COST-BENEFIT ANALYSIS –THEORETICAL AND APPLIED CRITIQUE OF
ALTERNATE METHODOLOGIES (1984,1988)
This book presents a comprehensive view of Cost- Benefit analysis in its theoretical and applied dimensions. It is a 'unique' product in that no other
book, Indian and foreign deals with the subject in all aspects. The authors, who are both seasoned practitioners in project appraisal, have distilled essential material from several sources for succinct presentation. Both the theory and case-studies have been dealt with in sufficient depth. It will be useful as a standard reference text in all universities where project appraisal is taught. It will also be of equal utility to the analyst, planner and interested laymen. Select references at the end of each chapter add to the utility of the contents.
Social cost-benefit analysis, SCBA, is an important facet of applied welfare economics which is increasingly being used for the assessment of public projects both in the developing and developed countries.
First used by the U.S. Army for the assessment of water resources management, itsapplication spread rapidly to other areas of socio-economic activity like health, nutrition, education and large industrial projects with linkage effects. A number of formalised methodologies were evolved by international agencies like the OECD, World Bank and UNIDO, each with their unique features.
Despite the large volume of literature which has appeared on CBA in the spheres of both theory and application, there is no single book on the subject which covers comprehensively all the methodologies in detail with relevant case studies. A student of the subject, has, therefore, to laboriously collate material from several treatises to visualise the complete framework.
This book aims to fill this gap and cater to the demands of both the theorists and practitioners. The general aspects common to all methodologies are covered in the initial
chapters after an exposition of the origin of CBA and its roots in welfare economics. The later chapters on the first part cover the alternative methodologies with a comparison of their respective standpoints, merits and drawbacks. The book also summarises case studies in various areas highlighting the different methodologies.
Being a pioneering venture, the authors hope it will reach a wide and receptive audience-project analysts, planners, academics and students, apart from interested laymen. We wish to thank MacMillan Accounts and Administration Ltd., for permission to use material from Sanjaya Lall and Paul Streeten, "Foreign Investment, Transnational and Developing Countries" and G. Mooney, Elizabeth Russel and Roy, D. Weir, "Choices for Health Care"; Heinemann Educational Books for similar permission in regard to I.M.D.
Little and M.F.G. Scott (editors) "Using Shadow Prices" in respect of articles by Gordon Hughes and Miss Anne Forbes; O.E.C.D. for permission in regard to Deepak Lai, "Wells and Welfare".
We have also been highly benefited by the technical publications of the World Bank and UNIDO on the subject, as also treatises on the subject by other authors, as listed in the footnotes and references. We acknowledge these with considerable gratitude. We thank Oxford & IBH Publishing Co., New Delhi for their zeal in bringing out this book.
If it succeeds in widening general understanding on the subject, the labours of the authors can be regarded as fruitful.
1. Cost-Benefit Analysis—Origin, Rationale and Scope 1
2. Capital Investment Appraisal 15
3. The Social Rate of Discount 21
4. Consumer's and Producers' Surplus Approach—Mishan's
5. The Little-Mirrlees Method for Project Appraisal 48
6. The UNIDO Approach 76
7. The World Bank Approach 118
8. OECD, UNTDO and World Bank Approaches—
A Comparison 150
9. The 'Value-Added' Approach to Cost-Benefit Analysis 159
10. Foreign Investment, International
Trade Policy and Cost-Benefit Analysis 170
11. CBA Applied to Irrigation 188
12.CBA Applied to a Textile Project in Pakistan—UNIDO
13.The Proposed Chamundi Ropeway, Mysore—A Case
14. CBA Applied to Transportation Sector 239
15. CBA Applied to Health, Housing and Education 250
16. CBA Applied to Forestry and Noise Pollution 259
17. Cost-Benefit Analysis: A Stock Taking 264
18. Select Index 267
Cost-beneflt analysis (CBA) is an esoteric subject, which only those well versed in economics, econometrics and mathematical economics can follow fully. However, even a common man can grasp the spirit of the subject, namely, that every project, indeed every endeavour in life, business or otherwise, has costs and benefits, and one must take both a long and a wide view, before, taking a decision. Naturally, this exercise is meaningless unless one considers alternatives, after evaluation of which a particular project has to be selected.
