SOCIAL COST

BENEFIT ANALYSIS
(SCBA)
By:
Narayan Gaonkar
 Meaning:
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.
 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 :
Little mirrless approaches
2.UNIDO approach
3.Net benefit in terms of economic prizes
4.Saving impacts and its value
5.Income distribution impact
6.Adjustment for merit and demerit goods
7.Little-Mirrlees approach
8.Shadow prices
9.SCBA by financial institutions
10.Public sector investment decisions in
India
Little Mirrless
approaches
The seminal work of Little and Mirrlees on benefit-cost analysis systematically develops a
theoretical basis for the analysis and its underlying assumptions and lays down step-wise
procedure for undertaking benefit-cost studies of public projects. The mathematical
formulation is identical to the UNIDO method except for differences in assigning value to
discount rates and accounting for imperfections and other market failures and social
considerations.
Like UNIDO guidelines, the Little-Mirrlees method also suggests valuation of
projectinvestment at opportunity cost (shadow prices) of resources to correct distortions due
tomarket imperfections. Both methods make use of border prices to correct distortions
butwith a major difference.
While Little and Mirrlees express the numeraire in terms of border prices in foreign
currencies, the guidelines recommend that foreign exchange values be calculated in terms of
domestic currency.
Little and Mirrlees have also suggested an elaborate methodology for calculating shadow
prices of non-tradables. Use of detailed input-output tables is suggested with a view to tracing
down the chain of all non-traded and traded inputs that go into their production. However, in
the case of non-availability of detailed input/output tables, a conversion factor based on the
ratio of domestic costs of representative items to world prices of these items could be used for
approximation of shadow prices of non-traded resources. Little and Mirrlees believe that in all
less developed countries, one of the major criteria for the choice of a project should be its
ability to generate savings and, hence, the Little-Mirrlees method suggests the use of
accounting rate of interests to calculate present worth of future annuities of savings and
consumption. Guidelines, on the other hand, do not make any adjustment for consumption and
saving impact of project investment. Unlike the five stages of UNIDO, the Little and
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 imperfections
Externalities
Taxes and subsidies
Concern for savings
Concern for redistribution
Merit 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 Subsidies
From 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
rupees
o 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 following
questions 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 tradability
A 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 prices

The 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 .
Treatment of Taxes
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.
Impact of the project on savings and
investment

Impact on Distribution
Measure 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?
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.
 3. Little-Mirrlees approach:
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.
Issues in Little- Mirrlees Approach to SCBA
Numeraire:
L-Ms numeraire is present uncommitted social income measured in terms
of convertible foreign exchange of constant purchasing power

L-Ms Shadow Price:

L-Ms 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 method

The accounting rate is the rate used for discounting social profits
Differences between UNIDO approach
and L-M approach
1. 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.