CHAPTER – SIX

SOCIAL COST BENEFIT ANALYSIS

(SCBA)

Project Management
 Contents

• Rationale for SCBA

• UNIDO Approach

• Net Benefit in Terms of Economic Prices

• Savings Impact
 Introduction
• Cost benefit analysis (CBA) is concerned with the examination of
a project from the view point of maximization of net social
benefit while cost benefit analysis originated to evaluate public
investment; it is also used in project appraisal.
• Earlier, project appraisal covered only private costs and benefits
at present social costs and benefits are also reckoned.
• Cost benefit appraisal a project proposes to describe and quantify
the social advantages and disadvantages of a policy in terms of a
common monetary unit.
• The unit should reflect society’s strength of performance for each
outcome. The economist uses as a measure of their preference,
the consumer’s willingness to pay (WTP) for a good.
 Scope of SCBA
• SCBA can be applied to both Public & private
investments –
 Public Investment: SCBA is important especially
for the developing countries where government
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 & quasi-governmental
agencies.
 Objectives of SCBA
• The main focus of Social Cost Benefit Analysis is to
determine:
 Economic benefits of the project in terms of shadow
prices;
 The impact of the project on the level of saving and
investment 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).
 Significances of SCBA
• CBA is unable to reflect social values. Hence
SCBA has been emerged with some interesting
significances.
• These significances make the SCBA different
from the CBA with respect to:
•Market Imperfections
• Externalities
• Taxes & Subsidies
• Concern for Savings
• Concern for Redistribution
• Merit Wants
Rationale for SCBA
Market Imperfections
• Market price reflects social values when perfect
competition exists
• When imperfection exists it does not reflect social values
• Causes of imperfection
– Rationing – when price of commodity controlled and less price
than competitive market is paid
– Minimum wage – more wage than competitive labor market is
paid
– Foreign exchange regulation when less than that of in absence
of foreign regulations
Rationale…Cont’d
Externalities
• Extra benefits or harms to neighboring areas
• Because beneficiaries do not pay for such benefits,
difficult to value it.
– Example: environmental pollution – can be valued as
medical expense because of pollution
Taxes and subsidies
• They are transfer payments because of absence of
transaction(exchange)
• So it’s irrelevant
Rationale…Cont’d
Concern for Saving
• In capital scarce developing country a money of
benefit saved is more important (important) than a
birr of benefit consumed
• Concern for saving and investment reflected in SCBA
Concern for redistribution
• Society concerned about distribution of benefits
across different groups
• A birr of benefit is going to economically poor is
more valuable than to an affluent section
Rationale…Cont’d
Merit wants
• Goal or preference not expressed in the
market place but believed by policy maker
– Ex: Adult education program which is not sought
by consumers in the market place
• They are important from social point of view
but not from private point of view.
 Approaches to SCBA