In this complex world of national and international economy, with numerous risks and uncertainties concerning the future, prima facie evaluation of projects is difficult because of all kinds of distortions, rigidities and regulation. All the prices current in the market —wages, interest rates, exchange rates and prices of goods and services have to be adjusted for distortions of various sorts to get at the real prices, and thereby the real return on the investment. The adjusted prices are termed shadow prices, though I would call them 'real' prices.
The task of locating real prices is not easy. Objective and subjective considerations go into this and what emerges is not a perfect formula but a set of rather rough guidelines, which are however better than the unadjusted prices for evaluating projects and choosing them. In the last forty-years, a lot of work has been done on the subject of cost-benefit analysis, particularly under the auspices of three great international organisations, namely, The Organisation for Economic Cooperation and Development, the United Nations Industrial Development Organisation and the World Bank.
Dr. K. Puttaswamaiah and Mr. S. Venu, combining as they do academic and practical background, have done a good job in giving a comprehensive account of the systems developed under the auspices of the three international organisations separately as also a comparison, though briefly, of the three approaches. Rightly they mention that each approach has its merits and demerits, and each is suited for particular categories of projects. There is also a lot of mathematics in the book. It is satisfactory to note that the authors do not claim a lot for the technique of cost-benefit analysis— 'cost-benefit analysis has costs and benefits itself’, as they put it. In fact, they enumerate a number of categories of projects for which costbenefit analysis may not be applied. Even otherwise, it is very difficult to forecast the complex future and the working out of the so called shadow prices is a very difficult affair, based as they are on numerous assumptions regarding the near and distant future, many of which may prove to be wrong. In short, neither actual market prices nor the shadow prices may represent the correct position. Varying combinations of the two have to be tried, depending upon the person(s) engaged in the analysis, and therefore a lot of arbitrariness is injected into the analysis. Nevertheless, the authors conclude that most economists agree on the value and usefulness of CBA inappropriately used'. The key portion is what is in the italics (supplied). Who is to decide whether CBA is appropriately used or not; it is begging the question. On the other hand, one can wholeheartedly endorse the view of the authors that:
CBA has educated planners and decision.makers. Each project has to be within a serious of interrelationships. Apart from direct profitability, a whole range of indirect effects have to be scrutinized. A carefully carried out CBA enforces regular collection of data in connection with all positive and negative effects, supply rich material for decision preparation. Specially important is the need for CBA to illumine the many early steps of projects planning, which tend to commit one to a decision, even before the format process of project evaporation had begun. To pose CBA against judgement and commonsense is a false polarisation.
The book under review* must have proved quite useful, as it has gone into a second printing. However, it seems to be rather suited to persons who already know not a little on the subject and are familer with the work of numerous writers, as may be seen by the considerable name-dropping that is done. The authors would do well to come out with a shorter book, of say 75-100 pages, written in absolutely simple non-technical style, without mathematical formula and theorems and without names, for the benefit of senior policy makers who are mostly politicians and bureaucrats, and some scientists and engineers. These persons must get the essence of CBA analysis, so that they are enabled to take wise decisions on investment projects. The relevance of CBA for large private sector projects too should be brought out in the study. Such a book would also be useful for students in the various Institutes of Management. It is hoped that the authors would render this valuable service to the community.
Before concluding, rich tribute must be paid to Dr. K. Puttaswamaiah who, in the midst of a very busy official schedule, has found it possible to author numerous scholarly books on a variety of economic subjects, including the monumental twovolume work on economic development of Karnataka. His special field is project Appraisal and he has many books on the subject. He should be a source of example and inspiration to our senior academic friends, most of whom seem to keep off research and writing work of this sort, getting lost mostly in teaching and administrative work.
