SOCIAL COST BENEFIT ANALYSIS

Social cost benefit analysis is the analysis of a project on the society, by calculating
the qualities of a project/ a government strategy. 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.
It is also known as Economic society benefit analysis which is a part of economic
analysis in project appraisal, which is methodology to evaluate investment projects
from the view point of the society.
Significance of SCBA : Market imperfections, Externlities, taxes and subsidies,
concern for saving, concern for redistribution, merit wants.
2 main approaches in analysing the cost benefit of a project
UNIDO (United Nations Industrial Development Organization) – guide to practical
project appraisal 1978
L-M approach – Little Mirless approach – industrial project analysis in developing
countries.
UNIDO approach: United Nations International Development Organization
STAGE 1: calculation of financial probability of the project
A good technical and financial analysis must be done before a meaningful
economic(social) evaluation can be made so as to determine financial profitability.
Financial profitability is indicated by the Net Present Value (NPV) of the project,
which is measured by taking into account the inputs (costs) and outputs (benefits) at
the market price.
STAGE 2: Obtaining net benefit of project at economic prices (shadow prices)
Shadow prices – economic prices, economic/ accounting efficiency prices
Shadow prices = cost of production + consumer willingness to pay (CWP)
The difference between the CWP and actual payment is called Consumer Surplus
Numeraire: A unit of account in which the values of inputs and outputs are to be
expressed.
It is usually determined at Domestic currency, rather than border price,
Present value rather than Future value and constant price rather than current price.
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.
Shadow pricing of resources: the shadow price of physical assets is calculated in same
manner in which the inputs and outputs are calculated. The opportunity cost of capital
(shadow price of capital) depends on the source from which the capital is generated.

STAGE 3: adjustment for the impact of the project on savings and investment
• The main purpose is to – determine the amount of income gained or lost
because of the project by different income groups (business, government,
workers, customers etc)
• Evaluate the net impact of these gains and loses in savings
• Measure the adjustment factor for savings and thus the adjusted values for
savings impact
• Adjust the impact on savings to the net present value calculated in stage 2.

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
• Distribution Adjustment Factor (Weight) is calculated and the impacts of the
project on income distribution have been valued by multiplying the adjustment
factor with the particular income of a group. This value will then be added to
the net present value re-calculated in stage three to produce the social net
present value of the project.
• Determination of weights: If there are only two groups in a society, poor and
rich, the determination of weight is just an iterative process between the
analysts (at the bottom) and the planners (at the top). This is
called "bottom-up" approach.
When more than two groups are involved, weights are calculated
by the elasticity of marginal utility of income.

STAGE 5: adjustment of 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
The steps are
• Estimating the present economic value
• Calculating the adjustment factor
• Multiplying the economic value by the adjustment factor to obtain the adjusted
value
• Adding or subtracting the adjusted value to or from the NPV of the project as
calculated in stage 4

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 Numeraire is present uncommitted social income.
• L-M approach rejects the 'consumption' Numeraire of UNIDO approach since
the LM exponents feel that the consumption of all level is valuable.
• L-M methods opt 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

FEATURES: This approach measures the cost and benefits in terms of

international or border prices, The border prices represent the correct social
opportunity costs or benefits of using or producing traded goods.

The resources of input and output of a project are classified into

Labour
Traded goods
Non traded goods

To find the real value of these resources the following values are to be calculated
Shadow wage rate (SWR)
Shadow price of traded goods
Shadow price of non-traded goods

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 need the
• Value of the output foregone due to the use of labour
• The cost of additional consumption due to the transfer of labour
Shadow price of traded goods
It is the border or the international price
If a good is exported its shadow price is its FOB price (Free on-board price) –
(includes all the expenses incurred until the goods are actually loaded on board the
ship at the port of shipment).
If a good is imported, its shadow price is its CIF (cost, insurance and freight)

Shadow price of non- traded goods:

Non traded goods are those which do not enter into international trade by their very
nature (land building, transportation)

Accounting rate of return (ARR) :

This is the rate used for discounting social profits
All the mutually compatible projects with positive present social value can be
undertaken

Similarities:
• calculation of shadow prices to reflect social value
• Usage of discounted cash flow
Differences:

UNIDO and L-M

Domestic currency is used as Nemeraire where as in L-M international price is used
Consumption is the measurement base and uncommitted social income is the
measurement base
SCBA objectives are met through stage by stage where as in L-M at one place all
SCBA objectives are fulfilled.

PREETHANA K S
212109210