

2. Obtaining net benefit of project measured.

3. Adjustment for the impact of project on Savings and

investment.
4. Adjustment for the impact of project on income
distribution.
5. Adjustment for the impact of project on merit goods
and demerit goods whose Social values differ from their
economic values. 7
 Ist Stage
- Calculation of financial profitability at Mkt
price.
- Measurement of Financial profitability (over all
profitability of project)
- Concern for project benefits to owner or
sponsors.
- To measure financial profitability we need
following
 Cost of project (civil, M/c, utilities cost etc)
 Financial resources (Share capital, equity,
preference, Debts NCD)
8
While planning means of financing following consideration
to be kept in mind
a. Regulatory bodies & financial distribution (project to
be approaches)
- regulation does following tasks
- Telecom regulatory authority, Insurance, Bands,
SCBI (s)
b. Important business consideration (selection of
sources of funds) cost, risk, return the org. face
business and financial risks
- Financial flexibility ( raise further capital – any
source to tab later)

9
II Stage of UNIDO approach
Obtaining net benefit of project on saving &
investment (i.e. obtaining net benefit of project in
terms of economic prices (shadow prices)

 Mkt. prices represent shadow prices only under

conditions of Perfect Mkt (Market Forces Control
conditions)
In developing Countries, perfect Mkt. conditions don’t
exist (Because of Government Control)

Thus need to develop shadow prices and measuring

net economic benefit in terms of these prices.
10
Basic issues in shadow pricing

(i) Choice of Numeraire:- (ie Unit of account used to

express the value of Input / Output.

Qs. Arise -

 In which currency (Domestic or Foreign)

 Cost & benefits to be measured / evaluated in

present or future values.

 Should the income to be measured in terms of

consumption or investment.

11
(ii) Concept of Tradability (In Shadow pricing
goods tradability
 Are the goods tradable or not?
 For tradable goods, international price is the
measure of its opportunity cost to the country.

 This is because for tradable goods, It is

possible to substitute import for domestic
production and vice a versa
ie. You import not produce in country
Thus international price is also known as the
border price ie. represent the real value in terms of
economic efficiency (Shadow pricing) 12
(iii) Sources of Shadow Pricing
 UNIDO approach suggest three sources of
Shadow pricing depending the impact of project
on the national economy.
 Project uses and produces resources (for
any inputs/outputs).
(i) Increase or Decrease of total
Consumption in economy.
(ii) Increase or Decrease of total Production
in economy.
(iii) Increase or Decrease of total
Import/Exports.
13
 The Impact of project and basis of shadow pricing
Impact Basis of Shadow Pricing

On the consumption in the Consumer willingness to pay

economy
On production in the Cost of production
economy

On International Trade
Increase/ Decrease in Foreign exchange value
exports
Increase/ Decrease in
imports
14
(iv) Taxes:
 Usually pose difficulties in computation of
shadow prices.
 Ignore taxes for fully trade it goods
 Include taxes for non- traded inputs.

(v.) Consumer willingness to pay

If the impact of the project is one the
consumption in the economy then the basis of
shadow pricing is the consumer willingness to
pay.
15
Price Total Willingness to pay Area ODEQ
Price Actually paid OPEQ
Consumer Surplus DEP
D
S-

E
P

D-

Qty
O Q

16
B. Shadow pricing of resources
Valuation of non – tradable output/input side
Valuation of Non – Valuation (Measure)
tradable
Output Side
Project increase in the Marginal consumers
consumption f the product in willingness to pay
the economy
Substitute other production Saving in cost f production
of the same non-tradable in
the economy
Input Side
Impact Measure (Mean of social
value) 17
Project reduces the User’s willingness to pay
availability of the input to
other users
Project’s input requirement Product cost
is met by additional
production of it

18
(C) EXTERNALITIES.
It refers to external effect.
The Characteristics are:-
 Not deliberately created by project sponsor but
incidental to outcome of legitimate economic
activity.

