Social rate of return for project evaluation : an estimate for Yugoslavia

Social Rate of Return for Project Evaluat~on; An Estimate for Yugoslavia World Bank Staff Working Paper No. 205 - . .. I. - ^ ' '. l2  This paper is prepared for staff use. The views are those of the author and not necessarily those of the Bank. -ITERNATIONAL BANK FOR RKONSTRUCTION AND DEVLT T Staff Working Paper No. 205 June 20, 1975 SOCIAL RATE OF RMEURN FOR PROJECT EVALUJTION -AN EST:IATE FOR YUGOSLAVIA- Based on the premise that the choice of projects can help achieve both growth and more equitable distribution of growth benefits, the paper attempts to apply the techniques of such project evaluation as developed in the recent World Bank staff guidelines to a concrete country case of Yugoslavia. It concentrates on the estimation of several country parameters, including criti- cal consumption level, marginal product of capital, and weights for saving and income distribution. From these estimates, the economy's marginal social rate of return is derived, depending on the overall consumption and saving weights. Similarly, it shows that a project's social rate of return can also be estimated by incorporating further the distribution weights. It suggests that by taking into account saving and incane distribution preferences, the social rate of return approach could be a step further from the pure effi- ciency economic rate of return approach in project selection, for affecting resource allocation towards both growth and equity. The paper recognizes that judgements are involved in any quantifi- cation of social values, but considers that sane enlightened judgements are perhaps better than none and that an attempt at quantification may stimulate policy-makers to refine their judgements consistent with their own priorities. The paper is an expanded and revised version of the the author's con- tribution of a chapter to a wider study entitled: "Yugoslavia: Preliminary Estima',es of Country Parameters for Economic Analysis of Projects " (Manu- script, January 10, 197.5), which was prepared jointly by Martin Schrenk and Shu-Chin Yang. The author is grateful to Johannes F. Linn, Martin Schrenk and lyn Squire for their comments on the draft at its various stages and to Boris Blazic-Metzner and D. Zelstra for their statistical assistance. He also benefited from comments on the last draft from George Beier, Paul Meo, Harold PilIvn, and Anandarup Ray. Prepared by: Shu-Chin Yang Poliicy Planning and Program Review Department Development Policy Staff  Table of Contents Page To. 1i. Tntroduction 1 IT. Personal Consumption vs. other C-NP Components 3 III. The Critical Consumption Level 7 IV. Marginal Social Rate of iReturn (SRIR) and Its Estimation 13 The marginal product of capital 14 Estimating SRR 16 V. The Consumption Distribution Wileight 17 VI. Project's Social ?,ate of Return and Implications for Project Selection 19 VII. Conclusion 22 jinnex Tables 1-3  SCIAL RATE OF REI'URN FOR PROJECT EVALUATION - AN PSTIATE FOR YUGOSLAVIA - Shu-Chin Yang Introduction 1. Ir. any economy, the decisions of resource allocation among various uses in achieving the societyts objectives are carried to a considerable extent through the choice of projects. In evaluating the merits of a project if only direct costs and benefits of the project are taken into account and only actual prices are used in evaluating such costs and benefits to arrive at an internal rate of return,the result would be that only projects with the highest rates of financial return to project owners are selected. The resultant resource alloca- tion may not necessarily be optimal if the society aims at the economic use of scarce resources. In the raal world,, partiou- larly in developing economies, for reasons of market imperfections or policy limitations, actual prices are in many cases significantly different from prices which would reflect the relative scarcities of various kinds of resources. Therefore, there is often a need for using different prices, let us call them "efficiency shadow prices", in project evaluat,ion to obtain the economic rates of return.  2 L?'cI>x/:y s.- c',*; r.ces'l are tle prices jnicn appr-)dmate c:2re osely TAle on cost of resources used. Ihe use of ' -etLc :_encv shado(:t: o s oioect evaluation ensures that the resources invest1ed in a project will be utilized in tile most efficient way and ,-eld t-'he maximum possible output and income. This efficiencyr Dricing, however, is not concerned with the beneficiaries of the inc ome st-reaim genet. ted by the project. To go a step further in evnluation of projects, one could ask how the project-generated income will be spent and who will be the likely recicients of the future income. For example, a country (or a government) which is concerned primarily with rapid growth would logically regard saving more valuable than current consumption, as the foximer can be re-invested to generate more income. Moreover, if a country (or a government) s also concerned with more equal income distribution, it would prefer projects resulting in increased income and consumption to the poor rather than those which benefit primarily the' rich. All this involves social weighing of various components of the income-expenditure streams generated by the project and of the different income brackets or con- 1/ sumption levels of the beneficiaries in project evaluation. This kind oL social weighting may be called "social shadoiw pricing" to be distinguished from "efficiency shadow pricing". 1/ There is a considerable amount of general works on this subject. *See, for e-xample, I,M.D. Little and J.A.. Mirrlees, Manual of ITndustrial Project Anal;rsis in Developing Countries, OECD, 1968, and United Nations Tindustrial Development Orgafi:zation (P. DasCupta, A. Sen and S. Mb.rglin), Guidelines for Project Evaluation New York, United Nations. - I s - i - i/ -t saB''-- - - - - - - - -r-- - - - - - - - - - - - - - - - - - - - - - - - - - ---- - - - - - - - - - - - - - - let  1