SOCIAL COST BENEFIT ANALYSISPresent ByDR P R KULKARNI**Dr.P.Kulkarni

Dr.P.Kulkarni

PROJECT APPRAISAL : THREE COMPONENTS

Financial Appraisal :examines the financial flows generated by the project itself, and the direct costs of the project measured at market prices. Economic Appraisal: adjusts costs and benefits to take account of costs and benefits to the economy at large, including the indirect effects of the project that are not captured by the price mechanism. Social Appraisal: examines the distributional consequences of project choices, both inter-temporal concerns (i.e. effects over a period of time, today versus the future); and also intra-temporal concerns (e.g. concerns between groups in society at a specific point in time).

**Dr.P.Kulkarni

Dr.P.Kulkarni

Rationale for SCBAIt provides a rational framework for project choice using national objectives and values.The choice of one project rather than another must be viewed in the context of their total national impact in term of employment, output, consumption, saving, foreign exchange earning, income distribution, and other things of relevance to national objectives.Social costs and benefits of the project is the primary focus of the SCBA and they tend to vary from monetary costs and benefits of the project.Some of the principal sources of discrepancy are :

**Dr.P.Kulkarni

Dr.P.Kulkarni

Principal Sources of Discrepancies for SCBAMarket Imperfections Externalities Taxes and Subsidies Concern for Savings Concern for Redistribution Merit Wants**Dr.P.Kulkarni

Dr.P.Kulkarni

Significance of SCBABasis of Evaluation :Prices that would be appropriate for social calculationIt helps t understand cost & benefit of project- directly and indirectly.Enables Decision Making: It is not technique. It is approach. It provide rational framework for project choice using national objectives. Projects are judged in term of precise impact on economy.**Dr.P.Kulkarni

Dr.P.Kulkarni

UNIDO Approach for Social Cost Benefit AnalysisUnited Nations Industrial Development Organization (UNIDO) Five stages Calculation of financial profitability at market priceShadow pricing of resources to obtain the net benefit at economic pricesAdjustment for the projects impact on saving and investmentAdjustment for the projects impact on income distribution Adjustment for the projects production or use of goods whose social values are less than or greater than their economic values

**Dr.P.Kulkarni

Dr.P.Kulkarni

Concept of Shadow Pricing

In perfect market conditions Market prices only reflect the shadow pricesIn imperfect market conditions Shadow pricing is done in terms of two criteria:Which resources figure most prominently in the benefits and costs of the project at market prices?What are the resources whose market prices are significantly different from the shadow prices?**Dr.P.Kulkarni

Dr.P.Kulkarni

Items for Shadow PricingMain Outputs : They constitute the entire benefit stream if there are no externalities and are often sold at protected prices

Importable Material Inputs : If produced domestically, they may enjoy substantial protection, if imported, they may be heavily taxed

Major Non-Imported Material Inputs : Involve tradable material content that is protected

Unskilled Labor : Its market wage often exceeds its shadow wage**Dr.P.Kulkarni

Dr.P.Kulkarni

Basic Issues of Shadow PricingTradability : A good is said to be tradable if it can be imported instead of domestic production and if it can be exported instead of domestic consumption. Its real value to country in terms of pure efficiency of such good is the international price.Major categories of Tradability:Tradable A good that would be imported or exported in the absence of trade barriers.

Non-Tradable A good whose real domestic cost of production is too high to permit export and too low to motivate import

Traded A tradable that is actually traded

Non-Traded A tradable that is not traded because of trade policies**Dr.P.Kulkarni

Dr.P.Kulkarni

ContdSources of Shadow Prices

In Perfect market conditions Market PriceTradable inputs and outputs: International PriceNon Tradable inputs and outputs :Willingness to pay is relevant shadow price .Labor inputs : Economic Efficiency.Capital Inputs : If it is fully traded goods value of its border Price.If it is partially traded or non traded its shadow price is its economic cost production

**Dr.P.Kulkarni

Dr.P.Kulkarni

ContdTreatment of Taxes

Fully traded goods Taxes should be ignored

Non-Traded consumer goods Taxes should be included as part of the indication of the consumer willingness to pay the marginal economic value

Taxes should be excluded if the project increases the production by other domestic producers**Dr.P.Kulkarni

