PAPER NO. : 16, PROJECT APPRAISAL AND IMPACT ANALYSIS MODULE NO. : 22, SOCIAL COST BENEFIT ANALYSIS MEANING AND RATIONALE

Transcription

1 Subject Paper No and Title Module No and Title Module Tag 16, Project Appraisal and Impact Analysis 22, Social Cost Benefit Analysis- Meaning and Rationale BSE_P16_M22

2 TABLE OF CONTENTS 1. Learning Outcomes 2. Introduction 3. Associated Important key terms 3.1 Social Costs 3.2 Social Benefits 3.3 Social Profits 4. Social Cost and Benefit Analysis (SCBA) 4.1 Concept 4.2 Meaning 4.3 History 5. Commercial vs. Social Cost Benefit Analysis 6. Users of SCBA 7. SCBA for public investments 8. Scope of SCBA 8.1 Commercial vs. Charitable 8.2 Public vs. Private Investment 9. Approaches to SCBA 9.1 UNIDO Approach 9.2 Little Mirrlees Approach 10. Limitations of SCBA 11. Summary

3 1. Learning Outcomes After studying this module, you shall be able to - Know how investment projects are evaluated from the stand point of society. Learn the fundamentals parameters in such evaluation. Identify the different types of social costs and benefits. 2. Introduction When a public or private investment project is planned, developed and executed, a preliminary task of its appraisal is conducted. This is done to evaluate the workability or feasibility of the project. A private investment project generally evaluates the direct financial benefits taking into account the prospective investment costs and revenue during its expected lifetime. It doesn t however consider the impact of that particular product on a society as a whole. For example commercial entrepreneur producing liquor while estimating the market price, will not consider the cost which the society might be incurring with the introduction of liquor in the market. The cost not considered can be in terms of increase in Road accidents, criminal activities or poverty and its negative impact on healthcare; this ignored cost is impacting the society in a significant way. If this on the other hand, been a public investment project, which instead of liquor, proposed to construct a bridge, it would also have considered the social impact in terms of traffic reduced, population displaced and other environmental implications. The Social Cost Benefit Analysis is a distinct methodology used for evaluation of such projects where social impact needs to be analyzed. This analysis however is not specific to public investments only; it may be applied to both public and private investment projects alike. SCBA plays pertinent role especially in developing economies where government has a significant role to play in attaining higher economic growth. 3. Associated Important Key Terms 3.1 Social Cost The cost of goods when transported from one place to other, private firm is said to incur transportation cost. Besides this transportation cost, there are certain costs which though ignored by a firm does have a serious impact on the society. These costs are related to the wear n tear of roads and pollution etc.these costs which has to be borne by the society, comes under the head of Social cost.

4 The following are some of the examples of social costs for which business firm is responsible: Air pollution Water pollution Depletion and destruction of animal resource Soil Erosion Deforestation Impairment of human resources Deterioration in the law and order conditions The social cost may be divided into two broad categories: 1. Social costs of Staff: a. Lay off and voluntary termination b. Extra hours put in by officers voluntarily c. Work-related injuries d. Undesired attitude formation 2. Social costs of Community and General public: a. Increase in cost of living in the vicinity due to cement plants b. Consumption of state electricity services c. Central services and facilities consumed d. State services and facilities consumed e. Expenditure in foreign in foreign exchange f. Environmental damage g. Product shortcomings 3.2 Social Benefits The term social benefits refer to an increase in the overall welfare of the community or society which is being derived from a particular course of action by a business firm or government other than the person who is receiving the benefit. For example Society gets benefitted from public parks developed and maintained by government. Under SCBA, it is social benefit. The term social benefits, in economics, refer to the total benefit to society from producing or consuming a good / service. Social benefit includes all the private benefits plus any external benefits (external benefit is cost or benefit that affects a party who did not choose to incur that cost or benefit) of production / consumption. If a good has significant external benefits, then the social benefit will be greater than the private benefit. The social benefits may be in the form of products and services provided, payment of taxes and rates, additional employee s benefits, donations to the community, ancillary benefits, environmental improvements, etc. It may be studied under the following categories: 1. Social benefits of Staff: a. Medical and hospital facilities b. Educational facilities c. Subsidized canteen facilities

5 d. Provident fund e. Housing and township facilities f. Holiday, leave encashment and leave travel benefits. g. Recreational and cultural facilities 2. Social benefits of Community and General public: a. Local taxes paid to panchayat/ Municipality b. Environmental improvements c. Generation of job potential d. Welfare activity for the community e. Business generation In nutshell, the terms social costs and benefits are concerned with measurement of impact of the project on society, which may be positive or negative. The positive impact is social benefit and negative impact is social cost. Infact when we evaluate a project from the point of view of the society (or economy) as a whole, it is called Social Cost Benefit Analysis. 3.3 Social Profit The term may be defined as the excess of social benefits received by the society from the activities of the business over the social costs borne by the society attributable to the same firm or Positive difference between Positive impact and Negative impacts on society. 4. Social Cost Benefit Analysis 4.1 Concept Generally speaking, the decision about a project should be taken only on the basis of three feasibility studies i.e. Technical Studies, Market Studies and Commercial Studies. The firm generally draws an inference, based on these studies and therefore it is said to be a project selection based on commercial criterion i.e. monetary gains or losses (CBA). The firm motivated

