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p. 67 of 74 BACK | NEXT I. Introduction II. Background III. The Economic Rationale of A Project IV. Macroeconomic and Sectoral Context V. An Integrated Approach To Economic Analysis VI. Identification and Quantification of Costs and Benefits VII. Valuation of Economic Costs and Benefits VIII. Large Projects, Linkages, and National Affordability IX. Least-Cost and Cost-Effective Analysis X. Investment Criteria: Economic Viability XI. Discount Rate XII. Uncertainty: Sensitivity and Risk Analysis XIII. Sustainability of Project Effects XIV. Distribution of Project Effects XV. Projects and Policies XVI. Appendices Appendix 1: Key Questions For The Economic Analysis of Projects Appendix 2: Project Economic Rationale: Market and Nonmarket Failures Appendix 3: The Project Framework Appendix 4: Identification and Measurement of Consumer Surplus Appendix 5: Treatment of Working Capital Appendix 6: Depletion Premium Appendix 7: The Use of Constant Prices In The Economic Analysis of Projects Appendix 8: General Methodology For Building Up Project Statements Appendix 9: Economic Evaluation of Project Output and Input Appendix 10: Economic Price of Traded Goods and Services Appendix 11: Valuation of Nontraded Outputs and Inputs Appendix 12: Shadow Wage Rate and The Shadow Water Rate Factor Appendix 13: The Economic Price of Land Appendix 14: Treatment of Resettlement Components of Projects Appendix 15: Calculating Economic Prices At The Domestic Market Price Or World Market Price Levels Appendix 16: Estimating The Shadow Exchange Rate Factor and The Standard (Or Average) Conversion Factor Appendix 17: Example of An Economic Rate of Return: An Irrigation Rehabilitation Project Appendix 18: Effect On Net Foreign Exchange and Budget Flows: An Example Appendix 19: Least-Cost Analysis and Choosing Between Alternatives Appendix 20: Estimating The Economic Opportunity Cost of Capital Appendix 21: The Treatment of Uncertainty In The Economic Analysis of Projects: Sensitivity and Risk Analysis Appendix 22: User Charges, Cost Recovery, and Demand Management: An Example For Piped Water Appendix 23: Financial Returns To Project Participants: An Illustration Appendix 24: Economic Evaluation of Environmental Impacts Appendix 25: Distribution of Project Effects Appendix 26: Impact On Poverty Reduction Appendix 27: Difference Between Economic and Financial Prices Appendix 28: Use of Economic Prices In Measuring Effective Protection Appendix 29: Exchange Rate Issues In Project Analysis XVII. Others

Guidelines for the Economic Analysis of Projects : XVI. Appendices

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Appendix 25 : Distribution of Project Effects

1. The costs and benefits of a project are shared among different groups. There are several ways in which the distribution of project effects can be analyzed. First, the project effects can be allocated among different project participants, usually suppliers, consumers, owners, lenders, workers or producers, and the government representing the rest of the economy. It is usual to expect owners, lenders, workers or producers, and the government all to share in the net project effects. Frequently, consumers and suppliers also do. Second, for projects that involve foreign investors, lenders, management, and labor, the distribution of net project effects between nationals and foreigners can be demonstrated. Third, project effects can be allocated between the public and the private sectors. This may be particularly important for infrastructure developments where public sector expenditures are made in support of private sector operations. Fourth, the net project effects can be allocated not only among different project participants but among participants with different income levels. Fifth, net project effects can be allocated according to whether the project net benefits are likely to be consumed or saved. Finally, costs and benefits can be allocated among different countries participating in subregional projects.

2. Considerable effort was expended in the past to include the distribution of net benefits between savings and investment into project analysis. The purpose was to identify and give priority to projects that would enhance savings, and therefore investment in the economy, by applying a premium to project effects resulting in extra savings. Considerable effort was also expended to include the distribution of net benefits by income group into project analysis. The purpose here was to identify and give priority to projects that would enhance incomes for lower income groups, by applying a different weight to the incremental incomes of different groups. However, both forms of analysis depend on specifying premia that are essentially subjective and open to disagreement. In addition, enhancing savings can lead to priorities that contradict the enhancement of incomes for lower income groups, and both savings and the distribution of income can be affected more directly by policy changes at the national level rather than through the net effects of new investment projects.

3. It is recommended that simply a statement of the distribution of project effects be given, without applying any premium to either incomes that are saved or to incomes accruing to particular income groups. There are three reasons for providing such a statement. The first is to assess whether the likely distribution of project effects corresponds with the objectives of the project. The second is to bring the financial and economic analysis of projects together to ensure that the consequences for the economic benefits of projects of changes in financial arrangements are assessed. The third is to assess the likely impact of policy changes on the distribution of project effects.