Dr.P.Kulkarni

ContdExternalities These are special class of non-traded goods that may be either positive or negativePositive Externalities Workers training but beneficiary pay no chargeNegative Externalities Air pollution but those adversely affected are not compensatedHerein the Shadow price is the economic valueEconomic value (in this case) = NPV+ Net cash flow

**Dr.P.Kulkarni

Dr.P.Kulkarni

ContdForeign Exchange The Shadow price of foreign exchange = Fi * Qi * Pi

Where Fi = Fraction of foreign exchange, at the margin, spent on importing commodity IQi = Quantity of commodity i that can be bought with the unit of foreign exchangePi = Domestic market clearing price of commodity**Dr.P.Kulkarni

Dr.P.Kulkarni

Stage III Distribution of Benefits over Time The Savings ImpactDifference between consumption and savingVital consideration to make a choice Rationale behind this stage Amount of income gained or lost Marginal propensity to save Rate of return

**Dr.P.Kulkarni

Dr.P.Kulkarni

Stage IV- Income Distribution ImpactIn many countries the redistribution of income to specific income classes is high priority.Because Government is not able to accomplish the distribution more efficiently.It is therefore important to measure the impact of the project from this point of view.The net gain and loss of each group is calculated.

**Dr.P.Kulkarni

Dr.P.Kulkarni

Stage V- Merit and Demerit GoodsMerit Goods :if the social value of the goods is more than its efficiency value , goods may called a merit goodsFor instance a country may want foreign exchange simply to increase its ability to withholds its export for strategic political reasons.Demerit Goods : if the social value of the goods is less than its efficiency value than that goods may be called as a demerit goods. Country may include tobacco, alcohol and luxury good items in this category.**Dr.P.Kulkarni

Dr.P.Kulkarni

LITTLE MIRRLEES APPROACHSIMILARITIES TO UNIDO APPROACH Calculation of accounting (shadow) prices for foreign exchanges savings and skilled labor Consideration of factor of equity Usage of discounted cash flows analysis

DISSIMILARITIES TO UNIDO APPROACH Measures cost and benefits in terms of international prices Measures costs and benefits in terms of uncommitted social income Considers efficiency, savings and redistribution together for analysis **Dr.P.Kulkarni

Dr.P.Kulkarni

Inputs and outputs The inputs and outputs in the project are classified:Traded good and services.Non traded goods and services.Labor

**Dr.P.Kulkarni

Dr.P.Kulkarni

SHADOW PRICES

Shadow Prices of Traded Good is its border priceShadow Prices of Non-traded Goods are defined in terms of marginal social cost and benefits.Calculation of marginal social cost and benefits is practically difficult L-M approach has suggested that the monetary cost of non traded items should be broken down into tradable , labor & residualsShadow Wage Rate.The accounting rate of return should used for discounting social benefits.

**Dr.P.Kulkarni

Dr.P.Kulkarni

EXAMPLE:

A multiple-purpose river valley project has been proposed by a government. The requirements of the project are4,00,000 tonnes of cement produced indigenously and supplied at a rate of Rs.800 per tonne.30 mn man days of unskilled labor at daily wage rate of Rs. 1220,000 tonnes of steel produced indigenously at a cost of Rs.6,500 per tonne

The annual benefits excepted from the project would be:300 mn units of electricity will be generatedFlood damages to the extent of Rs.30 mn will be saved annually

The following additional information is availableSteel is a tradeable item whose FOB value is $ 450/tonneThe shadow price per dollar is Rs.13Cement is not a tradeable itemThe shadow price of unskilled labor is Rs.8 per dayThe electricity tariff charged by the project central board would be 35 paisa per unit. The consumer willingness to pay is 50% more than the tariff charged.

Define the cost and benefit from the project control boards and economic point of view.**Dr.P.Kulkarni

Dr.P.Kulkarni

Social Cost Benefit Analysis by Indian Financial Institutions**Dr.P.Kulkarni

Dr.P.Kulkarni

IDBIProjects evaluated also with Social Angle

Uses three conceptsEconomic rate of returnEffective rate of protectionDomestic Resource Cost**Dr.P.Kulkarni

Dr.P.Kulkarni

Economic Rate of ReturnIBDI follows a modified version of little L-M approach to Social cost benefit analysis.Input and out are calculated by following methods.All non labor inputs and outputs are valued at international prices. The international prices reflects true economic value. In case of tradable items for which international prices are directly available , international prices are used.For tradable items whose international prices are not available social conversion factors are used.The rupee value of each good is divided into tradable, non tradable & residual components. Social conversion than applied to these components **Dr.P.Kulkarni

