Social Cost Benefit

Analysis (SCBA)

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 What is SCBA ?
“Social Cost Benefit Analysis” (SCBA) is a tool
to determine merits of a project on the basis of current
and future socio-economic impacts.”

SCBA is a systematic and formal method of

evaluation of the project in terms of Costs and
Benefits. Social cost-benefit analysis refers to cases
where the project has a broad impact across society
and, as such, is usually carried out by the government.
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Benefits ≥ Costs
The process of judging whether or not a project should be
accepted is called project evaluation.
 Impact of
SCBA

Positive Negative
(Social Benefit) (Social Cost)
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 Social Costs and Social Benefits
Social Costs: The costs of off-putting impacts of a project on
society, environment, ecology, human, animal, mankind.

Social Benefits: The benefits of a project other than economic gain.

Social Costs Social Benefits

Subsidies offered Taxes raised

Environmental degradation Improvement of environment

Depletion of energy Products and Services

Unemployment caused Indirect employment creation

Human services used Socio-economic developments

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 Example of Project Ranking

Here Project IV is selected as 1st priority,

as it is having 1st Rank in B/C ratio. Even though
it is having medium Net Benefits, Project IV is
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very good in Benefits/Cost Ratio.
 Social Costs and Social Benefits
Example 1 : Social Costs of
Tea Industry
Usage of Public utility :
Environmental degradation :  Consumption of Power
 Cutting of trees and shrubs
 Water pollution due to insecticide Global Warming :
use  Factory’s carbon emission
 Air pollution from factory

Ecological imbalance :
 Shrinkage of habitat of wild
animal
 Reduction of grazing land

Human Services Used :

 Shortage of labour for crop
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cultivation
 Social Benefits of Tea Industry
Improvement of environment :
 Tree planting
 Tree plantation

Employment creation :
 Direct employment
 Indirect employment

Foreign Exchange earning :

 Social Welfare
 Education
 Health Care
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 Example 2 : Social Costs of
Construction of a Bridge on a River
 Increased pollution during construction
 Migration of labour from farming
 Shortage of price hike of raw materials
 Unemployment to people engaged in ferries
 Abolishing of small shops existed at Ferry
ghats
 Loss of farms and houses of some families
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Social Benefits of Construction of a Bridge
 Employment to workers during construction
 Less cost in travel and transportation
 Saving of time of people
 Employment in toll tax collection
 Social Welfare

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Concept of ‘Shadow Pricing’
The term "Shadow Price" or "Shadow Pricing" is used to
refer to monetary values assigned to currently unknowable or
difficult to calculate costs. The origin of these costs is typically
due to an externalization of costs or an unwillingness to
recalculate a system to account for marginal production.

For example, consider a firm that already has a factory

full of equipment and staff. They might estimate the shadow
price for a few more units of production as simply the cost of
the overtime. In this manner some goods and services have
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near zero shadow prices, for example information goods.
 To let us make ourselves very clear with the concept of
shadow pricing, come, let us delve into one more example.
Suppose if you plan to travel from Mysore to Bangalore in
your car, what will be the cost of journey for 140kms if car gives a
mileage of 20 km/ltr and price of petrol is Rs. 70/ltr ?

You might estimate the cost of that trip by only including

the cost of petrol; but you are unlikely to include the wear on the
tires, the depreciation cost of car per km, the insurance cost, the
rare possibility of an accident and its consequences and so on.

So, Shadow Price can be thought of as the cost of decisions

made at the margin without consideration for the total
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cost.
 Objectives of SCBA
The main focus of Social Cost Benefit Analysis is
to determine:
1. Economic benefits of the project in terms of shadow
prices;
2. The impact of the project on the level of savings and
investments in the society;
3. The impact of the project on the distribution of
income in the society;
4. The contribution of the project towards the
fulfilment of certain merit wants (self- sufficiency,
employment etc). 16
 Scope & Relevance of SCBA
SCBA can be applied to both Public & private
investments –
⚫ Public Investment: SCBA is important specially for the
developing countries where govt. plays a significant role in
the economic development.
⚫ Private Investment: Here, SCBA is also important as the
private investments are to be approved by various
governmental & quasi-governmental agencies.

1. SCBA enables Governments to make logical decisions.

2. SCBA brings into force international and national
legislations for safeguarding:
 Social Justice
 Over exploitation of National Resources and Human
Resources
 Sustainable Development
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 Advantages and Disadvantages of
SCBA
 The ability to identify the projects that maximize the
welfare of the country.
 The ability to objectively assess and quantify the purpose
projects in relation to community needs.
 Exposure of the basis for decision-making for projects and
opportunity for public criticism.
 Ability to rank and prioritize limited resources so that the
maximum benefit is realized.

