1 10/12/03PP253/ARE253, Fall 2003 Alain de JanvryProject Appraisal for Developing CountriesI. Approaches to normative development1. Economic planningCentral planning (USSR)Indicative planning (France)National and State budgets (U.S.)Determine: tax revenues, government expenditures, public investment.Techniques: Input-Output analysis, Social Accounting Matrices, CGE models, macro models.2. Policy adviceStabilization policies. Determine: exchange rate, fiscal policy, monetary policy, wage and pricecontrol policies.Adjustment policies. Determine: trade liberalization, deregulation, privatization, tax reforms.Institutional reforms. Determine: property rights, land reform, regulatory policies, publicinstitutions, legal framework.Techniques: policy analysis for public policy advice, for public policy-making advice.3. Development projects and programs (public investments)Project cycle∑ Country strategy (special programming mission, country economists).∑ General identification of projects: broad options (special identification mission).∑ Specific identification∑ Project appraisal (ex-ante)Technical feasibility (engineering)Financial appraisal (at market prices): private willingness to accept the project.Economic appraisal (at shadow prices): true economic value of the project.Social appraisal (use of welfare weights to reflect distribution goals)Techniques: cost/benefit analysis, rapid appraisal∑ Project implementation (project in progress)Monitoring: revisions, closed-loop systems (experiments, learning, adjustments)Techniques:Logical framework (logframe): performance indicators at each stage of project.Public expenditure tracking surveys (PETS): accounting for expendituresParticipatory rapid appraisal (PRA)∑ Project evaluation and impact analysis (ex-post)Ex-post cost/benefit analysisCost/effectiveness (benefits measured in quantities instead of values)Impact analysis: attribution to the project of effects on indicators4. Management advicePublic sector advice (public administration)Private sector advice (consultants to firms): private investmentsII. Basic principles of project appraisal1. Discount rate and present value∑ Present value of a future income = How much can you borrow today against $100 of income next year ifthe interest rate is i ?Xi=+$1001 = present value of $100 next yearExamples: if i = 5%, X = $95if i = 10%, X = $91if i = 25%, X = $80i = discount rate = interest rate if perfect capital market = cost at which can borrow on the capitalmarket.d=+11 i = discount factorGeneral discounting formula: present value of a future value Ft obtained t years from now:PV F FFittttt()==+()d1Examples of present value of $100 of future income:Discountrate: i (%)Year0Year1Year2Year5Year10Year300 100 100 100 100 100 10010 100 91 83 62 39 625 100 80 64 33 11 0.1=10¢Environmental debate: “to discount or not to discount?”Environmentalists: No. Give full value to the future.Economists: Yes, but impose other constraints on calculus of costs and benefits as needed, e.g.,sustainability constraint: YYgeneration T+1 generation T≥Present value of a stream of future values Ft over n years: PV FFiFtttntttn()=+()===ÂÂ100dNote: Constant vs. time dependent discount rate:Hyperbolic discount rate: discount rate declines with time (decision-maker will become more farsighted in the future). Explains procrastination on decisions that imply immediate costs and delayedrewards, explains postponing actions.2. Criteria for project appraisalBt = benefit in year tCt = cost in year tRt = revenue in year t = BCtt-2.1. Net present value (NPV) criterionNPV RRiBCiBiCiPV B PV Cttttnttttntttntttn()=+()=-+()=+()-+()=()-()== ==ÂÂ ÂÂ111100 00Project rule: do the project if NPV > 02.2. Benefit-cost ratio (BCR) criterionBCRPV BPV CBiCitttntttn=()()=+()+()==ÂÂ11002 10/12/03Project rule: do the project if BCR > 12.3. Internal rate of return (IRR) criterionSolve NPV RBCitttttn()=-+()==Â100 for i = IRR. (i.e., IRR = i at which NPV = 0)Project rule: do the project if IRR > r (borrowing cost).Note: There can be multiple solutions to the IRR. Hence, should use both the IRR > r, and the NPV> 0 or BCR > 1 criteria.2.4. Comparison of projectsi) For a single project, the three criteria are identical to decide on doing or not the project.ii) For comparing projects: rankings based on the three criteria are not the same. Small projects may havevery high IRR, but very low NPV.If projects are mutually exclusive, use the NPV ranking as recognizes the scale of projects.If project are not exclusive, but there is a budget constraint K, use NPVK ranking as criterion (i.e.,rate of return on K).3. At what price to calculate NPV?3.1. Financial or commercial appraisal: private value of the project. Use market prices (e.g., wage paidto workers).3.2. Economic appraisal: social value of the project. Use shadow prices = social opportunity cost of theresources = return generated by these resources in the next best alternative to the project or foregone returnby drawing the resource away from that next best alternative.If perfect markets: shadow price = market priceIf price distortions: shadow price π market price. Sources of price distortions:Policy distortions: import tariffs, export taxes, subsidies, taxes, minimum wage, interest controls,price controls, fixed exchange rateInherent market failures: natural monopoly, externalities, transactions costs, public goods.Typical market distortions:i) Shadow e > official e (market e too low)Overvalued exchange rate due to:Inflation and lagged devaluationImport tariffs and quotas restricting demand for dollarsFixed overvalued e and unsustainable borrowingFixed overvalued e and foreign exchange quotasProjects that earn $ (increase exports) or save $ (reduce imports) are valued more at the shadow e than at themarket e. Hence, social logic = do more projects for import substitution or export earnings than underprivate logic.ii) Shadow w for unskilled labor < formal labor market w (market w too high)Overpriced labor due to:Minimum wage with unemploymentSubsistence wage with surplus laborEfficiency wage (internal labor market: equilibrium with unemployment)If there is unemployment, the shadow wage is 0 for unemployed labor categories.Projects that use unskilled labor are valued more at the shadow wage. Hence, social logic = do more laborintensive projects than under private logic..iii) Shadow r > official r due to credit
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