Ha 2 Be Div- o Roll No-08

8/12/2019 Ha 2 Be Div- o Roll No-08

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Social Cost Benefit Analysis:

Take an For example:

Suppose, a manufacturer produces cigarettes and sell it Rs.40 a packet

and another manufacturer produces soaps and sell it Rs.20 a bar.

Now, if we think about the impact of soaps & cigarettes on the society, the questions may be

Does the price of cigarettes take account of the smokers higher probability of heart disease orcancer?

Does the price of soap take note of the benefits from the use of soap, e.g., reduced risk of spread

diseases?

Obviously, a commercial entrepreneur cant give well answer to

these questions. What is Social Cost Benefit Analysis?

So, to reflect the real value of a project to society, we must consider the impact of the project onsociety. Impactositive egative ocial enefit ocial ostThus, when we evaluate a project

from the view point of the society (or economy) as a whole, it is called Social Cost Benefit

Analysis (SCBA)/Economic Analysis.

Scope of SCBA:

SCBA can be applied to both Public & private investments

Public Investment: SCBA is important especially for the developing countries where govt. playsa significant role in the economic development. rivate Investment: Here, A is also

important as the private investments are to be approved by various governmental & quasi-

governmental agencies.

Objectives of SCBA:

The main focus of Social Cost Benefit Analysis is to determine:

1. Economic benefits of the project in terms of shadow prices;2 The impact of the project on the level of savings and investments in the society;

3. The impact of the project on the distribution of income in the society;

4. The contribution of the project towards the fulfillment of certain merit wants (self- sufficiency,employment etc).

Significances of SCBA:

SCBA has been emerged with some interesting significances.

These significances also make the SCBA different from the CBA.

Market Imperfections: Market Imperfections:Market prices, the basis for CBA, do not reflect

the social values under imperfect market competition

Externalities: A project may have beneficial or harmful external effects that are considered in

SCBA, not in CBA.


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Taxes & Subsidies: From the social point of view, taxes & subsidies are nothing but transfer

payments. But in CBA, taxes & subsidies are treated as monetary costs and benefits respectively.

Concern for Savings: In SCBA, the division between benefits & consumption is relevant

wherein higher valuation is placed on savings. But in CBA such division is irrelevant.

Concern for Redistribution: In SCBA, the distribution of benefits is very much concerning

issue where commercial private firm does not bother about it.

Merit Wants: Merit wants are important from the social point of view and therefore, SCBA

considers these wants Approaches to SCBA

Aspects:

Contribution to industrial, sectoral infrastructural and economical development as a whole

Improvement in socio-economic status of people in the region

Balance Regional Economic Development

Contribution to Govt. exchequer

Net Impact on Balance of Payments

Savings/Earnings in Foreign Exchange

Export Promotion / Import Substitution

Employment Potential

Distribution of Income in Society

Ecological Implications (Power plants, irrigation schemes, etc.)

Environmental/Pollution Implications (Bulk drugs, chemicals,

leather, etc.)

Social and cultural values associated


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EFFECTIVE RATE OF PROTECTION:

The effective rate of protection is a commonly used measure of net

effect of trade policies on the incentives facing domestic producers. The measurement of

effective protection is clearly a two stage processfirst determining the nominal protection of

the policies in question, and second, analyzing the implications for effective protection of

different firms, sectors or activities.

Just as increases in nominal protection reduce overall economicwelfare by distorting the information provided by domestic prices about relative scarcities of

different goods, increases in effective protection cause economic waste by inducing producers to

supply goods domestically even when their domestic costs are higher than their opportunity costs

through trade. At the same time, producers of goods with relatively low levels of effectiveprotection are induced to refrain from producing goods domestically even when this could be

done at a lower cost than in international markets.

The effective rate of protection measures the net protective effect on producers ofany product due to the structure of protection on both its inputs and its outputs.

Consider a simple example:

roducer of garments that requires only one intermediate input cloth.Suppose that production

of garments worth 100 at world market prices requires the use of cloth worth 75 in world

markets. World value added or the cost of all manufacturing margins, including labor and

normal returns to capital is 25 (the difference between 100 and 75).

