Guide to COST-BENEFIT ANALYSIS of investment projects - Ramiri

2.5 Economic analysisThe economic analysis appraises the project’s contribution to the economic welfare of the region orcountry. It is made on behalf of the whole of society instead of just the owners of the infrastructure, as inthe financial analysis. The key concept is the use of accounting shadow prices, based on the socialopportunity cost, instead of observed distorted prices.Observed prices of inputs and outputs may not mirror their social value (i.e. their social opportunity cost)because some markets are socially inefficient or do not exist at all. Examples are monopoly or oligopolymarkets, where the price includes a mark-up over marginal costs; trade barriers, where the consumer paysmore than he/she could elsewhere. Prices as they emerge from imperfect markets and from some publicsector pricing or rationing policies, may fail to reflect the opportunity cost of inputs. In somecircumstances this may be important for the appraisal of projects. Financial data, while important forbudgetary reasons, may be misleading as welfare indicators.When market prices do not reflect the social opportunity cost of inputs and outputs, the usual approach isto convert them into accounting prices using appropriate conversion factors, if available from theplanning authority (see par. 2.5.1).In other cases, there may be project costs and benefits for which market values are not available. Forexample, there might be impacts, such as environmental, social or health effects, without a market pricebut wich are still significant in achieving the project’s objective and thus need to be evaluated and includedin the project appraisal.When market values are not available, effects can be monetised through different techniques, in partdepending on the nature of the effect considered (see par. 2.5.2). ‘Money’ valuation here has no financialimplication. CBA ‘money’ is just a convenient welfare metric and, in principle, any numeraire can be usedjust as well. In the context of the EU Funds, using the Euro as the unit of account, for both the financialand economic analysis, has clear presentational advantages.The standard approach suggested in this Guide, consistent with international practice (see the Referencesection), is to move from financial to economic analysis, starting from the account in Table 2.5 (theperformance of the investment regardless of its financial sources). To do so, appropriate conversionfactors should be applied to each of the inflow or outflow items to create a new account (Figure 2.3)which also includes social benefits and social costs.The methodology is summarised in five steps:- conversion of market to accounting prices;- monetisation of non-market impacts;- inclusion of additional indirect effects (if relevant);- discounting of the estimated costs and benefits;- calculation of the economic performance indicators (economic net present value, economic rate ofreturn and B/C ratio).The rest of this section explains these five steps and, at the same time, highlights the following topics:- the standard conversion factor;- the shadow exchange rate;- the marginal cost of public funds;- the shadow wage (see also Annex D); and- the social discount rate (see also Annex B).45