Social Cost Benefit Analysis

Also called Economic Analysis Developed for evaluating investment projects from the point of view of the society (or economy) as a whole. Primarily for evaluating public investments. Why this methodology? Once we agree with SCB, it helps in
decision-making deciding whether a particular project should go ahead or not. comparing different projects
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Increasing Emphasis
Growing importance of public investments in developing countries Aids in evaluating individual projects within the planning framework (i.e. national economic objectives) & broaden allocation of resources to various sectors. Reasons for the difference between social costs and monetary costs
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Reasons for difference between social cost & benefits and monetary costs & benefits
1. Market imperfection resulting in market prices not reflecting social values e.g.
Large Projects likely to yield significant secondary benefits to the economy.
Counting only the primary benefits is not OK

Rationing of a commodity valuation like control over its price and distribution including capital, interest & rates

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Reasons
2. Externalities Both costs and benefits to different people, groups in the society are taken into account E.g.
Large dam resulting in environmental pollution, deforestation, mosquito breeding, ecological imbalance, displacement etc. Infrastructure facilities like roads coming up, installation of telephone lines

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Examples of difference
A township coming up due to the project Employment opportunities in an otherwise non-industrial area A road or telephone line being laid A petrol bunk coming up due to the project A project closes down due to nonviability & hence the canteen outside the campus has to close down
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Reasons
3. Concern for Wealth Distribution

For public investments

= Goals & preferences not expressed in the market place but believed by policy makers to be in the larger interest have long-term social and economic benefits. E.g. rural telecommunication network, air connection with low density destinations, priority sector lending etc Merit goods and non merit goods

4. Merit Wants

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SCBA approaches
SCBA is not a technique (for measuring) like NPV etc but it is an approach Basically two approaches for SCBA viz.:
UNIDO Approach and Little Mirrlees Approach

United Nations Industrial Development Organization Primary objective is promotion & acceleration of industrial development in developing countries and countries with economies in transition. Practical Project Appraisal by UNIDO (1978) Tries to quantify the social impact

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UNIDO Approach
Calculate usual financial profitability of project as measured at market pries. Shadow price the resources Obtain the net benefit of the project on savings and investments. Adjust for the impacts of the project on savings and investment. Adjust for the impact of the project on income distribution. Adjust for the impact of project on merit goods and demerit goods whose social values differ from their economic values.

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Shadow pricing?
The opportunity cost of a scarce resource Maximum price that management is willing to pay for an extra unit of a given limited resource Measure of the contribution foregone by failing to have one more unit of scare capacity in a particular situation.
A shadow price is, in a way, an OPPORTUNITY COST Resources in excess supply have a shadow price of zero. Over time When foreign exchange is rationed, the shadow price of foreign exchange becomes the relevant exchange rate decisions. Benefits and costs are measured in terms of shadow prices of inputs and outputs instead of in actual market prices

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How to calculate shadow prices

Shadow prices = market prices under perfect market conditions; how to calculate otherwise? Concepts to be understood for this purpose 1. Numeraire unit of account for expressing input and output e.g. which currency to express, which time frame for comparison, whether costs at current values or constant values etc. 2. Tradability generally international price represents better price than the controlled domestic price. Free import and export equalises prices
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Basis for shadow prices

3.

Non-tradable Inputs and outputs e.g. when import price >domestic cost of production or export price < domestic cost of production.
For such items, value should be measured in terms of what domestic consumes are willing to pay

4.

5.

Taxes impact of tax on price estimate is subjective. To be included when the project consumes inputs which are in fixed supply by diverting from other producers Externalities
It is not deliberately created by the project sponsor but is an incidental outcome of legitimate economic activity. It is beyond the control of the persons who affected by it, for better or for worse. It is not traded in the market place. An external effect may be positive or negative.

