SOCIAL COST BENEFIT ANALYSIS (SCBA) SCBA, called economic analysis, is a methodology developed for evaluating investment projects

from the point of view of the society or economy as a whole. SCBA is relevant to developing countries where governments are playing a significant role in the economic development. It is also relevant to private investments as these have to be approved by various governmental and quasi-governmental agencies which bring to bear larger national considerations in their decisions. SCBA aids in evaluating individual projects within the planning framework which spells out national economic objectives and broad 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. The perspectives and parameters provided by the macro level plans serve as the basis for analyzing and appraising individual projects.

1. Rationale for SCBA In SCBA the focus is on the social costs and benefits of the project. These often tend to differ from monetary costs and benefits of the project. The major sources of discrepancy are: Market imperfections Externalities Taxes and subsidies Concern for savings Concern for redistribution Merit wants Market Imperfections: Where market imperfections exist, market prices do not reflect social values. The common market imperfections are: Rationing Prescription of minimum wage rates, and Foreign exchange regulation All these factors are relevant to SCBA

Externalities A project may have beneficial as well as harmful effects. Though these are ignored in assessing the monetary benefits to the project sponsors, in SCBA, externalities are relevant as in such analysis all costs and benefits, irrespective whom they accrue and whether they are paid for or not, are relevant. Taxes and Subsidies Taxes are monetary costs and subsidies are monetary gains. From the social point of view, however, taxes and subsidies are generally regarded as transfer payments and hence considered irrelevant. Concern for Savings Unconcerned about how its benefits are divided between consumption and savings, a private firm does not put differential valuation on savings and consumption. From a social angle, the division of benefits between consumption and savings ( which leads to investment ) is relevant.

In SCBA a higher valuation is placed on savings and lower valuation is put on consumption. Concern for Redistribution A private firm does not bother how its benefits are distributed across various groups in the society. A rupee benefit going to an economically poor section is considered more valuable than going to an affluent section. Merit wants Goals and preferences are not expressed in the market place, but believed by policy makers to be in the larger interest, may be referred to as merit wants. These are important from the social point of view. 2. UNIDO APPROACH The UNIDO method of project appraisal involve five stages: 1. Calculation of the financial profitability of the project measures at market prices. 2. Obtaining the net benefit of the project measured in terms of economic (shadow or efficiency ) prices.

3. Adjustment for the impact of the project on savings and investment. 4. Adjustment for the impact of the project on income distribution. 5. Adjustment for the impact of the project on merit goods and demerit goods whose social values differ from their economic values. Each stage of appraisal measures the desirability of the project from a different angle. 3. Net Benefit in terms of Economic (Efficiency) Prices UNIDO approach (second stage) is concerned with the determination of the net benefits of the project in terms of economic prices, also referred to as shadow prices. It may be noted that market prices represent shadow prices only under conditions of perfect markets which are almost invariably not fulfilled in developing countries.

Shadow Prices: Basic Issues Choice of Numeraire It is the unit of account in which the value of inputs outputs is expressed. To define or numeraire, the following questions have to be answered: i) Unit of currency- domestic or foreign to express benefits and costs. ii) Measurement of benefits in current or constant values iii) Evaluation with reference to which point- present or future. iv) Use- consumption or investment will be made of the income from the project. v) Group should the income of the project be measured The specification of the UNIDO numeraire in terms of the above questions is net present consumption in the hands of people at the base level of consumption in the private sector in terms of constant price in domestic accounting rupees.