 Difficulty in measuring social costs and benefits and

converting them into monetary term.
 Over statement of the value of social benefits
 Complexity
 Conflict between social welfare and financial justification.
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Distinguishing between SCBA & Monetary Cost
Benefit
Social Cost Benefit Analysis is different from the Cost
Benefit Analysis (or Monetary Cost Benefit Analysis or
CBA) in the following terms:
 Market Imperfections
 Externalities
 Taxes & Subsidies
 Concern for Savings
 Concern for Redistribution
 Merit Wants
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 Employment and Standard of Living
 Market Imperfections:
 Rationing
 Prescription of minimum wage rates

 Externalities:
A project may have both beneficial or harmful external
effects that are considered in SCBA, but not in Cost Benefit
Analysis. Therefore, both the effects are to be assessed and
considered before sanctioning a deal in SCBA.
Positive-externalities could be in the form improvement in
technology and negative-externalities could be in the form of
increase in pollution and destruction of ecology.

 Taxes & Subsidies:

From the social point of view, taxes & subsidies are nothing
but transfer payments. But in Cost Benefit Analysis, taxes &
subsidies are treated as monetary costs and benefits respectively
(i.e., expenses and income).
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 Concern for Savings:
In SCBA, the division between benefits &
consumption is relevant wherein higher valuation is placed
on savings. But in CBA such division is irrelevant.
Impact of the project on general savings and
investment level is to be considered.

 Concern for Redistribution:

CBA in a private firm does not bother how its benefits
are distributed across various groups in the society.
In SCBA, the distribution of benefits is very much
concerning issue where, the project should not lead to
accumulating income in the hands of a few but, it should
equally distribute the income. 21
 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 an
adult education programme or a balanced nutrition programme
for school-going children.
While Merit wants are not relevant from private point of
view, they are important from the social point of view (SCBA).

 Employment and Standard of Living:

How a project affects employment and standard of living of
people in society, will be taken into account as well in SCBA. The
deal should lead to increase in employment and standard of
living. But, for Monetary Cost Benefit Analysis this is irrelevant.
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Approaches to SCBA
Towards the end of the 1960s and 1970s two principal approaches
for Social Cost Benefit Analysis emerged. They are:
1. UNIDO Approach 2. L-M Approach (Little-Mirrlees approach)

UNIDO Approach: This approach is mainly based on the publication

of UNIDO (United Nations Industrial Development Organization)
named Guide to Practical Project Appraisal in 1978.

The UNIDO approach of Social Cost Benefit Analysis involves five

stages:
1. Calculation of financial profitability of the project measured at
market prices.
2. Obtaining the net benefit of the project measured in terms of
shadow prices (or economic prices or efficiency prices). (Objective of
SCBA-1)
3. Adjustment for the impact of the project on Savings & Investment.
(Objective of SCBA-2)
4. Adjustment for the impact of the project on Income Distribution.
(Objective of SCBA-3)
5. Adjustment for the impact of the project on Merit and Demerit
Goods whose social values differ from their economic 23 values.
(Objective of SCBA-4)
Stage-1: Calculation of financial profitability of the
project
The measurement of financial profitability of the
project in the 1st Stage is similar to the financial evaluation
of the project. This includes the Study of Cash Flow
Statement, Balance Sheet, Means of Financing,
Depreciation, Tax factor etc.

Stage-2: Obtaining the net benefit of the project at

shadow prices
Under UNIDO approach, for obtaining the net benefit
of the project at shadow prices is done as follows:

Shadow pricing: The shadow price of a good

measures the net impact on social welfare of a unit increase
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in the supply of that good by the public sector.

 Choice of Numeraire : One of the important aspects
of shadow pricing is the determination of the Numeraire.
Numeraire is the unit of account in which the value of
inputs or outputs is expressed. To define the nummeraire,
the following questions have to be answered:
 What unit of currency, domestic or foreign, should be used
to express benefits/costs?
 Should costs and benefits be measured in current values or
constant values?
 With reference to which point - Present or Future - should
costs and benefits be evaluated?

Other things to consider in Stage 2 of UNIDO

approach to SCBA are: Concept of tradability, Sources of
Shadow Prices and Treatment of Taxes 25
Example of a 'Bridge Project' to illustrate the calculation of
Net Economic Benefit in terms of shadow prices or
economic prices. (Stage 2 of UNIDO approach)

Presently, a ferry service, operated privately, is being

used to cross a river. The ferry operator charges Rs. 3 per
person. It costs him Rs. 2 per person. Currently per year
50,000 persons use the ferry service for crossing the river.

