Catalog

	Table of Contents
p. 8 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 A. Scope of Economic Analysis B. The Project Framework C. Financial and 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 XVII. Others

Guidelines for the Economic Analysis of Projects : V. An Integrated Approach To Economic Analysis

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C. Financial and Economic Analysis

28. The economic analysis of projects is similar in form to financial analysis: both appraise the profit of an investment. The concept of financial profit is not the same as economic profit. The financial analysis of a project estimates the profit accruing to the project-operating entity or to the project participants, whereas economic analysis measures the effect of the project on the national economy. For a project to be economically viable, it must be financially sustainable, as well as economically efficient. If a project is not financially sustainable, economic benefits will not be realized. Financial analysis and economic analysis are therefore two sides of the same coin and complementary.

29. Both types of analysis are conducted in monetary terms, the major difference lying in the definition of costs and benefits. In financial analysis all expenditures incurred under the project and revenues resulting from it are taken into account. This form of analysis is necessary to

• assess the degree to which a project will generate revenues sufficient to meet its financial obligations,
• assess the incentives for producers, and
• ensure demand or output forecasts on which the economic analysis is based are consistent with financial charges or available budget resources.

30. Economic analysis attempts to assess the overall impact of a project on improving the economic welfare of the citizens of the country concerned. It assesses a project in the context of the national economy, rather than for the project participants or the project entity that implements the project. Economic analysis differs from financial analysis in terms of both (i) the breadth of the identification and evaluation of inputs and outputs, and (ii) the measure of benefits and costs. Economic analysis includes all members of society, and measures the project's positive and negative impacts in terms of willingness to pay for units of increased consumption, and to accept compensation for foregone units of consumption. Willingness to pay and willingness to accept compensation are used rather than prices actually paid or received because

• many of the project impacts that are to be included in the economic analysis either will be nonmarketed, for example, biodiversity preservation, or incompletely marketed, such as, water supply and sanitation benefits. Thus, some form of nonmarket value must be estimated.
• many project impacts that are marketed will be bought and sold in markets where prices are distorted by various government interventions, by macroeconomic policies, or by imperfect competition.

31. Shadow prices may be used in estimating the willingness to pay and willingness to accept compensation values in the face of these market absences and market imperfections.

32. The benefits from a project constitute the extent to which the project contributes to increasing the value of the consumption available to society. Consumption can be defined broadly. Societal consumption may apply equally well to a society's willingness to pay for preservation of plant or animal species, as to society's willingness to pay for the consumption of agricultural produce or clean drinking water.

33. Costs reflect the degree to which consumption elsewhere in society is sacrificed by diverting the resources required by the project from other uses. The total net changes in consumption available to the society represent the net impact of the project. When the units of consumption are valued in terms of marginal willingness to pay for the units of increased consumption and marginal willingness to accept compensation for foregone units of consumption, the resulting economic net benefits from the project will reflect the summation of the changes in the net income of the society as a whole, resulting from the situation with the project compared with that without the project.

34. Shadow prices are used to take into account the major impacts of a project where economic values differ from financial values. In many developing member countries, many prices paid and received in the project accounts may come from relatively complete markets where the major impacts are captured in the transaction between buyer and seller, and are reflected by the prices paid and received. As structural adjustment and sectoral adjustment measures proceed, and as projects involving institutional and organizational approaches to market development are successfully implemented, the differences between financial values and economic values may lessen. The overall objective of the structural and sectoral adjustment programs, and of the projects financed by the Bank, is to attempt to create just such an economic environment in the Bank's developing member countries.

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