6 by the commercial return on its investment may or may not be concerned about its impact on the society. However projects having economic importance for a nation or a society, commercial viability can t be the only criterion to assess the project and thus will have to include social welfare aspect in the analysis. In order to consider the social welfare aspect, Commercial cost and benefit analysis (CBA) will not be an appropriate tool. Social Cost benefit Analysis is thus the methodology used for evaluation of such investments projects. 4.2 Meaning Social Cost benefit Analysis is a systematic evaluation technique for long-term decision making in capital projects appraisal. It is an analytical tool in decision making which enables a systematic comparison to be made between the social costs and related social benefits with due emphasis on technical and other feasibility studies but focusing more on social impact. In the context of planned economies, the social costs benefit analysis aids in evaluating individual projects within the planning framework. 4.3 History The concept of social cost benefit analysis (SCBA) has been introduced by the French economist Jules Dupuit. Jules Dupuit (18 May September 1866) was an Italian-born French civil engineer and economist. The concept of CBA dates back to an 1848 article by Jules Dupuit and was formalized in subsequent works by Alfred Marshall. The Corps of Engineers initiated the use of CBA in the US, after the Federal Navigation Act of 1936 which effectively require cost benefit analysis for proposed federal waterway infrastructure. The Flood Control Act of 1939 was instrumental in establishing CBA as federal policy. It demanded that the benefits to whomever they accrue should be in excess of the estimated costs. 5. Commercial vs. Social Cost Benefit Analysis Commercial Cost Benefit Analysis (CBA) is a tool or technique for project appraisal considering the total cost of the project (Cost) and the expected future gains (benefits) from such specific project. So CBA is nothing but a profitability analysis. The Projects adopting CBA doesn t take into account the impact in terms of costs and benefits that a society may have to bear/ or receive from such proposed project. SCBA truly considers quantification of impact on society. Let us take an example of a commercial entrepreneur contemplating to take up a new project to manufacture cigarettes. While evaluating the workability of the product, he will simply look at its commercial profitability. This product however also increases certain risks which the society has to bear which can be in terms of heart diseases or cancer. This adverse impact of the product will not be analyzed by the Commercial Cost benefit analysis. This social cost can be taken into consideration under SCBA only. In the same example if the product had been soap instead of cigarettes it would have helped the society by reducing the risk of spreading of diseases and thus would have impacted the society in a positive way.

7 Core differences between CBA & SCBA 6. Users of SCBA Every investment requires project appraisal which may be CBA or SCBA. CBA is primarily in commercial projects. However it still doesn t mean that SCBA is useful only for and is undertaken by Government organizations. It is true that SCBA is primarily for public investments by the Government/Governmental and quasi-governmental agencies, but the technique is equally relevant for private sector, especially in cases, where they are subjected to government approvals, licenses or grants and subsidies. In fact public investments are inevitable in all the countries, particularly in developing countries and so is SCBA. SCBA is also important for private corporations who have a moral responsibility to undertake socially desirable projects, use scares natural resources in the best interest of the society, generate employment and revenues to the national exchequer. The indicators of social contribution include: 1. Employment potential criterion 2. Capital output ratio (Output per unit of capital) 3. Value added per unit of capital 4. Foreign exchange benefit ratio 7. SCBA- whether always required for Public Investments? Private investments are always subjected to commercial benefit analysis. They are less concerned about its social aspects/implications. However it is not true in case of public Investments. Public investments have greater impact on the welfare of society. Such investments invariably require some form of SCBA. But what about the public investments where social benefits are clearly visible? Do they also need Social cost benefit analysis to be conducted? There are certain governmental projects, where social benefits are clearly visible and tangible and hence in those specific cases, there won t be any requirement of SCBA. To illustrate the point, let us take an

