Journal of International Development: Vol. 6, No. I , 1-5 (1994)

NEW DEVELOPMENTS IN PROJECT APPRAISAL IN DEVELOPING

COUNTRIES: EDITOR’S INTRODUCTION

COLIN KIRKPATRICK Development and Project Planning Centre, University of Bradford

The early 1970s witnessed a major development in the methodology of social cost- benefit analysis as applied to investment projects in developing countries. The emergence of a distinctive approach to project appraisal in developing countries can be attributed to the growing realization of the significant distortions in resource allocation and inefficiency costs associated with the development strategies being pursued by many LDCs at this time, and by a more general desire to apply systematic procedures to public investment decision-making. The various contribu- tors to this new literature on project appraisal shared a common approach, namely the valuation of outputs (benefits) and inputs (costs) using shadow prices, where these shadow prices were based on international (border) values.

During the 1970s, serious attempts were made to implement some form of shadow pricing for project appraisal in the international development institutions and in national planning agencies. A sizeable proportion of development assistance was allocated to the training of analysts to conduct the appraisals, with the result that by the end of the 1970s most economists working on developing countries’ problems were familiar with the shadow pricing methodology and its use.

In the 1980s there was a marked decline in the theoretical development and practical use of shadow pricing methods for appraising investment projects in developing countries. This decline can be traced to a number of related factors. Firstly, the general shift in development policy towards market liberalization and ‘getting the prices right’ fostered the belief that the process of economic policy reform would allow market prices to reflect opportunity costs, thereby eliminating the need for shadow prices. Consequently, a ‘good policy environment’ came to be regarded as not just a necessary, but also a sufficient, condition for satisfactory project appraisal. Secondly, the introduction of structural adjustment lending by the World Bank and other lending institutions led to a relative decline in project lending. The increasing proportion of structural adjustment loans, and sectoral lending with no identifiable portfolio of projects, caused a diversion of attention away from project appraisal and cost-benefit analysis. Thirdly, there was mounting

’ The seminal works of this period are Little and Mirrlees (1974), UNIDO (1972) and Squire and van der Tak (1975). Recent surveys of the literature are Drtze and Stern (1987) and Squire (1989). A detailed recent introduction is Curry and Weiss (1993).

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2 C. Kirkpatrick

specticism among practitioners as to the cost-effectiveness of devoting time and resources to cost-benefit analysis. It was suggested, for example, that the use of shadow pricing made little difference in the selection of worthwhile projects- ‘Appraisal of financial rates of return were just as good a predictor of ex post economic rates of return as ex ante economic rates of return. The adjustments for price distortions seemed to make little difference, at least for projects that had been accepted for World Bank financing’ (Pohl and Mihaljek, 1989, quoted in Little and Mirrlees, 1990, pp. 368-369). This scepticism was reinforced by the evidence of a sizeable divergence between ex ante appraisal rates of return and ex post com- pletion rates of return. An analysis of 1015 World Bank projects covering the period 1974-87 showed a mean appraisal rate of return of 22 per cent, and a project completion rate of 16 per cent (Pohl and Mihaljek, 1992, p. 259). Analysis by year of approval showed that the gap in the rate of return had increased considerably in the 1970s: ‘the main cause appears to have been the increasing optimism of project evaluations. . .’ (Pohl and Mihaljek, 1992, p. 274). To sceptics this ‘optimism’ was attributable to the more widespread adoption of shadow pricing methods of valua- tion, which gave project analysts increased scope of validating their project pre- dilections.

By the end of the decade there was a growing realization that the pendulum had swung too far, and a more balanced approach to project appraisal began to emerge. Evidence of this renewed interest is provided by the commitment of the World Bank to the provision of increased training in project appraisal. In response to the growing demands for project training, the Bank’s Economic Development Institute (EDI) has already published a new ‘practitioner’s guide’ to the economic analysis of projects (Ward and Deren, 1991) and has organized an international conference on curriculum design for economic project analysis (EDI, 1992).

A number of factors have contributed to the renaissance in project appraisal. Firstly, it has been encouraged by the less dogmatic approach to development strategy which has begun to replace the rigid market orthodoxy which prevailed in the earlier years of the decade:

The approach to development that seems to have worked most reliably, and which seems to offer most promise, suggests a reappraisal of the respective roles of the market and the state. Put simply, governments need to do less in those areas where markets work, or can be made to work, reasonably well.. . At the same time, governments need to do more in those areas where markets alone cannot be relied upon (World Bank, 1991).*

If governments are to ‘do more’ in the traditional areas of market imperfection and failure, their investment decisions need to be well chosen. As a measure of the marginal effect on economic welfare of any quantity change, shadow prices are fundamental to the evaluation of both investment projects and, more generally, policy changes (Little and Mirrlees, 1990, p. 362).3

Secondly, there is growing concern over investment behaviour in developing

Interestingly, the World Bank data on average economic rates of return for projects financed by the World Bank and the IFC during the period 1968-69 show that public projects yielded a higher return than private projects (World Bank, 1991, Table 4.2).

The use of the standard techniques of development planning, including cost-benefit analysis, in the context of development policy management is examined in Chowdhury and Kirkpatrick (1993).

Editor’s Introduction 3

countries during the 1980s, when many LDCs adopted programmes of economic policy reform. There has been a marked decline in the investment ratio in LDCs with the share of gross capital formation in GDP falling from a median value of 25.3 per cent in 1981 to 20.0 per cent in 1989 (IMF, 1990, p. 130).4 Furthermore, the evidence on project productivity shows a deterioration in the 1980s. Data from the World Bank’s Operations Evaluation Department show that, whereas 15 per cent of completed projects approved in the mid-1970s did not perform satisfactorily, over 30 per cent of those approved in the mid-1980s were rated as unsatisfactory at completion (Picciotto, 1992, p. 2). Not surprisingly, therefore, efficient public investment decision-making has again been identified as a key factor in generating economic growth in the 1990s.