— S. L. N. Simha.
· COST-BENEFIT ANALYSIS by K. Puttaswamaiah ana S. Venu, Oxford & 1BH Publishing Co.Pvt. Ltd., Second Printing, 1988. Pp. 269.
MANAGEMENT IN GOVERNMENT
A JOURNAL OF ADMINISTRATIVE REFORMS
By K. Puttaswamaiah and S. Venu, Oxford & IBH Publishing
Co., New Delhi, 1984, Pages 269.
Reviewed by D. Venugopal
Social Cost-benefit analysis is a modern management tool increasingly being used for assessment of public projects with linkage effects. First used by the U.S. Army, its usage has spread to both developed and developing countries : initially used for assessment of water resources management it has now become an accepted facet of applied welfare economics.
Basically it seeks to assess social benefits and costs as distinct from private costs and profits when making choices between alternative public policies. Hence its great usefulness to the public sector policy maker who is more concerned with the maximisation of social welfare than with profits.
The Cost-Benefit Analysis seeks to convert everything into money terms; a project would be considered desirable "if the benefits to whomsoever they accrue are in excess of estimated costs". It was in 1969 that under the auspices of OECD, I.M.D. Little and J. Mirrilees brought out the first Manual of Project Analysis with a rigid methodology. The essence of this approach is that the social cost of using resource in developing countries differs widely from the price paid for it. Hence their use of "shadow" or accounting price to denote its real value to the society as a resources. Quickly on its heels in 1972, Partha Dasgupta, A. K. Sen and Stephen Marglin formulated a different methodology under the auspices of UNIDO. This approach places a premium on aggregate consumption as an important measure of the standard of living and views raising of the level of aggregate consumption as a crucial objective for project choice. The World Bank, which has been evaluating several projects in the developing countries for financing, evolved its own approach combining the features of the OECD Manual, the UNIDO Guidelines and some original concepts. Their numeraire is public income and except in special cases, regard public investment and public consumption as equally valuable. In recent times the net national "Value-added" as the parameter for national welfare has gained ground. The UNIDO revised their methodology subscribing to this approach; Mark Chervel of France also adopting this line termed it the "effects" method while Jan Tinbergen used it in his semi-input-output methodology for quantitative analysis of an economy. The main strength of this book lies in its ability to lucidly present all these
developments in sufficient detail. The authors have done well to cover first the general aspects common to all these methodologies in the chapters on Capital Investment Appraisal, the Social Rate of Discount and Consumers and Procedures Surplus Approach before devoting themselves to these methodologies in turn. The chapter on OECD Approach (the Little-Mirlees Method) deals with in detail the need for accounting/shadow prices, world prices, the & shadow wage rate and its practical computation, of accounting ratios, the accounting rate of interest, the consumption rate of interest and weighting consumption benefits. It also outlines the methodology adopted by the Industrial Credit and Investment Corporation of India in its assessment of 50 projects assisted by them. The chapter on UNIDO Approach covers aggregate consumption, shadow pricing of
goods/services, adjustment factors to the financial values to convert them into economic values, social value of capital, shadow wage rate, shadow price for foreign exchange called shadow exchange rate.
The chapter on World Bank Approach deals with social value of private consumption, social value of public income, consumption distribution weight, economic accounting rate of interest and the social accounting rate of interest in detail. Tables from a staff working paper have been appended to illustrate the practical application of this methodology.
Subsequent developments in CBA in the value added approach have also been dealt with in a separate chapter outlining the UNIDO (1980) approach, and the contributions of Marc Chervel and Jan Tinbergen.
Attention has also been given to Deepak Lai and Sanjaya Lall's contributions in the area of quantification of costs and benefits of private foreign investment in developing countries. Application of CBA to transportation sector, health, housing and education, forestry and noise pollution has also been covered.
Not only does each chapter have a critique, but a separate chapter also deals specifically with comparison of the OECD, UNIDO and World Bank approaches. The concluding chapter also takes stock of the entire cost-benefit analysis.