 It is beyond the control of person who are

affected by it. For better or losses.
 It is not traded in Mkt. place.

19
Examples of beneficial external effect.
1. Oil Co drilling own field finds info that there is oil potential
in close by fields.
2. Approach road may improve the transport system (DND
bridge & approach road.).
3. Training programme may enhance skills of workers thus
may increase the earning power in Subsequent
employments.
Examples of Harmful effect
 Environment pollution emitted by a new factory
(smoke/dirt) thus neighbor hood exposed to hazard.
 Metro line produces noise, dust exposes & neighbor
hood.
 Location of an Airport.
20
 A high way may cut farmers land into two.
Thus difficult to find values directly but can be
estimated by indirect means.
1. Neighboring oil field info can be equated with the
money saved by virtue of available info.
2. Approach road (DNB) can be estimated by the value,
the time and fuel saved by the short cut provided.

3. Cost of pollution can be estimated by loss of earning

by damage to health (Due to Sickness man powers
lost).
4. Loss of rent by virtue of Metro line in neighbor hood.

21
(D) LABOUR INPUTS
The principle of Shadow pricing for goods can be
applied to labors
When a project hires labours it has three possible
impacts on cost of economy.
 It may take labour away from other employment.

 It may induce production of new workers.

 It may involve import of workers.
Shadow pricing for labour taken from other
employment is equal to other users of labour
willing to pay for this labour. In free Mkt. it is
equal to marginal product of such labour. 22
The Social cost associated with inducing additional
production of workers consists of:-
 The value assigned by worker on leisure fore gone.
 Additional cost of consumption – as he is not idle but
working.
 Cost of transport / rehabilitation when worker moved
from one place to other.
 Cost of transport / rehabilitation when worker moved
from one place to other.
 Impact on saving / investment in society when worker
paid Mkt. wage rate by project.
Social cost associated with impact of foreign
workers is Wage they command according to his
skill. The FE remitted by him, back home – effect on
society as saving / investment. 23
E. For Shadow pricing of capital invested
raises issues.

Capital invested produces two effects.

1. Financial resources are converted into physical
assets.
2. Financial resources are withdrawn from national
pool of savings and hence alternative project are
fore gone.
- What is the value of physical assets
- What is the opportunity cost of Capital. 24
The value physical resources calculated as value of
other resources.
If it is fully traded then Shadow price is border price.
It non tradable then consumer willingness to pay.

OPPORTUNIT COST

1. consumption rate of interest ie price the saver must

be paid to sacrifice consumption.
2. The denial of capital to alternative project, the
opportunity cost is the rate of return that would have
earned also called investment rate of return.
25
In practice consumption rate of interest is the discounted rate
as under UNIDO analysis all input / output are converted into
consumption equivalents.
However the UNIDO approach recommends bottom up
procedure. As per this it is internal rate of return of the
project.
When project is approved the planners assume that
consumption rate of return is more than IRR.

(F) FOREIGN EXCHANGE

- UNIDO method uses domestic currency as
NUMERAIRE.
- FE input identified and adjusted at a appropriate
premium.
- It means that value of input / output are adjusted
upwards to reflect the Shadow price of FE. 26
III(A) STAGE MEASUREMENT OF THE IMPACT ON
INCOME DISTRIBUTION
To measure the value of project in terms of its
contribution to savings and income redistribution, we
measure the income gained or lost by individuals in
society.
UNIDO approach identifies the income gains &
losses by the following groups
- Project
- Other private businesses
- Govt.
- Workers
- Consumers
- External fector 27
(There could be some other groups however)
Measure of gain or loss with in the society as a result of
project is equal to:-
- Difference between shadow price and Mkt. price
of each input / output in case of physical
sources.
Or
- Difference between price paid and value received
in case of financial transaction.

28
III(B)
STAGE SAVING IMPACT AND ITS VALUE
In developing countries as capital is scarce Govt. is
concerned with the impact of savings and its value
there of.