Concept of tradability For a good that is tradable, the international price is a measure of its opportunity cost to the country. The international price, also referred to as the border price, gives the real value of the good in terms of economic efficiency. Sources of Shadow Prices The UNIDO approach suggests three sources of shadow pricing,depending on the impact of the project on national economy. i) increase or decrease the total consumption in the economy, - consumer willingness to pay ii) decrease or increase production in the economy, - cost of production iii) decrease imports or increase imports, or increase exports or decrease exports foreign exchange value

Taxes UNIDO Guide lines are: i) For non-traded inputs or addition to non-traded inputs consumer goods, taxes should be included a part of the consumer willingness to pay the marginal economic value ii) For a project augmenting domestic production by other producers, taxes should be excluded. iii) For fully traded goods, taxes should be ignored. Shadow Pricing of Specific Resources Tradable inputs and outputs Non-tradable inputs and outputs Externalities- beneficial or harmful Labor inputs Capital inputs Foreign exchange Externality It has the following characteristics: a) It is not deliberately created by the project sponsor but

is an incidental outcome of legitimate economic activity. b) It is beyond the control of the persons who are affected by it, for better or worse. c) It is not traded in the market place Since SCBA seeks to consider all costs and benefits, to whomsoever they may accrue, external effects need to be taken into account. However, the valuation of external effects is difficult as they are intangible in nature. Their value is estimated by indirect means. Examples are: oilfield, approach road, training programs, pollution, noise, harmful external effect of the highway etc. Labor Inputs When a project hires labor, it could have three possible impacts on the economy a) it may take labor away from other employments In this case, the shadow price of labor is equal to what other users of labor are willing to pay

b) it may induce the production of new workers The cost associated with this consists of marginal product of the worker in the previous employment- if unemployed this would become zero, the worker on the leisure reservation wage, increased expenditure on food if he is idle or partly employed, movement of workers: cost of transport, negative impact on savings if paid market wage and the cost of training to improve skill c) and it may involve import of workers A premium should be added on account of the foreign exchange remitted by these workers from their savings. Capital Inputs Impact of capital investment : i) conversion into the physical assets ii) resources are withdrawn from the national pool of savings and hence alternative projects are foregone. Thus shadow price of capital investment involve two questions: 1. Value of physical assets 2. The opportunity cost of capital ( which reflects the benefits foregone)

Foreign Exchange The UNIDO method uses domestic currency as the numeraire. Valuation of inputs and outputs that was measured in border rupee has to be adjusted upward to reflect the shadow price of foreign exchange. It is on the basis of marginal social value as revealed by the consumer willingness to pay for the goods that are allowed to be imported at the margin. 4. Measurement of the impact on distribution First measure the income gained or lost by individual groups within the society. Groups Project Other private business Government Workers Consumers External factors

Measure of Gain or Loss The gain or loss to an individual group within the society as a result of the project is equal to the difference between the shadow price and the market price of each input in the case of physical resources or the difference between the price paid and the value received in the case of financial transactions. 5. Savings Impact and its Value The 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? 6. Income Distribution Impact Investment proposals are considered as investments for income redistribution and their contribution toward this goal is considered as 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 them.

The guidelines of UNIDO suggest that the weights, which essentially reflect political judgements, may be determined by an iterative process involving interaction between the analyst and the planners. 7. Little-Mirrlees Approach There is considerable similarity between the UNIDO and the L-M approach. Both approaches call for: 1. Calculating accounting (shadow) prices particularly for foreign exchange savings and unskilled labor 2. Considering the factor equity 3. Use of DCF analysis Despite this, there are certain differences between the two approaches: 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 in different stages. The L-M approach, however, tends to view these considerations together. 8. SCBA by Financial Institutions The financial institutions follow essentially a similar approach which is simplified version of the L-M approach. IDBI in its economic appraisal of industrial projects, considers three aspects: Economic rate of return It has two aspects viz. i) Find out social costs associated with the initial outlay ii) Convert financial cost into social costs

 Effective Rate of Protection (ERP) ERP=Value added at domestic prices Value added at world prices Value added at world prices Domestic Resources Cost(DRC) It reflects the domestic cost incurred per unit of foreign exchange saved or earned. The formula used is as under: DRC = A +B + C x Exchange rate P ( Q+R+S+T) A = annual charge on domestic capital calculated at 10% B = annual depreciation on domestic capital assets at 8% C = cost of domestically procured operating inputs P = sales realization at international prices Q = annual charge on imported capital assets at 10% R = annual depreciation on imported capital assets at 8% S= annual cost of imported inputs T = annual cost of domestically procured, tradable inputs. Note: taxes,duties and subsidies are excluded