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Export Parity Price for Sugar

(for project in Central area of Mozambique)
Shadow Price Variable US$/Tonne World price of sugar exported FOB from Beira 264 Less transport costs from mill to docks 12 Net value per tonne of sugar at mill 252 Net value of cane at mill (10 % of sugar price) 25.2 Less cane processing costs at mill 7 Less transport costs from project area 3 Delivered mill economic price for cane at project area in US$ 15.2

Expected economic price of cane at project area (local currency) Actual financial price of cane in project area (local currency) Conversion factor (220/200)

220 200 1.10

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Import Parity Price of Maize

(for project in Central area of Mozambique)
Shadow Price Variable US$/Tonne Import price of rice from Johannesburg, South Africa 127 Bagging and loading in Durban 15 Freight, insurance and customs Durban to Maputo 30 Total CIF (Customs, Insurance and Freight) at Maputo 172 Unloading and storage in Maputo 3 Total in-store price in Maputo 175 Less transport and bagging to project area (200 km away) 25 Expected economic farm gate price at project area in US$ 150

Expected economic farm gate price at project area (local currency) Actual financial farm gate price at project area (local currency)

1900 1800

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Little- Mirrlees Approach

This also involves shadow prices and the usual mathematical arrival of result like NPV Differs from UNIDO approach in
UNIDO approach measures cost & benefit in domestic currency whereas this measures in international prices UNIDO approach measures costs and benefits in terms of consumption where here it is measured in terms of uncommitted social income Little and Mirrlees has an elaborate methodology for calculating shadow prices of non-trade-ables Unlike the five stages of UNIDO, the Little and Mirrlees procedure is relatively more practical
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Differences
Little and Mirrlees emphasise on generating savings and hence it suggests the use of accounting rate of interest to calculate NPV. UNIDO Guidelines, on the other hand, do not make any adjustment for consumption and saving impact of project investment

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Accounting rate of return

Subjective Chosen such that only a few of the best among the lot is cleared The future social profit of all projects should be discounted using the same accounting rate of return Should be chosen such that it balances between investments made and funds available for such investments Mathematical risk based rate is not the criterion
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Applications
Divide each input into tradeable (i.e. merchandise related), labour (i.e. service related) and residual (i.e. others). Each (public) organisation will use a specify social conversion factor (SCF) or proportion of T, L, R for each asset.
E.g. if the T, L, R of building given as 0.5, 0.25 & 0.25 respectively. Then the financial cost of building of Rs 10 lacs is = social value of building is T of 5, L of 2.5 and R of 2.5 If the SCF for land is 0.66, convert the financial cost of land of Rs 20 lacs into social value of Rs 13.2 lacs (it cannot have L & R) Convert every asset cost into social value at the SCF given or split them into T, L, R Arrive at the total of T, L & R for the whole project cost At SCF, convert the total of L & R into social value equivalent. Total of this figure and T gives the social value of the project components compared to its financial cost. Using this calculate NPV etc

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 The capital outlay on a new project is estimated to be as follows;

Rs. In lakh Land Buildings Imported equipment (CIF value Rs.120 lakh) Indigenous equipment (CIF value Rs.300lakh) Engineering and know-how fees 5 30 150 375 20

The working capital requirement of the project is Rs.159lakh(CIF value Rs.125lakh)

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 The estimated annual profitability of the project is as follows;

( Rs. In lakh) Sales revenue Imported raw material Indigenous raw material Labour Salaries Repairs and maintenance Water, fuel, etc Electricity Other overhead 1800 220 1,000 100 50 5 15 20 10

The annual value of output of CIF prices is Rs.1,300lakh The CIF value of imported raw material is Rs.200 lakh per annum. The effective tax rate for the firm is 34%.

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 Social conversion factors(SCF) or proportions of tradable components(T), labour(L) and residual( R) to be used for various items are as follows;
Item Land Buildings Indigenous equipment Engineering and know-how fees Labour Salaries Repairs and maintenance Water, fuel, etc Electricity Indigenous raw materials and store Other overhead SCF or Proportions SCF=1/1.5 Proportion T=0.5, L=0.25, R=0.25 SCF=0.7 SCF=1.5 SCF=0.5 SCF=0.8 SCF=1/1.5 Proportions T=0.5, L=0.25, R=0.25 Proportions T=0.71, L=0.13, R=0.16 SCF=0.8 SCF=1/1.5

Ignoring salvage value of fixed and current assets and assuming a project life of 5 years, calculate the Economic Rate of Return (ERR) for the project. Assume that the conversion factors for tradable, labor and residual components are 1/1.5, 0.5, 0.5 respectively.
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 Social cost associated with Initial outlay

