No. 3 - Department of Treasury - The Western Australian Government

Western Australian Economic Summary2006 No.3The types of projects (usually large resource-processing projects) thatrequest assistance from the Western Australian Government are verycomplex, expensive and risky. While the initial financial analysis of a projectmight paint an optimistic picture, there are a multitude of things that can gowrong, especially price changes for construction and intermediate inputs inremote locations.Risk in a public CBA is better explicitly identified rather than beingincorporated into the discount rate (Sugden and Williams, 1978, p. 62), andthis line of reasoning is also justifiable for a CGE analysis. This is because, ina public CBA, the public discount rate is the Marginal Rate of TimePreference (MRTP) for money. The MRTP for money simply representssociety’s valuation of a dollar today versus a dollar tomorrow, and not theopportunity cost of capital or the risk associated with the project, as wouldbe evaluated by a financial analysis of a company.This means that the modeller must run several scenarios based on potentialoutcomes for the project. A probability of each outcome must be assigned toeach scenario and a net result calculated.Assigning probabilities is a subjective exercise, but a long enough historyexists to show that, contrary to many project assistance submissions, themost optimistic scenario for multiple project starts almost never occurs.ConclusionThis paper outlines several issues relevant to the modelling of a request forassistance to the Western Australian Government from a potential majorresource project. It canvasses the theoretical basis for modelling the project,the steps involved in an analysis and the assumptions that should beincluded.Following the recommendations in this paper should allow projectproponents and their CGE modelling consultants to produce results that willenable the Western Australian Government to make a reasonable assessmentof whether assisting the particular project will enhance the net economicwelfare of Western Australians.While only a discussion of issues at this stage, it is anticipated that in thenear future the Department of Treasury and Finance will draw up a set ofguidelines based on these issues that project proponents must follow fortheir proposal to be considered.Comments and suggestions can be forwarded to the author, Bruce Layman,at the contact address and phone number given at the beginning of thispublication.88 Department of Treasury and Finance