The book has incorporated some useful case studies : the Mukarthihal Irrigation Project, Cho Phya Irrigation Project (World Bank Method), Small-Scale Irrigation in Ahmednagar (OECD Method), Textile Project in Pakistan (UNIDO Method), Chamundi Ropeway, Mysore, Trinidad Hilton Hotel (OECD), two suburban Rail Papssenger Service in Britain, and low income housing project in Kenya.
The authors have thus traversed the entire range of CBA both in detail and in depth. Their conclusion is interesting. They are of the view that if CBA is carried out in several variants under alternative economic assumptions and alternative numerical hypotheses, it may facilitate the many-sided comparison of the advantages and disadvantages of the projects. No one unique salutary cost- benefit indicator is necessary. Instead, a set of indicators may emerge.
This is an extremely useful publication on CBA presenting as it does at one place all the methodologies in detail with relevant case studies. It will be eminently suitable as a text-book on the subject and would be of use both to the theorist and the practitioner. The authors have been somewhat modest in stating that if the book succeeds in widening the understanding of the subject their labour would have been fruitful. One should think that they have been eminently successful in producing an excellent and well-balanced book on the subject.
Cost—-Benefit Analysis—A Theoretical and Applied Critique of Alternate Methodologies by
K. Puttaswamaiah and S. Venu. Oxford & IBH Publishing Company, New Delhi, 1984. Page.
269. Cost-Benefit Analysis
Choice, relative scarcity and want satisfaction are basically recurrent tenets in economics whether it pertains to the early concept of the theory of the "economic man" (who would maximise gains and minimise losses) or of later developments in Welfare Economics. Since investment decisions in private sector may not be informed entirely of the group welfare, public sector does consider resource allocation-investment decisions in the light of the implications of costs and benefits to the society. Keeping track of the demand in this field, methodologies for application of Cost-Benefit Analysis have grown, the successive improvements representing increased sophistication both in theory and in practice. There is no single book so far which has even attempted to group together the extant literature and concepts at one place. The book under review is a pioneering attempt in this field.
The book covers in seventeen well written chapters not only the general aspects common to the various methodologies for project appraisal but also a critique on ach.. Starting with explanation of basics, viz., net present value, internal rate of return, Social Rate of Discount, etc. The authors have discussed in detail the Little-Mirrlees Method with its concept of "shadow” pricing, the UNIDO Approach with domestic accounting money as "numeraire", the World Bank Approach with emphasis on rate of return, and the Value-Added Aproach to Cost-Benefit Analysis The book contains summaries of case studies of the practical application of the Cost-Benefit analysis to-various seeforal projecets, as also references of originals.
One feels satisfied with the content painstakingly postulated by the authors in such lucid style to serve not only as a standard reference text for academic curriculum but to be of use to the planner and] decision maker in covering the field at one stretch. No doubt the authors have brought to bear on the their incisive knowledge and insight on the subject matter. The book appears to be priced higher than the reach of the common student, but then, in the ultimate analysis, the benefit-cost ratio in this case would be higher than unity.
Yojana, February 16-28,1987 R. C. Srinivasan
Importance of Cost-Benefit Analysis in Welfare Economics
THE developing countries of today are giving equal importance to growth and welfare. Since these countries experience shortage of crucial inputs like capital, they must aim at optimum utilisation of these scarce resources. The technique of cost-benefit analysis (CBA) is being increasingly used to evaluate the costs and benefits involved in a project undertaken. It has become a useful tool to find out the legitimate limits of investment in areas like heath, nutrition, education and large industrial projects with linkage effects. Even the OECD, World Bank and UN1DO have taken interest in CBA. Thus cost benefit analysis assumes special significance in the sphere of welfare economics. Each project has to be examined within a series of interrelationships. Apart from direct profitability a whole range of indirect effects have to be scrutinised.