A third factor has been the methodological advances in cost-benefit analysis which have extended the procedures for the valuation of benefits and costs into new areas of application. For example, the linkages between changes in macro- parameters resulting from structural adjustment reforms and the estimation of shadow prices are now much better understood (Kanbur, 1990). In addition, the concern with sustainable development and the environmental impact of projects can now be incorporated into the cost-benefit approach to project appraisal (Pearce and Warford, 1992; Pearce, 1993).

To conclude, the earlier shift away from the use of project appraisal in favour of structural adjustment reforms has now been halted. There is a general appreciation that sound project appraisal is complementary to, rather than in competition with, market liberalization and policy reform. The economic appraisal of projects therefore continues to have a central role in achieving more efficient investment decisions, and hence more rapid economic growth in developing countries.

The papers in this special issue address many of these problems and concerns. The first three contributions explore the ways in which the cost-benefit analytical framework can be extended to incorporate more recent development priorities. John Weiss focuses on the impact of the relative price changes expected under a structural adjustment programme on the economic appraisal of projects, and shows how these changes can be allowed for in the estimation of shadow prices. In the last 15 years or so considerable progress has been made in refining the techniques for estimating national level shadow prices which can be applied to all projects regard- less of their sector. The paper by John MacArthur describes the semi-input-output (SIO) method of estimating simultaneously a set of national economic parameters, and gives a detailed review of the features of recent SIO studies. The contribution by Axel Sell returns to a more traditional topic in the cost-benefit literature, by examining the ways in which financial, economic and environmental analysis can be linked as elements of a comprehensive approach to project appraisal.

Considerable advances have been made in recent years in applying cost-benefit techniques to the valuation of environmental benefits and costs, and incorporating these values in the decision criteria used in the selection of projects. The paper by Michiel van Pelt discusses the use of cost-benefit analysis as an analytical tool in the appraisal of sustainability-oriented agricultural projects. Although he judges the full integration of sustainability criteria into cost-benefit analysis (CBA) as

The decline in investment ratios during the 1980s has been noted in Faini et al. (1991) and Servan and Solimano (1992).

4 C. Kirkpatrick

premature, he demonstrates how CBA and multi-criterion analysis (MCA) can be used as complementary appraisal tools. Euston Quah’s paper discusses the apprai- sal of projects which give rise to significant pollution damage, and shows how cost- benefit methods can be used to establish compensation criteria to effect payment to injured parties.

The next three contributions are concerned with pedagogical issues relating to project appraisal and cost-benefit analysis, and were orginally prepared as contri- butions to an Economic Development Institute Workshop on Curriculum Develop- ment for the Economic Analysis of Projects. The paper by Arnold Harberger contains detailed ‘notes’ on a number of issues that are central to project appraisal: risk analysis, the social discount rate, the shadow exchange rate, and the treatment of changes in relative prices. The papers by William Ward and Glenn Jenkins are essentially concerned with the teaching of project analysis. The Ward paper argues that project analysis training should occur in the broader context of institutional development and should include management training. The paper by Glenn Jenkins discusses the curriculum for project analysis of the Harvard Institute for International Development.

The final contributions are in the form of field reports. Frances Cleaver reports on a rural water supply project in Nkayi District, Zimbabwe, and shows how a historical approach to project planning which pays little attention to past patterns of provision of water supply by the state and its effect on people’s motivation has contributed to proper failure. Behrooz Morvaridi reports on a water supply and sanitation project in Mahrashtra State, India, which was used as a field study to sensitize water engineers to the socioeconomic and environmental aspects of water supply projects.

The techniques of project appraisal in developing countries were developed some 25 years ago. Since then, the methodology has been subject to much critical evaluation, and, arising from that, the techniques have been expanded and refined. At the same time, considerable experience in the application of these techniques has been accumulated. The papers in this special issue are evidence of the ways in which social cost benefit is continuing to develop new approaches in response to changes in economic circumstances and development objectives. Nevertheless, the fundamental notion of shadow pricing and social cost-benefit analysis-the valua- tion of investment choices in social opportunity cost terms-remains as the touch- stone for public investment decision-making and, as such, is at least as relevant for the 1990s as it was for previous decades.

REFERENCES

Chowdhury, A. and Kirkpatrick, C. (1993). Development Policy and Planning: An Introduc- tion to Methods and Techniques. London: Routledge.

Curry, S . R. and Weiss, J. (1993). Project Analysis for Developing Countries. London: Macmillan.

Drkze, J. and Stern, N. (1987). ‘The theory of cost-benefit analysis’. In Auerbach, A. and Feldstein, M. (eds) Handbook of Public Economics. Amsterdam: North-Holland.

ED1 (1992). Workshop on a Curriculum for The Economic Analysis of Projects: Back- ground Papers. Washington DC: Economic Development Institute of the World Bank.

Editor’s Introduction 5

Faini, R., de Melo, J. Senhadji, A., Semlali, A. and Stanton, J. (1991). ‘Macro performance under adjustment lending’. In Thomas, J. et al. (1992) (eds) Restructuring Economics in Distress. Oxford: Oxford University Press, pp. 29-54.

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Pearce, D. (1993). Economic Values and the Natural World. London: Earthscan. Pearce, D. and Warford, J. (1992). World Without End: Environment, Economics and

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