SOCIAL COST BENEFIT

ANALYSIS (SCBA)

By:Narayan Gaonkar

Social cost benefit analysis (SCBA)called Economic analysis, is a methodology developed for evaluating investment projects from the point of view of the society as a whole.

SCBA aids in evaluating individual projects within the planning framework which spells out national economic objectives and broad allocation of resources to various sector. In other words , SCBA is concerned with Tactical Decision making within the framework of macro level.

Meaning:

Advantages

• The ability to identify the projects that maximize the welfare of the country.

• The ability to objectively assess and quantify the purpose projects in relation to community needs.

• Exposure of the basis for decision-making for projects and opportunity for public criticism.

• Ability to rank and prioritize limited resources so that the maximum benefit is realized.

Disadvantages • Difficulty in measuring social costs and benefits

and converting them in to monitory term.

• Over statement of the value of social benefits

• Complexity

• Conflict between social welfare and financial justification.

Approach's of SCBA :1.Rationale for SCBA2.UNIDO approach3.Net benefit in terms of economic prizes4.Saving impacts and its value5.Income distribution impact6.Adjustment for merit and demerit goods7.Little-Mirrlees approach8.Shadow prices9.SCBA by financial institutions10.Public sector investment decisions in India

1.Rationale for SCBA

In SCBA the focus is on the special costs and Benefits of the project. The principle sources of discrepancy are:

Market imperfectionsExternalitiesTaxes and subsidiesConcern for savingsConcern for redistributionMerit wants.

Market imperfections:When imperfection exits, market price do not reflect social values. The common imperfections found in developing Countries are :

Rationing:Rationing of a commodity means control over its price and distribution .The price paid by a consumer under rationing is often significantly less Than the price that prevail in the competitive market.

Prescription of minimum wage rates :When minimum wages would be in a competitive labour market free from such wage legislations .

Foreign exchange regulation:The official rate of foreign exchange in most of the developing countries, which exercise close regulation over foreign exchange ,typically less than the rate that would prevail in the absence of foreign regulation . That is why foreign exchange usually commands a premium in unofficial transactions.

Externalities:A project may have a beneficial external effects. For example, it may create certain infrastructural Facilities like roads which benefit the Neighbouring areas. Such benefits are considered in SCBA , though they are ignored in assessing the Monetary benefits to the project sponsors because they do no receive any monetary compensation from those who enjoy the external benefit created by the Project . Likewise, a project may have harmful effect like environmental pollution.

Taxes and SubsidiesFrom the private point of view ,taxes are definite monetary costs and subsidies are definite 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:A rupee of benefits saved is deemed more valuable than a rupee of benefit consumed. The concern of society for saving and investment is dully reflected in SCBA wherein a higher a valuation is placed on saving and lower valuation is put on consumption.

Concern for Redistribution:The society is concern about the distribution of benefits across different group. A rupee of benefit going to an economically poor section is considered more valuable than a rupee of benefit going to an affluent section.

Merit wants:Goals and preferences not expressed in the market place, but believed by policy maker to be larger interest . For ex: Govt. may promote an adult education programme or balanced nutrition programme for school –going children even though these are not sought by consumer in market place .

2. UNIDO Approach:• UNIDO approach was first articulated

in the Guidelines for Project Evaluation which provides a comprehensive framework for SCBA in developing countries .UNIDO approach is based largely on the latter publication though at places we will draw on the former publication too.o Measures cost and benefits in terms of

domestic rupeeso Measures cost and benefits in terms of

consumption.o Focuses on efficiency, savings and

redistribution aspects in different stages.

UNIDO method of project appraisal involves five stages:

1. Calculation of the financial profitability of the project measured at market prices.

2. Obtaining the net benefit of the project measured in terms if economic (efficiency) prices.

3. Adjustment for the impact of the project on savings and investment.

4. Adjustment for the impact of the project on income and distribution.

5. Adjustment for the impact of the project on merit goods and demerit goods whose social values differ from their economic values.

Net benefit in terms of economic prizes

Choice of Numeraire

One of the important aspects of shadow pricing is the determination of the numeraire , the unit of account in which the value of inputs or outputs is expressed. To define the nummeraire ,the followingquestions have to be answered: 1. What unit of currency , domestic or foreign,

should be used to express benefits or costs?2. Should costs and benefits be measured in

current values or constant values ?3. Should the income of the project is measured in

terms of consumption or investment?

Concept of tradabilityA key issue in shadow pricing is whether a good is tradable or not. For a good that is tradable, the international price is a measure of its Opportunity cost to the country. Why? For a tradable good, it is possible to substitute import for domestic production and vice versa .

Sources of shadow pricesThe UNIDO approach suggests three sources of

shadow pricing, depending on the impact of the project on national economy .A project , as it uses and produces resources, may for any given input or output(i) Increase or decrease the total consumption in

the economy. (ii) Decrease imports or increase imports .(iii) decrease or increase production in the

economy .

When shadow prices are being calculated, taxes usually pose difficulties. The general guidelines in the UNIDO approach with respect to taxes are as follows:1. When a projects results in diversion of non-

traded consumer goods taxes should be included.

2. When a project augments domestic production by Other producers, taxes should be excluded.

3. For fully traded goods , taxes should be ignored.

Treatment of Taxes

Impact on DistributionMeasure of gain or loss: Difference between price paid and value received.Impact on saving:

Its seek to answer fallowing question-1. Given the income distribution project what

would be its effect on saving?2. What is the value of such saving?

Impact of the project on savings and investment

Adjustment for merit and demerit

goods

Merits good is one for which the social value exceeds the economic value.

Demerits good is one social value of goods is less than the economic value.

Income distribution impact

Redistribution of income in favour of economically weaker sections.

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.

3. Little-Mirrlees approach:

Issues in Little- Mirrlees Approach to SCBA

Numeraire: L-M’s numeraire is “present uncommitted social income measured in terms of convertible foreign exchange of constant purchasing power”

L-M’s Shadow Price:L-M’s approach measures costs and benefits in terms of international price as against UNIDO method that measures costs and benefits in terms of domestic prices.

L-M Shadow Price for traded goods:The shadow price of traded good/service is equal to its border because it represents the appropriate social opportunity cost/benefit of producing /using a traded good/service

L-M Shadow Price for Non- Tradable Goods:Non tradables include goods like land, building and services like power, internal transport etc. Shadow price for non-tradables is arrived at in terms of marginal social cost and marginal social benefit.

L-M Shadow Wage Rate:It is an important but difficult to determine element in social cost benefit analysis. It is a function of several factors:

The marginal productivity of labour The cost associated with urbanisation The cost of having an additional amount committed to

consumption

Accounting/ Average rate of return methodThe accounting rate is the rate used for discounting social profits

Differences between UNIDO approach and L-M approach1. 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).

2. 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.

3. The UNIDO approach focuses on efficiency, savings and redistribution aspects in different stages. L-M approach tends to view these aspects together.

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