The book* under review presents both the theoretical and applied dimensions of cost-benefit analysis, it contains 17 chapters. A unique feature of the book is the discussion in depth of some case studies. After discussing the origin, rationale and scope of CBA, the book deals with various approaches to this new technique...the social rate of discount, consumers, and producers surplus approach. The Little- Mirrlees Method for project appraisal, the UNIDO approach, the World Bank approach, the 'value added' approach and the utility of CBA in the spheres of foreign investment and international trade policy. The book also case studies relating to irrigation, a textile project in Pakistan, the proposed Chamundi Ropeway (Mysore), transportation sector, health, housing and education, forestry and noise pollution.
CBA weighs up social benefits and costs as distinct from private benefits/costs, when making choices between alternate public sector policies. It is well known that the private producers aim at maximising their profits; they are least interested in social costs. In the production, distribution and consumption of certain goods, there are side-effects borne by people not involved in the transactional exchange. These side-effects, whether beneficial or harmful, are externalities or 'spill-over effects’or 'third party effects'. If the monetary value of benefits exceeds that of costs, the beneficiaries can, theoretically, compensate the losers (who bear the costs) and still enjoy some gains in the balance. Thus, the Kaldor-Hicks compensation principle constitutes the basic foundation of CBA.
I.M.D.Little and James A Mirrlees believe that market prices, in developing countries, do not adequately reflect social values. Wages, in the Organised sector of industry, are very much higher that those paid to labourers in the rural areas. The social cost of employing labour in the organized sector is much higher than the loss of rural production, if any, as a result of migration. This is the rational of shadow wage rate. More over, capital markets are imperfect as evidence by the wide spectrum of rates of interest. The purpose of computing the shadow wage rate is to determine the opertunity cost of employing an additional worker in the project by (i)determining the value of the output fore gole due to the use of a unit of labour and (ii) determining the cost to the economy of the additional consumption due to the transfer of a worker from a traditional to a fresh activity.
The UNIDO approach places premium on aggregate consumption since it is an important indicator of the standard of living. "The raising of this level may be called the aggregate consumption objective which is clearly a crucial objective for project choice". Here comes the key role of income distribution in project selections. The UNIDO approach is probably more suitable for projects with a large domestic content, or which are not traded—transportation, electricity etc.
The World Bank approach believes that projects which enhance Public revenue for investment in intrastructural and social services are socially more valuable than those which do not. This approach discounts private consumption benefits by dividing these by the social price of public income—the private consumption equivalent of a unit of government income rather than multiply government income with a factor so as to impute a premium. (P. 119).
The case studies discussed in the book are highly useful, CBA seeks to convert everything, including both favourable and unfavourable effects, into money terms. There is an urgent need for utilising scarce resources and CBA does provide the basis for rational decisions. The book is useful to case analysts, planners and policy makers as it presents both the theoretical and applied dimensions of cost-benefit analysis.
* COST-BENEFIT ANALYSIS : A THEORETICAL AND APPLIED CRITIQUE OF ALTERNATE MET-HODOLOGIES by K. Puttaswamaiah and S. Venu, Oxford & IBH Publishing Co, 66 Janpath, New Delhi, 110.001, Pp 269, .
MARCH 15, 1985 — I. Satya Sundaram
EXTRACTS FROM THE BOOK REVIEWS
(A Theoretical and Applied Critique of Alternative Methodologies) "It goes to the credit of Professors K. Puttaswamaiah and S. Venu for putting together this almost unwieldy crop of material in a concise and meaningful presentation which shall be welcome to laymen and extensively satisfying and useful to serious-students of the subject"
"The authors have traversed the entire range of CBA both in detail and depth. Their conclusion is interesting"
-Management in Government
"One feels satisfied with the contents so painstakingly postulated by the authors in such lucid style to serve not only as a standard reference text for academic curriculum but to be of use to the planner and decision maker in covering the field at one stretch" -Yojana
"The book is useful to case analysts planners and policy makers as it presents both the theoretical and applied dimensions of Cost-Benefit Analysis"