As per UNIDO method, we seek answer to the

following Qs.
a Given the income distribution impact of the
project what would be its effects on savings.
b What is the value of such savings to Society.
The value of rupee of saving is the present value
of the additional consumption stream produced
when that rupee of savings is invested at the
margin. 29
The additional consumption of the rupee invested
depends upon
- Marginal productivity of capital.
- The rate of reinvestment from additional income
(return).
The social value of savings is also called shadow
price of investment.

30
IV STAGE INCOME DISTRIBUTION IMPACT
Govts. regard redistribution of income to Weaker
Section of society or to backward region ie a socially
desirable objective.
- One way to do is through taxes, subsidies and
transfer measures of Govt.
- Investment measures are also considered as
income redistribution.
If involves suitably weighting net gains and loss by
each group.
The weights are usually reflected by political
judgment.
The weights are usually reflected by political
judgment. 31
 V. STAGE ADJUSTMENT FOR MERIT &
DEMERIT
A merit good is one for which social value exceeds
the economic value.
Eg. Producing some goods in the country even if it is not
economical for reasons of avoiding dependence on
foreign suppliers.

The concept of merit goods can be extended to include

socially desirable outcomes like creation of employment.
In case of demerit of goods the social value is less than
economic value.
32
 LITTLE-MIRRLEES APPROACH
I.M.D Little and J.A. Mirrlees have developed an
approach (hereafter referred to as the L-M approach).
There is considerable similarity between the UNIDO
approach and the L-M approach.

Similarities
1. Calculating accounting (shadow) prices particularly for
foreign exchange savings and unskilled labour.
2. Considering the factor of equity.
3. Use of DCF analysis.
33
Differences
1. The UNIDO approach measures costs and benefits in
terms of domestic rupees whereas the L-M approach
measures costs and benefits in terms of international
prices, also referred to as border prices.
2. The UNIDO approach measures costs and benefits in
terms of consumption whereas the L-M approach
measures costs and benefits in terms of uncommitted
social income.
3. The stage-by-stage analysis recommended by the
UNIDO approach focuses on efficiency, savings, and
redistribution considerations in different stages. The
L-M approach, however, tends to view these
considerations together.
34
 14.9 SHADOW PRICES

The outputs and inputs of a project are classified

into the following categories: (i) traded goods and
services, (ii) non-traded goods and services, and
(iii) labour.
Shadow Price of Traded Goods
The shadow price of a traded good is simply its border
price.

If a good is exported, its shadow price is its FOB price

and if a good is imported its shadow price is its CIF price.
35
If foreign demand is not perfectly elastic, the
marginal export revenue is substituted for the FOB
price; similarly, if foreign supply is not perfectly
elastic, the marginal import cost is substituted for
the CIF price.

The logic for using border prices for traded goods

is fairly straight-forward: border prices represent
the correct social opportunity costs or benefits or
using or producing a traded good.

36
Accounting Price of Non-Traded Goods
Some goods and services like land, building, transportation, and
electricity are not amenable to foreign trade.

Hence, there is no border price observable for them.

Accounting prices for non-traded items are defined in terms of

marginal social cost and marginal social benefit.

The marginal social cost of a good is the value in terms of

accounting prices of the resources required to produce an extra unit
of the good.

For example, the marginal social cost of a bus trip is roughly equal
to the cost of material inputs (fuel, oil, wear and tear of the bus,
etc.) evaluated at border prices plus the social wage of the driver
and the conductor.
37
The marginal social benefit is the value of an extra unit of the the
accounting price of a non-traded input, one should estimate good
from the social point of view

When a good is not taxed and is consumed by only one income

group, its marginal social benefit is equal to its market price
multiplied by a factor which represents the value assigned to an
increase in the income of that group vis-à-vis an equal increase in
uncommitted social income.

To determine the proportion in which the demand for that input will
be met from increased production and decreased consumption
elsewhere in the economy.