Now consider a domestic producer of garments in a county providing nominal protection at a

rate of 30 percent on garments and 20 percent on cloth. The protection provided to garments

is clearly beneficial to garment makers, while that on cloth is harmful. What is the net effect?The net effect depends not only on the nominal protection, but also on the market in which

the producer wishes to sell.

1. Sales in the Domestic Market:Under this structure of protection the domestic price of garments becomes 130 (100 times 130

percent) while the cost of the cloth required to produce these garments becomes 90 (75 times 120

percent). The maximum domestic value added (or cost of all manufacturing margins) that will

permit domestic garment producers to still be able to compete with imports is 40 (130 minus 90),which is higher than world value added of 25. In other words, domestic value added permitted

by the structure of protection on cloth and garments is 160 percent of or 60 percent higher than

world value added. This increase in domestic value added permitted by the protection structure isknown as the effective rate of protection provided to local garment production directed at thedomestic market.


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2. Exports to World MarketsConsider now a garment producer working under the same

protection structure but wanting to sell for export in world markets. In this case, the domesticprotection of garments is of no assistance; in order to compete in world markets, the garments

must be priced at 100. However, the protection of cloth still raises its cost to 90 (75 times 120

percent).In order to compete in the export market, therefore, the producer

must be able to manufacture garments with a margin of no more than 10 the domestic value-

added permitted in thiscase cannot exceed this amount. This is substantially less than worldvalue-added. In other words, the effective protection provided by the domestic protection

structure in this case is negative minus 60 percent (the domestic value-added of 10 is 60

percent less than world value-added of 25).

This example illustrates an important point. Nominal protection in

the domestic market does not provide any benefit to domestic producers wanting to sell this good

for export. However, protection of goods which are a firms inputs raises production costs and so

provides negative effective protection to exports.

The only way around this is to eliminate protection of inputs

altogether, or to provide special provisions whereby goods used as inputs by exporters are free ofthe cost-raising effects of protection. Export processing zone privileges usually include tax-free

access to imported inputs; duty drawback and exemption programs for exporters have a similar

effect.

DOMESTIC RESOURCE COST

(DRC) is a measure, in terms of real resources, of the opportunity

cost of producing or saving products to foreign exchange. It provides a comparison between thedomestic costs to produce a given good with its value added at international price. It is thus an exante measure of comparative advantage, used to evaluate exchange projects and policies. The

term was introduced to the economics literature by Bruno (1963, 1972). It was used frequently

since this date by many economists and international institutions such the World Bank, whichuse it mainly to evaluate development policies in less developed countries.

The DRC sought to take account of market-factors distortions in

contexts where factors opportunity cost could be measured in domestic currency, and the

opportunity cost of tradable products and inputs can be measured in a foreign currency. Byseparating the two types of factors, this ratio allows ranking of activities without knowing the

shadow value of foreign exchange. A shadow exchange rate is still necessary to determine the

cut-off between efficient and inefficient activitiesThe DRC provides also comparison of the relative economic

efficiency in production across sectors. In fact, the comparison of DRC calculations values

across sectors provides estimation on which sector can use more efficiently domestic resources

than others. According to this, policy makers can take efficient decisions on domestic factorallocation between sectors.

Moreover, examined in conjunction with the goals and incentives

supplied by economic policy, the DRC can also be used as an indicator of the impact of


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restrictions to external trade (Ruiz, 2003). It provides, according to the same author, an

approximation of the effects of trade policy on the efficiency of the allocation of production

resources and hence of the influence of trade policy on the productive structure in a givencountry.

The analytical form of the DRC ratio can be represented by the value of

non tradable inputs (primary production factors) evaluated at their opportunity cost divided bythe value added of this product evaluated at border/frontier prices.

Opportunity costs of domestic resources

DRC = -------------------------------------------------------

Value added in border price

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Ha 2 Be Div- o Roll No-08