Dr.P.Kulkarni

Proportions of Tradable (T), Labor (L) & Residual (R) and Social Conversion Factors (SCF)**Dr.P.Kulkarni

ItemProportionLandSCF=1/1.5Building & ConstructionT=0.5, L=0.25, R=0.25Indigenous EquipmentSCF=0.70TransportationT=0.65, L=0.25, R=0.10Engineering & Know How feesSCF=1.50Bank ChargesSCF=0.02Preoperative ExpensesSCF=1.00LaborSCF=0.50SalariesSCF=0.80Repairs & MaintenanceSCF= 1/1.5Water, Fuel, etc (Utilities)T=0.50, L=0.25, R=0.25ElectricityT=0.71, L=0.13, R=0.16

Dr.P.Kulkarni

Proportions of Tradable (T), Labor (L) & Residual (R) and Social Conversion Factors (SCF) (Contd.)**Dr.P.Kulkarni

Domestic StoresSCF=0.80Other OverheadsSCF=1/1.5The SCF of tradable, labor& Residual components is the same for all goodsTradable Component1/1.5Labor Component0.5Residual Components0.5

Dr.P.Kulkarni

Example on SCB Appraisal of a ProjectProjects aims to produce a product which is imported.Life of project is 8 years.Output of the plant to substitute the whole import.First, appraise the capital expenditureSecondly, Appraise the annual statementsCalculate IRR of the cash flows of Social Benefit.If, the required Social discount rate is less than IRR, accept the project else reject it**Dr.P.Kulkarni

Dr.P.Kulkarni

Capital Expenditures(Rs. Crores)**Dr.P.Kulkarni

Land0.5Building11.00P&M (Imported) (CIF Value = 9 Crore)7.00P&M (Indigenous) (CIF Value of similar items = 50 Crore)60.00Transportation Costs2.00Technical Know How Costs6.00Pre operative expenses5.00Bank Charges0.50W.C Requirements (CIF Value = 15 Crore)20Total112

Dr.P.Kulkarni

Calculations**Dr.P.Kulkarni

ItemFinancial CostBasis of ConversionTradableValue Ab InitioTLRLand0.5SCF=1/1.50.33---Building11T, L , R-5.52.752.75P&M (Imported) 7CIF9---P&M (Indigenous) 60CIF60---Transportation Costs2T, L , R-1.30.50.2Technical Know How Costs6SCF=1.509---Pre operative expenses5SCF=1.005---Bank Charges0.5SCF=0.020.01---W.C Requirements 20CIF15---Total11298.346.83.252.95

Dr.P.Kulkarni

Calculation of Social Value of Capital Expenditure**Dr.P.Kulkarni

Rs ( Crores)Tradable Value Ab initio98.34Social Cost of Tradable component(6.8/1.50)4.53Social Cost of Labor Component (3.25*0.50)1.63Social Cost of Residual Component (2.95*.50)1.48Total Social Value of Capital Expenditure105.98

Dr.P.Kulkarni

Annual Statements**Dr.P.Kulkarni

Income(Rs. Crores)Net Sales (15,000 tonnes @ Rs 90,000/tonne, CIF Value = 80,000/tonne)135ExpenditureImported R.M. (CIF Value = 7 crore)9Indigenous R.M.70Labor7Salaries5Repairs & Maintenance3Water, Fuel, Etc.7Electricity (Rate=4, Duty =2)6Depreciation10Other Overheads8Taxable Profit10

Dr.P.Kulkarni

Calculations**Dr.P.Kulkarni

ItemFinancial CostBasis of ConversionTradable Value Ab InitioTLRImported R.M.9CIF7---Indigenous R.M.70SCF=0.8056---Labor7SCF=0.53.5---Salaries5SCF=0.804---Repairs & Maintenance3SCF=1/1.52---Water, Fuel, Etc.7T, L, R-3.51.751.75Electricity6T, L, R-2.840.520.64Other Overheads8SCF=1/1.55.33---Total77.836.342.272.39

Dr.P.Kulkarni

Calculation of Social Cost of Annual cash flows**Dr.P.Kulkarni

Rs ( Crores)Tradable Value Ab initio77.83Social Cost of Tradable component(6.34/1.50)4.23Social Cost of Labor Component (2.27*0.50)1.14Social Cost of Residual Component (2.39*0.50)1.20Total Social Value of Capital Expenditure84.40