Now the Government is considering construction of a

bridge over the river. It is estimated that after the bridge is
constructed 2,50,000 persons will cross the river on the
bridge. The bridge is expected to cost Rs. 3 million initially
and its annual maintenance cost would be Rs. 10,000. It has
an indefinitely long life. Once the bridge is constructed the
ferry operator is expected to close down the ferry service
and sell the ferry boats for Rs. 1,00,000. 27
 Solution:- Now the social costs and benefits of
constructing the bridge may be defined as follows:

Costs:
1) Construction cost = Rs. 30,00,000 (This is one shot cost)
2) Maintenance cost = Rs. 10,000 (This is an annual cost)

Benefits:
1) Value of ferries released = Rs. 1,00,000 (one time benefit)
2) Savings in the cost of ferry operations = Rs. 1,00,000/year
3) Increase in consumer satisfaction : This is equal to
willingness to pay of 2,00,000 additional persons who are
expected to use the bridge.
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 Since the first additional person is willing to pay
almost Rs. 3 (the charge of the ferry operator) and the last
person is willing to pay almost nothing (there is no toll for
using the bridge) the average willingness to pay of
additional users, assuming that the demand schedule is
linear, is Rs. 1.50.
So the willingness to pay of 2,00,000 additional
persons is 2,00,000 x Rs. 1.50 = Rs. 3,00,000 as shown below

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Stage-3: Adjusting Impact of the project on Savings and
Investments
The purposes of this stage 3 are to :
 Determine the amount of income gained or lost because of
the project by different income groups (such as project
other than business, government, workers, customers etc.)
 Evaluate the net impact of these gains and losses on savings
 Measure the adjustment factor for savings and thus the
adjusted values for savings impact.
 Adjust the impact on savings to the net present value
calculated in stage two.
For example: A project appoints 1,000 labourers at a
wage rate of Rs. 150 per day. These workers were ready to
work for a daily wage of Rs. 100.
Therefore, the gain of the group of 1,000 workers from
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the project is {(150 - 100) × 1,000} = Rs. 50,000 per day.
Stage-4: Adjusting Impact of the project on Income
Distribution
Government considers a project as an investment for
the redistribution of income in favour of economically
weaker sections or economically backward regions.
This stage provides a value on the effects of a project
on income distribution between rich & poor and among
regions.
Distribution Adjustment Factor (Weight) is calculated
and the impacts of the project on income distribution have
been valued by multiplying the adjustment factor with the
particular income of a group. This value will then be added
to the net present value re-calculated in stage three to
produce the social net present value of the project.
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Stage-5: Adjusting Impact of project on Merit and
Demerit Goods
Merits good is one for which the social value exceeds
the economic value. (ex: Oil, Creation of employment etc.)
Demerits good is one social value of goods is less than
the economic value. (ex: Cigarette, Alcohol, etc.)

Adjustment to the net present value of stage 4 is done

as per the below procedure :
 Estimating the present economic value
 Calculating the adjustment factor
 Multiplying the economic value by adjustment factor to
obtain the adjusted value
 Adding or subtracting the adjusted value to or from the net
present value of the project as calculated in stage four.
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L-M Approach (Little-Mirrlees Approach)
I.M.D Little & J.A.Mirlees have developed this
approach for analysis of Social Cost-Benefit
Analysis.

The core of this approach is that the social cost

of using a resource in developing countries differs
widely from the price paid for it. Hence, it requires
Shadow Prices to denote the real value of a
resource to society.

L-M Numeraire is present uncommitted social

income.
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 The resources – inputs & outputs – of a project are
classified into mainly: Labor, Traded Goods & Non-traded Goods
Therefore, to find out the real value of these resources,
we should calculate –

Shadow Wage Rate (SWR)

The purpose of computing the SWR is to determine
the opportunity cost of employing an additional worker in
the project. For this we have to determine –
 The value of the output foregone due to the use of a unit
of labor
 The cost of additional consumption due to the transfer
of labor 33
Shadow price of Traded Goods
Shadow price of traded goods is simply its
border or international price.
 If a good is exported, its shadow price is its FOB price;
 If a good is imported, its shadow price is its CIF price.

Shadow price of Non-traded Goods

Non-traded goods are those which do not
enter into international trade by their very nature.
(e.g. land, building, transportation). Hence, no
border price is observable for them.
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Similarities between UNIDO & L-M Approach:
There is considerable similarity between the
UNIDO approach and the L-M approach. Both the
approaches call for:

 Calculation of Shadow Prices to reflect social

value.

 Usage of Discounted Cash Flow Techniques.

 Taking into account about the effect of a project on

savings, investment and income of a society.
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Differences between UNIDO & L-M Approach:
UNIDO Approach L-M Approach

Domestic currency is used International Price is used

as Numeraire as Numeraire
Consumption is the Uncommitted Social
measurement base Income is the
measurement base
SCBA objectives are met At one place all SCBA
through stage by stage objectives are fulfilled

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