Social Cost Benefit
Analysis
Commercial Cost Benefit
Analysis (CBA)
•Benefit > Cost is desirable here.
•So it is nothing but a profitability
analysis.
•But what will be the costs and/or
the benefits that a society may
have to bear and/or get from the
proposed project are not
considered here.
Social Cost Benefit
Analysis
So, to reflect the real value of a project to society,
we must consider the impact of the project on
society.
• Impact
• Positive
• Negative
• (Social Benefit)
• (Social Cost)
Thus ,when we evaluate a project from the view
point of the society (or economy) as a whole, it
is called Social Cost Benefit Analysis (SCBA) /
Economic Analysis
Scope of SCBA
• SCBA can be applied to both public
and private investments
• Public Investment: SCBA is important
specially for the developing countries
where govt. plays a significant role in
the Economic development
• Private investment: Here, SCBA is
also important as the private
investments are to be approved by
various governmental and Quasi-
governmental agencies.
Objectives of SCBA :
The main focus of SCBA is to determine
• Economic benefits of the project in
terms of shadow prices
• The impact of the project on the level of
savings and investments in the society
• The impact of the project on the
distribution of income in the society;
• The contribution of the project towards
the fulfillment of certain merit wants
(self-sufficiency, employment etc)
Significance of SCBA
Market imperfection
Externalities
Taxes & Subsidies
Concern for savings
Concern for redistribution
Merit wants
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 :- IMD Little and J.A.
Mireless approach for analysis of Social
Cost Benefit in Manual of Industrial
Project “ Analysis in Developing
countries and project Appraisal and
planning for Developing Countries.
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.
UNIDO Approach Stage
-2
General Principles Of Shadow Pricing :
• The import (CIF) price is less or the export
(FOB) price is more than the domestic
cost of production
a) A good/service is non-tradable; if
• It import (CIF) price is greater than its
domestic cost of production and/or
• its export (FOB) price is less than its
domestic cost of production.
UNIDO Approach Stage
-2
General Principles of Shadow pricing :
Taxes:
• If the project augments(enlarges)
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
UNIDO Approach Stage
-2
General Principles of Shadow
pricing :
Consumer Willingness to Pay (CWP)
• What a consumer wants to spend for
a product or service
UNIDO Approach Stage
-2
Shadow Pricing of Resources :
Tradable inputs and outputs
For a fully traded goods, the
shadow price is border price
translated into the domestic
currency at shadow foreign
exchange.
UNIDO Approach Stage
-2
Shadow Pricing of Resources
Non-tradable Inputs and
outputs
Shadow Price = Cost of
production + Consumer
willingness to pay
UNIDO Approach Stage
-2
Shadow Pricing of Resources :
Externalities
• An externality is an external effect
(either beneficial or harmful) causes
from a project which is - not
deliberately created by the project
sponsors but is an incidental outcome
beyond the control of the persons who
are benefited or affected by it not
traded in the market place
UNIDO Approach Stage
-2
Shadow Pricing of Resources :
• people had lost lands due to the project of
River Bridge
• People may be affected by erosion and
flood conditions brought about by changes
to the river which result from the
construction Activities of a bridge
• Environmental pollution created by brick
field
• A project of planting trees for commercial
purpose may give protection to the
environment against the increasing global
warmth.
UNIDO Approach Stage
-2
Shadow Pricing of Resources :
• Shadow Pricing of Externalities
• Although valuation of external effects is
difficult as they are often intangible in
nature and there is no market price,
shadow pricing of externalities may be
made ;indirect
• The harmful effect of bridge may be
measured by the consumer willingness to
pay for the output of the people which has
been reduced due to the bridge
• The cost of pollution may be estimated in
terms of the loss of earnings as a result of
damage to health caused by it
UNIDO Approach Stage
- 2 Pricing of Resources :
Shadow
Capital
• Investment of capital in a project causes to happen two
things
a)Financial resources are converted into physical assets
b)Financial resources are withdrawn from national pool
of savings. Thus alternative projects are foregone and
there is an opportunity cost of it
• The shadow price of physical assets is calculated in the
same manner in which inputs and outputs are calculated.
• The opportunity cost of capital (shadow price of capital)
depends on the source from which the capital has
generated.
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
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
UNIDO Approach-
Stage for
Adjustment 5 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
L-M Approach :
• I.M.D. Little and James A. Mirrless
have developed an approach to
SCBA which is famously known as L-
M approach.
• The core of this approach is that the
social cost of using a resource in
developing countries differs widely
from the price paid for it
• Hence, it requires Shadow Prices to
denote the real value of a resource
to society.
L-M Approach :
Features of L-M Approach :
This approach measures the cost
and benefits in terms of
international or border prices.
Why do they prefer Border Prices?
It is because that the border
prices represent the correct social
opportunity costs or benefits of
using or producing traded goods.
L-M Approach :
Social Cost Benefit Analysis (SCBA) :
• The resources of input and output of a
project are classified into:
o
Labour
o
Traded goods
o
Non-traded goods
• Therefore, to find out the real value of
these resources, the following values
are to be calculated
o
Shadow wage rate (SWR)
o
Shadow price of traded goods
o
Shadow price of Non-traded goods
L-M Approach :
a. Shadow Wage Rate (SWR) :
• The reason for computing the SWR
is to determine the opportunity cost
of employing an additional worker in
the project. For this we have to
determine
• The value of the output foregone
due to the use of a unit of labour
• The cost of additional consumption
due to the transfer of labour
L-M Approach :
b) Shadow price of Traded Goods
Shadow price of traded goods is simply its
border or international price.
• if a good is exported, its shadow price is its
FOB Price
• if a good is imported, its shadow price is its
CIF price.
c) Shadow price of Non-traded goods
• Non-traded goods are those which do not
enter into international trade by their very
nature. (e.g., land, building, transportation)
• Hence, no border price is observable for
them.
UNIDO VS. L-M
Similarities
Calculation of Shadow prices to
reflect social value
Usage of Discounted Cash Flow
Techniques
UNIDO VS. L-M
Differences :
UNIDO L-M
Domestic International price
currency is used is used
Consumption is Uncommitted
the measurement social income is
base the measurement
base
SCBA objectives At one place all
are met through SCBA objectives
stage by stage are fulfilled.