Highlight the importance for conducting social-cost benefit analysis. Briefly explain the features of social-cost benefit analysis.

Ans. The term “social costs” refers to all those harmful consequences and damages which the community on the whole sustains as a result of productive processes and for which private entrepreneurs are not held responsible. The definition of the concept is comprehensive enough to

include even certain “social opportunity costs”, avoidable wastes and social inefficiencies of various kinds. Implicit in such an appraisal is the assumption that the principal objective of investment decision-making is to maximize the net present value of monetary flow or some variant of it.The social cost-benefit analysis is a tool for evaluating the value of money, particularly of public investments in many economies. It aids in making decisions with respect to the various aspects of a project and the design programs of closely interrelated projects. Cost benefit analysis has become important among economists and consultants in recent years.

 Need for cost-benefit analysis

The essence of the theory of social cost-benefit analysis is that it does not accept that the actual receipts of a project adequately measure social benefits and actual expenditures measure social costs. The reason is that actual prices may be an inadequate indicator of economic benefits and

costs. For example, in developing countries like India, the prices of necessities are set low, despite their economic importance, while the prices of less essential goods are set high (through a system of taxes and duties). As a result, some projects which appear very profitable when their outputs and inputs are valued at actual prices are, in fact, unattractive from the viewpoint of the national economy, while other apparently unprofitable projects have high economic returns. But the theory accepts that actual receipts and expenditures can be suitably adjusted so that the difference between them, closely analogous to ordinary profit, will properly reflect the social gain.In Social-Cost Benefit Analysis (SCBA) the focus is on social costs and benefits of a project. These often tend to differ from the costs incurred in monetary terms and benefits earned in monetary terms by the project.The principal reasons for discrepancy are:

(i) Market imperfections: Market prices, which form the basis for computing the monetary costs and benefits from the point of view of project sponsor, reflect social values only under conditions of perfect competition, which are rarely, if ever, realized by developing countries. When imperfections obtain, market prices do not reflect social values.

The common market imperfections found in developing countries are: (i) rationing, (ii) prescription of minimum wage rates, and (iii) foreign exchange regulation. Rationing of a commodity means control over its price and distribution. The price paid by a consumer under rationing is often significantly less than the price that would prevail in a competitive market. When minimum wage rates are prescribed, the wages paid to labour are usually more than what the wages would be in a competitive labour market free from such wage legislations. The official rate of foreign exchange in most of the developing countries, which exercise close regulation over foreign exchange, is typically less than the rate that would prevail in the absence of foreign exchange regulation. This is why foreign exchange usually commands premium in unofficial

transactions.

(ii) Externalities: A project may have beneficial external effects. For example, it may create certain infrastructural facilities like roads which benefit the neighbouring areas. Such benefits are considered in SCBA, though they are ignored in assessing the monetary benefits to the project sponsors because they do not receive any monetary compensation from those who enjoy this external benefit created by the project. Likewise, a project may have a harmful external effect like environmental pollution. In SCBA, the cost of such environmental pollution is relevant, though the project sponsors do not incur any monetary costs.It may be emphasized that externalities are relevant in SCBA because in such analysis all costs and benefits, irrespective to

whom they accrue and whether they are paid for or not, are relevant.

(iii) Taxes and subsidies: From the private point of view, taxes are definite monetary costs and subsidies are definite monetary gains.From the social point of view, however, taxes and subsidies are generally regarded as transfer payments and hence considered irrelevant.

(iv) Concern for savings: Unconcerned about how its benefits are divided between consumption and savings, a private firm does not put differential valuation on savings and consumption. From a social point of view, however, the division of benefits between consumption and savings (which leads to investment) is relevant particularly in capital-scarce developing countries. A rupee of benefits saved is deemed more valuable than a rupee of benefits consumed. The concern of society for savings and investment is duly reflected in SCBA wherein a higher valuation is placed on savings and lower valuation is put on consumption.

(v) Concern for redistribution: A private firm does not bother how its benefits are distributed across various groups in the society. The society, however, is concerned about the distribution of benefits across different groups. A rupee of benefit going to a poor section is considered more valuable than a rupee of benefit going to an affluent section.

(vi) Merit wants: Goals and preferences not expressed in the market place, but believed by policy makers to be in the larger social interest, may be referred to as merit wants. For example, the

government may prefer to promote adult education or a balanced nutrition programme for school-going children even though these are not sought by consumers in the market place. While merit wants are not relevant from the private point of view, they are important from the social point of view.

Main features of social cost-benefit analysis

Prest and Turvey defined cost-benefit analysis as “a practical way of assessing the desirability of projects, where it is important to take a long view in the sense (looking at repercussions in the future as well as the near future and a wide view in the sense of allowing side-effects of many

decisions relating to industries, regions etc.), i.e., it implies the enumeration and evaluation of all the relevant cost and benefits”. This definition focuses attention on the main features of cost-benefit analysis.It covers five distinct issues:

1. Assessing the desirability of projects in the public, as opposed to the private sector.

2. Identification of costs and benefits.

3. Measurement of costs and benefits.

4. The effect of (risk and uncertainty) time in investment appraisal.

5. Presentation of results– the investment criterion.