Item Financia Basis of l cost conversion 5 30 150 375 20 159 SCF=1/1.5 T=0.5,L=0.25 , R=0.25 CIF value CIF Value SCF=1.5 CIF value Trade able T value ab initio 3.33 15 120 300 30 125 578.33 15 7.5 7.5 7.5 7.5 L R

Land Building Imported Equipment Indigenous Equipment Engineering & know-how Working Capital

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Tradable value ab initio Social cost of trade able component(15/1.5) Social cost of labour component (7.5x0.5) Social cost of residual component (7.5x0.5)

578.33 10 3.75 3.75

Total social cost of initial outlay

595.83

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 Conversion of financial operating costs into social costs

Item Imported RM Indigenous RM Labour Salaries Repairs & Mten Water, Fuel,etc Electricity Financi Basis of al cost conversion 220 1000 100 50 5 15 20 CIF value SCF=0.8 SCF=0.5 SCF=0.8 SCF1/1.5 T=0.5,L=0.2 5, R=0.25 T=0.71, L=0.13, R=0.16 SCF=1/1.5 Trade able ab initio 200 800 50 40 3.33 7.5 14.2 3.75 2.6 3.75 3.2 T L R

Other overhead
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10

6.67 1,100 21.7 6.35 6.95

 Annual Social Cost of Operation

Trade able value ab initio Social cost of trade able component (21.7/1.5) Social cost of labour component (6.35x0.5) Social cost of residual component (6.95x0.5) 1,100 14.47 3.18 3.48 1121.13

Social net benefit per year=Rs.1300Rs.1121.13=Rs178.87 Economic rate of return(r ) 595.83=178.87PVIFA(r,5) r= 15.27%
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ERP
= Effective rate of protection = {VA @ domestic prices VA @ intl prices}/VA @ intl prices VA = value added = selling price input cost (exclude tax elements which are characteristic of domestic price) Take FOB of export item and CIF of imported item ERP = 0 = no protection to domestic industry, >0 = protection exists, <0 = domestic industry more efficient
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DRC
Domestic resources cost = VA @ domestic prices X exchange rate VA @ intl prices DRC = (ERP +1) X Exchange rate That means any positive value of ERP results in spending more for a project than if import had been permitted. Conflict of interest viz.: domestic Vs forex position
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Environmental Appraisal
Conflict of interest between industrial growth and heritage preservation Controlled industrial growth Governmental control Central and State regulations Competition among States Increased public awareness
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Types
Land Air Water Noise General environment

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Specific Cases
Coco Cola plant in Kerala Alang Ship-breaking industry Biocon Garment industries of Tirupur Low count yarn spinning units Ganesh Chathurthi

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Sources
Tanneries Distilleries, sugar, BT industries Hardware units, photographic units Drugs and pharmaceuticals Fabric dyeing units Cement 15 October 2013 Chemicals Organic substances Heavy metals Chemicals into air and water Heavy chemicals Fly ash

Remedies
Solid, liquid and gaseous forms Pollution control equipments
Technology, cost, process,

Treatment
Air, water, noise

Primary and secondary Large captive waste disposal area Areas earmarked for hazardous products
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Financial Implications
Non-availability of suitable technology Institutions clearance only after this Yearly monitoring Environmental audit Inspections etc Increased cost Possible delay

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Construction Projects
Environmental clearance from the Ministry of Environment & Forest (MoEF), GoI Covers new construction projects
viz. new township, industrial township, settlement colonies, commercial colonies, hotel complexes, hospitals and office complexes with
Projects that serve 1,000 persons or above Discharging sewage of 50,000 liters per day or above. With an investment of Rs.50 cores or above.

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Procedure for obtaining environmental clearance

Preparation of Rapid Environment Impact Assessment report. Application for consent to establish & Public Hearing to State Pollution Control Board (SPCB.) Attending Public Hearing held by SPCB. Securing consent to establish from SPCB. Application to MoEF, Government of India, for Environmental Clearance. Presentation to MoEF, New Delhi. Securing Environmental Clearance from MoEF, Government of India. Application to SPCB for Consent to Operate. Securing consent to operate from SPCB
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