• There are two principal approaches for Social

Cost Benefit Analysis.
UNIDO Approach And
L-M Approach
 UNIDO Approach:
• This approach is mainly based on the publication of UNIDO
(United Nation Industrial Development Organization) named
Guide to Practical Project Appraisal in 1978. The UNIDO
approach of Social Cost Benefit Analysis involves five stages:
 Calculation of financial profitability of the project measured at
market prices.
 Obtaining the net benefit of the project at shadow (efficiency)
prices. (Objective of SCBA-1)
 Adjustment for the impact of the project on Savings & Investment.
(Objective of SCBA-2)
 Adjustment for the impact of the project on Income Distribution.
(Objective of SCBA-3)
 Adjustment for the impact of the project on Merit and Demerit
Goods whose
 UNIDO Approach…Cont’d
• Net Benefit interims of economic (Efficiency)
prices – measured at shadow price (value)
• Basic issues of Shadow price
i. Choice of Numeraire - to express the value of
inputs and outputs requirements
Example:
• type of currency – foreign or domestic
• current or constant value
• Present or future values
• Consumption or investment
 UNIDO Approach…Cont’d
– Having above requirements UNIDO uses “Net
Present Consumption” at base level of
consumption in the private sector in terms of
constant price in domestic accounting money
ii. Concept of tradability:
– for tradable goods we use opportunity cost (to
substitute import for domestic production and
vice versa)
– So we use international (border) price
 UNIDO Approach…Cont’d
iii. Source of Shadow price: depending on
impact on national economy it may
• Increase/decrease total consumption
• Decrease /increase production
• Increase/decrease import –export
 To measure consumption we consumer willingness
 To measure production we use cost of production
 For international trade (import –export) we use foreign
exchange value
 UNIDO Approach…Cont’d
iv. Taxes - poses difficulty for shadow price
calculation
– If the project results in diversion of non-traded
inputs in fixed supply from other producers or
addition to non-traded consumer goods taxes
should be considered
 Little – Mirrlees Approach
• L.M.D. Little and James A. Mirrlees 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. (Mentioned
earlier)
 Features of L-M Approach
• L-M Numeraire is present uncommitted social income.
• L-M methods opts for savings as the yardstick of their
entire approach. Present savings is more valuable to
them than present consumption since the savings can
be converted into investment for future.
• L-M approach rejects the ‘consumption’ numeraire of
UNIDO approach since the authors (L & M) feel that
the consumption of all level is valuable.
• This approach measures the cost and benefits in terms
of international or border prices.
 Similarity between UNIDO and Little –
Mirrlees Approach
• There is considerable similarity Between the
UNIDO approach and the L.M approach both
the approaches call for:
• 1. Calculating accounting shadow prices
particularly for foreign exchange savings and
unskilled labor.
• 2. Considering the factor of equity.
Little – Mirrlees Approach
Shadow Price
• For three categories of goods goods (inputs
and outputs)
a) Traded goods and services
b) Non-traded goods and services
c) Labor
 Little – Mirrlees Approach
a) Shadow price for traded goods
• Is simply border (international) price
• For exported goods, FOB (Freight on Board)
price
• For imported goods, CIF price
• For not perfectly elastic foreign demand,
use marginal export revenue
• For not perfectly elastic foreign supply, use
marginal import cost
 Little – Mirrlees Approach
b) Accounting (shadow) price for non traded goods
• For goods and services like: land, building, transportation,
electricity
• Not amenable(liable) to foreign trade, hence no border
price for them
• Measured in terms of marginal social costs and marginal
social benefits
• Marginal social cost – the value of resource required to
produce an extra unit of good
• Marginal social benefit – the value of an extra unit of the
good from the social point of view.
• In practice, the calculation of marginal social costs and
marginal social benefits is often difficult task
 Little – Mirrlees Approach
• L-M suggests to break down its monetary costs
into:
– Tradable, labor, residual components
• Tradable and residual components may be
converted into social cost by applying suitable
Social Conversion Factors
– Example: for labor component shadow wage rate
can be used
 Little – Mirrlees Approach
Shadow wage rate (SWR)
• The following factors considered
– Marginal productivity of labor
– Urbanization cost(transport, urban overhead, etc)
– 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
 Little – Mirrlees Approach

Where:
SWR – shadow wage rate
c’ – additional resource developed to consumption
1/s – value of a unit of committed resource
c – consumption of the wage earner
m – marginal product of the wage earner
 Little – Mirrlees Approach

Where:
m - marginal productivity of labor
(c’-c) – cost of urbanization
- the cost of having an additional amount
committed to consumption
1 – is the value of a unit of uncommitted
resource
1/s – the value of a unit of committed resource
 Little – Mirrlees Approach
Accounting rate of return
• The rate (interest rate) used for discounting social
profit

SCBA by Financial Institutions

• Commonly used three aspects are
– Economic rate of return
– Effective rate of return
– Domestic resource cost
 Difference between UNIDO and Little –
Mirrlees Approach
• Despite considerable similarities there are certain differences
between the two approaches.
• The UNIDO approach measures costs and benefits in terms of
domestic Birr whereas; the L.M approach measures costs and
benefits in terms of international prices, also referred to as
boarder prices.
• The UNIDO approach measure costs and benefits in terms of
consumption whereas the L.M approach measures costs and
benefits in terms of uncommitted social income.
• 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 tighter.
 Savings Impact
• What is saving impact mean and it does?(Class
work )
 End

Thank you