If the proportion of increase in production to decrease in

consumption is, say, 2:1 the accounting price of the non-traded
input will be:

2 Marginal social cost 1 Marginal social benefit

3 3
38
Use of Conversion Factors

Ideally, the accounting price of a non-traded item

is defined in terms of marginal social cost and
marginal social benefit.

In practice, the calculation of marginal social cost

and marginal social benefit is often a difficult
task.
As a practical expedient, L-M suggest that the
monetary cost of a non-traded item be broken
down into tradable, labour, and residual
components.
39
Shadow Wage Rate
The shadow wage rate is an important but difficult-to-
determine element in social cost benefit analysis.

It is a function of several factors:

(i) The marginal productivity of labour,
(ii) The cost associated with urbanisation (cost of
transport, urban overheads, etc.), and
(iii) The cost of having an additional amount committed to
consumption when the consumption of the worker
increases as a result of the higher income he enjoys
in urban employment.

40
L-M Suggest the following formula for
calculating the shadow wage rate:
SWR = c’ – 1/s (c - m)
Where SWR = shadow wage rate
c’ = additional resources devoted to
consumption

1/s = value of a unit of committed resource

c = consumption of the wage earner
m = marginal product of the wage earner.

41
To understand clearly the components of SWR, may be
rewritten as follows:
1
SWR = m + (c’ – c) + (1 - ---- )(c – m)
s

(i) The first term, m, is the marginal product of labour

(ii) The second term, (c’ – c), represents the cost of
urbanisation (it is the cost associated with providing
the consumption level of c though it does not form
part of it).
(iii) The third term, (1 – 1/s) (c – m), represents the cost of
having an additional amount (c – m) committed to
consumption (it may be noted that 1 is the value of a
unit of uncommitted resource and 1/s is the value of a
unit of committed resource). 42
Accounting Rate of Return
The accounting rate of return (interest) is the rate used for
discounting social profits. In determining the accounting rate of
return the following considerations should be borne in mind:

• The future social profit for all the projects must be discounted in
the same way.
• The accounting rate (s) of interest should be such that all
mutually compatible projects with positive present social value
can be undertaken.
• The accounting rate of interest should maintain some kind of
balance between investment and investible resources: too low an
accounting rate of interest would lead to over-investment with
inflationary effects and too high an accounting rate of interest
would leave savings under-utilised and result in excessive
unemployment.
43
• The rate of return currently being earned is a good guide to the
accounting rate of interest when the following conditions are
reasonably satisfied: (i) indirect taxes are fairly uniform with little
discrimination between imported and exported commodities, and
(ii) the social wage rate is close to the actual wage rate.
• The initial estimate of the accounting rate of interest should, in
principle, be such that it would allow only a few of the best
projects in the past.
• Experience is the best guide to the choice of accounting rate of
interest: if the investment requirement of acceptable projects
exceeds the availability of investible funds, decrease the
accounting rate of interest. The adjustment in the accounting
rate of interest, however, should be gradual over a time.

44
Techniques for Social Cost Benefit Analysis

 Some method is required for comparing / evaluating

the projects for its effect on economic and Social
front.

 For commercial project, the financial appraisal using

sale, revenue, sales of return etc can be used for
comparison ie

 Thus conventional method of financial appraisal

leaves a gap when profitability is to reflect national
gains ie Cost benefit analysis will fill that gap.
45
 - Method has to provide basis for evaluation by
estimating prices that are appreciated for social
calculation ie Shadow pricing not Mkt.
pricing.

- Method is to be a substitute to pure adhoc

decision making.
 SCBA is not a technique but a general approach.

- Projects are judged for impact on economy

using parameters reflecting national goals and
social objectives.

Evaluation of project by SCBA begins by stating

relevant social objectives. 46
Some of the these social AIMS and benefits could
be as follows:-

- Accelerated economic & social development of

the regain of project.

- Distribution of benefit to larger number of poorer

section of society.

- Increased economic and social productivity and

increased consumption of goods and services.

- Generation of employment and job opportunity.