Dr.P.Kulkarni

Calculation of Social Cost of Annual cash flows (Contd.)CIF Value of Output @( Rs. 80,000/ tonnes x 15,000 tonnes) = 120 Crores.Net Social Benefit P.A = 120 84.4 = 35.60 Crores.In the final yearW.C Liquidation = 15 CroresSalvage value of Assets = 2 Crores

**Dr.P.Kulkarni

Dr.P.Kulkarni

IRR Calculation**Dr.P.Kulkarni

YearCash Flows0-105.98135.6235.6335.6435.6535.6635.6735.6852.6IRR30.08%

Dr.P.Kulkarni

Effective Rate of ProtectionThe Government protect domestic industry through means such as taxes &tariffs, import and export restrictions.The degree of protection given to industry provides an idea, How vulnerable the industry is?The degree of protection available to industry is judged by value added made by industry at domestic and at world price. **Dr.P.Kulkarni

Dr.P.Kulkarni

Effective Rate Of Protection-FormulaERP = Value added at domestic prices - Value added at world prices Value added at world prices

Value added = Selling price Inputs cost

The traded inputs are valued at both world prices and domestic prices while the non traded inputs are valued only at the domestic prices.

**Dr.P.Kulkarni

Dr.P.Kulkarni

Valuation of GodsTraded goods are valued at both world price and domestics price.Non traded goods are valued only at domestics price.The classification of inputs into tradable &non tradable goods:Raw materials and stores: These in general treated as traded goods and also valued at world price. **Dr.P.Kulkarni

Dr.P.Kulkarni

Cotinu..Power fuel and water: These are treated as a non traded goods. If fuel cost is significant it should be valued at both at domestic and world price.Repairs and Maintenance: Generally a non traded item but value of spares consumed is considered both domestic and world price.Selling Expenses: Non -traded items.Administrative Expenses: The expenses like rent, telephone, and telegraph etc are treated as non- traded expenses.**Dr.P.Kulkarni

Dr.P.Kulkarni

Domestic prices World PricesInputsTradable inputs Raw material 450350Consumable stores7540Non tradable inputsPower fuels and water35Repairs and maintenance20Administrative overheads45Selling expenses30Total input cost655390OutputSales realization750450Value added9560ERP = (95-60)/60*100 = 58.33%**Dr.P.Kulkarni

Dr.P.Kulkarni

Domestic resource costIt is the spending required in terms of domestic currency to generate a saving of one unit of a foreign currency. The commonly used foreign currency for estimating DRC is the US dollar.

DRP = Value added at domestic prices * Exchange rate Value added at world prices

The amount of value added for computation of DRC is estimated as follows:**Dr.P.Kulkarni

Dr.P.Kulkarni

Domestic InternationalSelling PriceLess: Operation costRaw materialsPower fuel waterRepairs and maintenanceAdministrative OverheadSelling expensesLess: capital costsCharge on capital employedDepreciation**Dr.P.Kulkarni

Dr.P.Kulkarni

Relation Between ERP and DRCDRC = (ERP + 1)* Exchange rate

Assuming Exchange rate, 1 USD = INR 45

DRC = (0.5833 +1)*45 = INR 71.25**Dr.P.Kulkarni

Dr.P.Kulkarni

Following details available in respect of project**Dr.P.Kulkarni

Rs croresValue of tradable inputs in domestic price700Value of non- tradable inputs at domestic price180Value of tradable inputs at world price560Sales realization at domestic price1000Sales realization at world price800

Dr.P.Kulkarni

Calculate ERPCalculate DRP at Exchange rate Rs 26 per dollar**Dr.P.Kulkarni

Dr.P.Kulkarni

solution**Dr.P.Kulkarni

At domestic priceAt world priceSelling price1000800Input cost tradable goods 700560Input cost non tradable goods180180Value Added12060

Dr.P.Kulkarni

ERP= 120-60/60 * 100 = 100% protection

DRC=Value added at domestic price/ Value added at world price * Exchange RateDRC =120/60*26 = Rs52**Dr.P.Kulkarni

Dr.P.Kulkarni

**Dr.P.Kulkarni

Dr.P.Kulkarni

*************************************