Guide to COST-BENEFIT ANALYSIS of investment projects - Ramiri

In conclusion, indirect effects should be added to CBA only when the size of the distortion is sufficientlyrelevant and measurable, while, in general, a good use of shadow prices and a good monetisation ofexternalities are usually enough to account for indirect effects.Since the identification of which benefits are to be included in CBA is not always obvious, the box belowreviews some common mistakes in benefits counting that should be avoided by the project proposer.EXAMPLE: MISTAKES IN BENEFITS COUNTINGDouble Counting of Benefits. In considering the value of an irrigation project, both the increase in the value of the land andthe present value of the increase in income from farming are counted as benefits. Only one of them should be counted becauseone could either sell the land or keep it and get the gains as a stream of income.Counting Secondary Benefits. If a road is constructed, one might count the additional commerce along the road as a benefit.Problem: under equilibrium conditions in competitive markets the new road may be displacing commercial activity elsewhere, sothe net gain to society may be small or zero. People forget to count the lost benefits elsewhere (e.g. for newly generated traffic).Counting Labour as a Benefit. In arguing for ‘pork barrel 8 ‘ projects, some politicians often talk about the jobs created by theproject as a benefit. But wages are part of the cost of the project, not the benefits. The social benefit of employment is alreadygiven by using shadow wages. However, a separate analysis of labour market impact can be helpful in some circumstances and isrequired by the Funds regulations.2.5.4 Social discountingCosts and benefits occurring at different times must be discounted. The discount rate in the economicanalysis of investment projects - the social discount rate (SDR) - reflects the social view on how futurebenefits and costs should be valued against present ones. It may differ from the financial discount ratewhen the capital market is inefficient (for example when there is credit rationing, asymmetric informationand myopia of savers and investors, etc.).For the 2007-2013 period, the European Commission has suggested using two benchmark social discountrates: 5.5% for the Cohesion countries and 3.5% for the others. These SDRs are based on estimates oflong term growth potentials and other parameters. For a more detailed discussion about the socialdiscount rate see Annex B. SDRs that differ from the benchmarks may, however, be justified on the basisof individual Member States’ or Candidate countries’ specific socio-economic conditions. Once a socialdiscount rate is set at country level by a planning authority, it must be applied consistently to all projectsbelonging to the same country (the only possible exceptions being significant differences in expectedgrowth rates at NUTS I or macro-regional level within the country).2.5.5 Calculation of economic performance indicatorsAfter the correction of price/wage distortions and the choice of an appropriate social discount rate, it ispossible to calculate the project’s economic performance using the following indicators:- economic net present value (ENPV): the difference between the discounted total social benefits andcosts;- economic internal rate of return (ERR): the rate that produces a zero value for the ENPV;- B/C ratio, i.e. the ratio between discounted economic benefits and costs.8The term refers to the political metaphor for the appropriation of the government spending for projects that are intended to benefit particularconstituents or contributors.55