Catalog

	Table of Contents
p. 68 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 26 : Impact on Poverty Reduction

1. Poverty reduction is the most formidable development challenge. To reduce poverty some projects target the poor directly, but most aim at economic growth, benefiting the poor indirectly as well as directly. This appendix shows how to trace the economic impact of growth projects on the poor.

2. The poverty-reducing impact of a project is traced by evaluating the expected distribution of net economic benefits to different groups. With financial prices determining who controls net economic benefits, the first step is to estimate the present value of net financial benefits by participating group. Next, the difference between net benefits by group at economic and financial prices is added to net financial benefits by group to give the distribution of net economic benefits by group. Finally, the net economic benefits accrue to the poor according to the proportion of each group that is poor. A poverty impact ratio expressing the proportion of net economic benefits accruing to the poor can be calculated by comparing net economic benefits to the poor with net economic benefits to the project as a whole.¹

3. This can be illustrated through a publicly funded water utility project selling piped water. The water supply project serves a small rural town. All capital equipment is imported, subject to an import tariff. Labor and electricity account for total operating & maintenance (O&M) costs. Wages are controlled by a minimum wage law, with the economic price of labor being a proportion of the minimum wage. Electricity is subject to a sales tax and a production tax. The water utility is not subject to income tax. All financial and economic values are given in constant year-of-appraisal prices and in present value terms. Tradables are valued at border prices at the domestic price level and nontradables at domestic market prices. Net financial benefits (NFB) and net economic benefits (NEB) are expressed in domestic currency (rupees).

4. For the purpose of poverty impact analysis, project beneficiaries are divided into three national groups: the poor, the nonpoor, and the government. Net economic benefits by group are distributed between the poor and the nonpoor, according to the extent that they benefit the poor. In the case of net economic benefits to the government, it is assumed that 50 percent potentially benefit the poor.

5. The present value of project capital costs is $25 million at border prices. Import duties are 30 percent, the official exchange rate (OER) is Rs20/$ and the SERF is 1.20. The market value of electricity is Rs300 million, including a production tax of 20 percent and there is a sales tax of 10 percent. Wages amount to Rs80 million and the supply price of labor is 70 percent of the average wage rate. Water sales are Rs1,000 million. The quantity of water illegally consumed is 20 percent of revenue water. The economic cost of water consumed and paid for is Rs1,500 million.

6. The NFB is equal to sales revenue of Rs1,000 million minus capital costs of Rs650 million ($25 million multiplied by the OER of Rs20/$ plus the import tariff of 30 percent), electricity costs of Rs330 million (the market value of electricity plus sales tax), and labor costs of Rs80 million. The NFB of the project shows a loss of Rs60 million in present value (see Table 1).

7. The NEB of the project expressed at the domestic price level is Rs894 million. It is equal to gross benefits of Rs1,800 million (the cost of water increased by the proportion of water consumed but not paid for) minus capital costs of Rs600 million (capital imports converted to local currency at the OER multiplied by the shadow exchange rate factor), electricity costs of Rs250 million (market value of electricity less production tax), and labor costs of Rs56 million (wages valued at the supply price of labor).

8. The difference between the NEB and the NFB is distributed by group. The difference of Rs954 million is made up of (i) consumer surplus of Rs800 million (the difference between the without project cost of water and the with project expenditure on piped water, plus the value of water consumed but not paid for); (ii) government tax revenues from capital imports of Rs150 million; (iii) government tax revenue from electricity production of Rs80 million (production tax of Rs50 million plus sales tax of Rs30 million); (iv) benefits to labor of Rs24 million (wages of Rs80 million less opportunity cost of Rs56 million); and (v) loss in the economy to government of Rs100 million through overvaluation of the exchange rate.

9. The NEB-NFB difference is added to the NFB by group to arrive at the distribution of the NEB by group. The government's financial losses from investing in the water supply project amount to Rs60 million. Adding Rs130 million in taxes results in a net economic benefit to the government of Rs70 million. Consumers gain Rs800 million in consumer surplus and laborers earn Rs24 million more than they would have without the project. The NEB by group is Rs894 million.

10. The final step is to distribute the NEB by group between the poor and the nonpoor. One quarter of consumer surplus and one third of surplus for labor go to those living below the poverty line. Fifty percent of the return to the government is assumed to benefit the poor. The NEB accruing to the poor is therefore Rs243 million. The PIR of the project is Rs243 million/Rs894 million or 27 percent.

Charges, Benefits, and the Poverty Impact Ratio

12. The new level of charges captures some of the consumer surplus. Financial returns become positive and substantial while economic returns, though still positive, are reduced. The distribution of the net benefits between groups changes significantly. The government receives less tax revenue but now receives a surplus from the water supply corporation instead of a loss. Its share of the benefits increase considerably. The benefits to labor remain the same, while the benefits to consumers decrease substantially, both because of the reduction in consumer surplus per unit of water consumed and because of the decrease in consumption.

13. The PIR in these new circumstances is 39 percent instead of 27 percent. It has increased significantly but it is not the main parameter to be affected by the increase in charges, which has transferred more benefits to the owner of the water supply corporation, the government. In fact, the absolute amount of benefits going to the poor has decreased with the increase in water charge. This suggests two things. First, the charges may have been raised by too much; given the new financial returns, a lower increase in charges could have ensured the financial sustainability of the corporation. Second, the tariff structure is as important for the PIR as the tariff level. In this case the tariff levels were increased for all types of consumer. An increase in tariff together with a different tariff structure could have captured some of the consumer surplus from the higher income groups while leaving the poor groups unaffected. In other words, the increase in charges could be designed to leave a higher proportion of benefits going to the poor.

14. By focusing attention on cost recovery mechanisms and tariff structures, PIR analysis can help improve project design by identifying who benefits and who pays, and by how much. Pricing policy can affect the poverty impact of a project; it can also affect the distribution of benefits between the private and public sectors, for example, where the water supply corporation is privately not publicly owned. However, projects designed to have a significant impact on the poor may at the same time have to be provided at a different scale or in a different location, to raise the proportion of benefits going to the poor.

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¹ The poverty impact ratio is based on the distribution of project net benefits. This differs from the Banks project classification criterion, that is expressed in terms of the number of beneficiaries.

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