4. The following example illustrates the construction of a statement on the distribution of project effects. For simplification, the project excludes the effects of project financing, that is, it does not consider the possible net costs or benefits to lenders. Neither does it include direct tax payments. The illustration concerns a telecommunications project involving 50,000 new lines and associated exchanges that will extend the national network into a rural area through the provision of publicly accessible telephones in villages and rural towns. The analysis of the distribution of project effects is based on the incremental number of calls for the telecommunications corporation and the incremental costs of providing the new telephone facilities. Values for the costs and benefits of the project, at both financial and economic prices, are all given as present values calculated at a discount rate of 12 percent representing the economic price of investment funds in the economy.

5. The forecast project financial statement at constant domestic market prices is summarized in Table 1. At the projected future charge level, which will apply across the whole telecommunications network and not just in the project area, the telecommunications corporation will not recover the full incremental costs of the project at financial prices inclusive of the opportunity cost of capital. The corporation will have a loss on resources in present value of 100.

6. The economic analysis of the project introduces three major considerations. First, with project telephone calls will be made at a cost that includes the telephone charge going to the corporation plus the costs of traveling to the telephone. Without the project a high proportion of telephone users would continue to communicate through other means, including traveling to the call destinations. The difference between the cost of communication without the project and the full costs with the project, including the costs of reaching the telephone, represents an economic benefit to telephone users that is not incorporated in the financial charge for the telephone calls. In addition, a further economic benefit will stem from the fact that several small businesses and farmers will benefit from the better access to communication relating to input and output markets and prices, and transport schedules. Taken together these additional economic benefits can be added on to the financial revenues as a consumer surplus. Second, there is a difference between the economic price of foreign exchange and the official exchange rate. A SERF of 1.3 has been estimated for the country implying that foreign exchange costs have a higher economic than financial cost to the economy. Third, there is a surplus of labor that could easily be trained for telecommunication operations in the area. The opportunity cost at domestic prices for operating labor has been estimated as 90 percent of the wage level, in other words a shadow wage rate factor of 0.9.

7. The financial project statement has been adjusted by the consumer surplus and the appropriate conversion factors to derive the project economic statement in Table 2. The economic values have been expressed at the domestic price level in national currency. Table 2 also shows the differences between the financial and economic value of resources. These differences give rise to losses and gains among the project participants. As indicated by the consumer surplus, consumers of the new telephone services benefit to the extent to which the economic value of communication cost savings and business efficiency improvements exceed the full cost of making calls. The economic valuation of the equipment for the project exceeds its financial value to the extent of the SERF; the consequent loss because of the overvaluation of the exchange rate is borne by the government representing others in the economy, especially importers. The financial cost of labor exceeds its opportunity cost; the difference accrues as a gain to operating labor. These gains and losses are complemented by the loss to the corporation because not all the full financial costs, including capital costs are recovered. The right-hand-side section of Table 2 summarizes these gains and losses to different project participants.

8. The overall results for the project are a financial net present value (NPV) of minus 100 and an economic NPV of 40. The economic NPV exceeds the financial NPV by 140. More specifically, as at present structured, two participants lose from the project. The corporation will suffer a loss of 100, and the rest of the economy will suffer a loss of 120 because foreign exchange is available at a price lower than its economic price. On the other hand, two participants will gain. Operating labor will gain by 10 at the project wage level, while consumers will gain from their consumer surplus of 250. These gains and losses in part compensate for each other; the net gain is positive and is equal to the economic NPV of 40.

9. The differences between the financial and economic values, and the consequent gains and losses for different project participants, provide the basis for considering the impact of policy changes. First, there is a small gain to labor. If there were a completely competitive market for labor this would not occur. However, this is not a major source of difference between financial and economic outcomes. Second, a substantial gain has been identified accruing through the corporation to the consumers as a result of revaluing the foreign exchange element of project inputs. This gain could only be corrected by a general realignment of domestic and world prices, outside the context of project level changes.

10. Finally, the main beneficiary of the project will be the consumers. In part, their benefits could be incorporated into the telephone charges they must pay. If the telephone charge was raised to cover the financial loss of 100, that is, by 100/700 or 14.3 percent on a project basis, most consumers would still be making substantial gains. However, the most marginal consumers may not use the new telephone in these circumstances and so some of the economic benefits would be lost. Moreover, any change in telephone charges in real terms would also impact on existing network users.

11. The distribution of project effects is of interest for its own sake. It also assists those designing projects by drawing attention to the effects of current policies on the financial and economic results, in this case, exchange rate and pricing policy. Changes in project design within the current policies can be assessed within the same framework. The effects of policy alternatives can be presented in this way to inform policy dialogue with governments and the stipulation of loan covenants.

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