- Production of exportable good and minimisation

of import. 47
We can see the information required for SCBA is
substantially greater than conventional financial
analysis. It also requires relative weights to be given
to alternative objectives.

Information is also required to adjust Mkt. price to

social opportunity cost.

48
SCBA By Financial Institutions
The main Financial Institutions are
- IDBI
- IFCI
- ICICI
eg. IBDI considers three aspect for appraising industrial
project.
To calculate the economic rate of return.
IDBI follows “Partial Little Mirlees approach”
1 ECONOMIC RATE OF RETURN
- The international prices are regarded as
economic prices. 49
 (i) For tradable items CIF prices are used.
(ii) For tradable items without relevant international
prices and for non tradable items, social
conversion factors are used.
Tradable Component – Social cost of tradable
component obtained by multiplying 1/1.5
Labour Component – Social cost to labour is
obtained by multiplying factor of 0.5
Resident Component – Multiplying Factor 0.5
2 Effective rate of protection (ERP)
Value added at domestic prices – value added at
world prices divided by value added at world
prices to get percentage multiply it by 100.
50
2 Domestic Resources Cost
It reveal domestic cost incurred per unit of foreign
exchange saved or earned.
Formulas :-
DRC = A+B+C X Exchange Rate
P-(Q+R+S+T)
A= A/L Charge (rate of interests) on domestic
Capital normally 10%
B= A/L Depreciation (normal 8%)
C= A/L Cost of non tradable input.
P= Sales realization at int. prices
Q= A/L Change on imported capital (10%)
51
 R= A/L Depreciation on imported capital (8%)
S= A/L Cost of imported inputs
T= A/L Cost of domestically procured but tradable
inputs
Note 1 International prices – also called border prices
which means CIF prices for importable.
2 Substitute good and FOB price for exportable
good.

52
Public Sector Decisions in INDIA
Def. Public policy is the sum of Govt. activities, whether
acting directly or through agents as it has influence on the
life of citizens.
Some Govt. Institutions - Help Public Sector
Investments in INDIA.
1 Bureau of Public Enterprises (BPE) – 1965
Decision making of Govt. is strengthened , integrated
and economically coordinated with the help of
evaluating tech, economic and financial aspect of
project.
2 Project appraisal Division (1972) ((PAD)
Established 1972 under Planning Commission.
- Suggest standard Formats for Projects 53
 - Conduct Techno - economic evaluation of major
projects.
- Assets of Centre / State Govts.
3 High Powered Public Investment Board (PIB)
1972 (to help take public investment decision)
- Examines investment proposal.
- Prepares feasibility report.
- Revises cost estimates if required.
Decision making Process in Public investment
- Planning commission makes five year plans.
- To identify project of public sector enterprises.
- Sectoral plans are developed by administrative
ministries. 54
 - Preliminary feasibility report is also done by Admin.
Ministry.
- PAD (of planning commission) ie public appraisal
dir. does detailed appraisal.
- Investment Planning Committee of Planning
Commission discussions the appraisal report of
PAD & recommends to PIB (Public Investment
Board).
- PIB takes into view PAD, BPE, Plan Finance Div.
Under Ministry of Finance views and forwards with
comments to cabinet for approval.
Note PAD follows the modified version of LM approach.
ie - All tradable inputs are valued at border price.
55
- Transfer cost items are ignored.
 - Non tradable items are evaluated in terms of
marginal cost.
- FE involved in input / output are valued at specified
premia.
- Social Wages are applied in unskilled and semi
skilled labour.
- Numeraire is defined as saving in domestic rupee
rather than FE.
PIB (members)
- Secretary Expenditure men of Finance serves as
chairman.
- Secretary Economic Affairs. (Min. of Finance).
- Secretary Planning Commission
- Secretary Industrial Development. 56
- Secretary to Prime Minister.
- Secretary to Administrative Ministry.
Director General of BPE and the adviser PAD are
permanent member of PIB.

57