8 example where government wants to start a hospital project in a region so as to provide medical facilities to the community at an affordable price. If only commercial viability of the project is to be examined, one can easily infer that expenses/costs is likely to be significantly high. This would be more prominent if it is a project of building charitable hospital. Considering the commercial norms firms generally adopts the project should straightaway be discarded.. In this example if the project however is looked upon considering the impact this project will have on the society, the analysis would surely be giving a different result. In this case social benefits and social costs associated with hospital would also be taken into account, and thus the probability of benefits exceeding the cost will be significantly high. Factors like how many people are suffering if the project is not undertaken would also be considered. These are the factors which are taken into account only under SCBA. Extending this example if we further assume that this would be the first and the only hospital the region of a huge population would be having, there would not be a need of SCBA being carried out since the benefits are clearly visible and tangible. 8. Scope of SCBA 8.1 Commercial vs. Charitable: Most of the investment projects necessarily involve long term heavy expenditure. These may be either pure commercial, like manufacturing of consumer products, or purely for social purposes like a charitable hospital. There may be a project which may serve both purposes. For example a private hospital serves charitable motive in the form of General OPD whereas the same organization earns profit from Private OPD. 8.2 Public vs. Private Investment: SCBA can be applied to both public and private investments. But, the investment proposals to be considered in Social cost benefit analysis are basically public investments rather than private investments. The technique is important especially for the developing countries where govt. has to play a significant role in the Economic development. In case of public investments it is quite clear that SCBA is an inevitable tool. Like if a village has to be connected with the city, it requires development of overall infrastructure besides constructing concrete roads for smooth connectivity and for movement of public and goods. This type of project is not viable from the point of view of commercial feasibility. In such cases government will have to take the initiative and to make the investment. Now-a-days government is not the sole investor. It may be in the form of PPP, BOT, BOLT, etc. Let us take an example of Delhi Metro Project. As per the report of RITES (2005), the total cost of Phase I (comprising kms. Spread over five routes) was estimated at Rs crores. Now it is a public project and government is always expected to proceed with this type of public venture. But if we look at the sources of funding, around 30 percent of total investments of DM are raised through equity capital with the Government of India (GOI) and Government of the National Capital Territory of Delhi (GNCTD) having equal shares in it. More than 60 percent of the funds required for investment are raised as debt capital. The remaining 10% was estimated to be covered out of the revenues earned. It means Government has participated to the extent of 30% only.

9 One point which is pertinent to understand is that why SCBA besides in public investment projects is also carried out in private projects when entrepreneurs almost invariably focus on commercial feasibility of the project? SCBA is important for private corporations which are bound by either moral responsibility to undertake socially desirable projects, use scares natural resources, or those projects which are subject to subsidy or other similar support from the Government. SCBA thus is an important tool for the private investments, which are to be approved by various governmental and Quasi-governmental agencies. 9. Approaches to SCBA It must be emphasized that, there can be no definite principle which can be universally applied to convert commercial costs and benefits into social costs and benefits. However, the following two principal approaches are suggested for SCBA: 9.1 UNIDO Approach: This approach focuses on consumption as the final goal of all investments and therefore the benefit and costs relating to a project are determined in terms of impact on consumption. 9.2 Little-Mirrlees Approach: The Little-Mirrlees approach determines the benefits and costs of projects in terms of investment. The social costs and benefits are measured in terms of international prices. Apart from above, some financial institutions like IDBI, IFCI and ICICI are following simplified version of L-M approach: economic rate of return, effective rate of protection and domestic resource test. All these approaches have been discussed in detail in subsequent modules. 10. Limitations of SCBA The following are some of the limitations of SCBA: 1. The advantage of social cost benefit analysis depends upon the accuracy of the data input. 2. There are certain public investments where the benefits are quite visible and tangible from the point of view of society. In these cases SCBA is not required. 3. It is very difficult to measure social costs and benefits in a precise manner. 4. The application of this approach is subject to various assumptions which are the basic source of limitations. 5. The utility of approach gets diluted due to involvement of high degree of subjectivity. 6. The implementation of outcome of SCBA depends upon various factors like political scenario, economic conditions, risk of anti-social evils, environmental threats, etc.

10 11. Summary The term Social cost is a sacrifice or detriment to society. For example air and water pollution. The term social benefits refer to the increase in the overall welfare of the community or society which is being derived from a particular course of action by a business firm or government other than the person who is receiving the benefit. For example Medical and hospital facilities provided by the firm. Every investment requires project appraisal which may be CBA or SCBA. Social Cost benefit Analysis (SCBA) is a methodology used for such evaluation of primarily public investments. It is a systematic evaluation technique for long-term decision making in capital projects appraisal. Commercial Cost Benefit Analysis (CBA) is a tool or technique for project appraisal considering the total cost of the project (Cost) and the expected future gains (benefits) from such specific project. So CBA is nothing but a profitability analysis. In certain projects where social benefits are apparent there is no need for SCBA. So where the social benefits are likely to be visible and tangible, there may not be any need to make SCBA on sophisticated basis and systematic manner. SCBA can be applied to both public and private investments. The two principal approaches are suggested for SCBA are UNIDO and L-M approach. The limitations of SCBA include the accuracy of the data input, less applicability of the approach in developed countries, difficulty to measure social costs and benefits in a precise manner, dilution in results due to involvement of high degree of subjectivity.