Lecture Notes

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• Lecture Notes
• ECON 437/837 ECONOMIC COST-BENEFIT ANALYSIS
• Lecture Nine

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• STAKEHOLDER
• IMPACTS
• OF PROJECTS

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Assess Stakeholder Impacts of Projects

• A comparison between economic and financial
  values tells us who wins and who loses from a
  specific project, i.e., the Stakeholders.

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• For Each Input and Output Variable
• Economic Financial S Stakeholder Impacts
• Example of a non-traded good with a sales tax
• Economic Value Financial Value
• Change in Government Tax Revenues
• Increase in Consumer Benefits
• Loss in Profits to other producers
• Taken over all variables and time periods of
  project (using a common discount rate)
• - NPV economic NPV financial S PV
  Stakeholder Impacts
• Note Stakeholder Impacts are often called
  externalities of project

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General Relationship

• NPVECOeco NPVFINeco ?PVEXTeco

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Stakeholder Analysis is composed of six distinct
steps

• Identify the externalities.
• Measure the net impact of the externalities in
  each market as the real economic values of
  resource flows less the real financial values of
  resource flows.
• 3. Measure the values of the various
  externalities throughout the life of the project
  and calculate their present values by using the
  economic discount rate.

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Stakeholder Analysis is composed of six distinct
steps (contd)

• Allocate the externalities across the various
  stakeholders of the project.
• Summarize the distribution of the projects
  externalities and net benefits according to the
  key stakeholders in society.
• 6. Reconcile the economic and financial resource
  flow statements with the distributional impacts.

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Financial, Economic and Distributive Effects of
Project to Supply Non-Tradable Goods with No
Distortions
Financial Value of Output QsCBQd or P1 (Qd
-Qs) Economic Value of Output
QsCABQd Difference (Economic - Financial)
CAB CAB P1P0AB -P1P0AC Gain in Consumer
Surplus - Loss in Producer Surplus Economic Value
Financial Value Gain in Consumer Surplus -
Loss in Producer Surplus Financial
Value Distributive Impacts
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Financial, Economic and Distributive Effects of
Project to Supply Non-Tradable Goods with Unit
Tax
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Measuring Distributive Impact from Financial and
Economic Values of Inputs with Tariffs
Financial Cost of Importable Goods
Qd1CFQd2 Economic Cost of Importable Goods
Qd1GHQd21(Ee/Em - 1) where (Ee/Em - 1)
Foreign Exchange Premium (FEP) Financial Cost -
Economic Cost GCFH Qd1GHQd2(Ee/Em - 1)
Gain in Tariff Revenues to Government Loss in
Government Revenues due to foreign exchange
premium on additional use of foreign exchange
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Examples

• Who benefits from worker transportation?
• Why was the Makar Port built?

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Workers Transportation Case

• Basic Facts
• Factory currently employs 20 workers. These
  workers take taxis every day at a cost of 1.00.
• Factory wants to employ 40 workers, but can not
  recruit any additional worker without either
  subsidizing transportation or paying higher
  wages.
• The proposal is to buy a bus for a total of
  25,000 including 5,000 of import tariff. The
  bus is expected to have a value of 10,000 in
  year 5.
• The bus will operate for 250 days per year.
• The charge per person/day on the bus will be 40
  cents.
• A driver will be hired to operate and maintain
  the bus at a wage of 10.00 per day.
• The cost of oil and gas will be 2.00 per day.
• The spare parts bill is expected to be 100 per
  year.
• No income taxes are levied on the income of
  public enterprise.

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Workers Transportation Case (contd)

• The economic opportunity cost of employing the
  driver is equal to approximately 80 of his wage.
• The conversion factor for oil and gas is
  estimated to be 0.60 because of the high taxes
  imposed on their purchase price.
• Spare parts have a tariff and taxes on them that
  are equal to 25 percent of their CIF price. Thus,
  the spare parts conversion factor is equal to
  0.80.
• The ratio of the economic exchange rate to the
  market exchange rate is equal to 1.
• The financial discount rate is equal to 6, and
  the economic discount rate is equal to 10.

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Workers Transportation Case (contd)
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Measurement of Economic Benefits
Financial Revenue/person/day 0.40 Economic
Benefits/person/day (201.020(10.40)
/2/40 0.85 Conversion Factor 0.85/0.40
2.125
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Workers Transportation Case (contd)
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Table 3 Distribution of Net Benefits of the
Externalities to Stakeholders
Workers Transportation Case (contd)
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Port Rehabilitation and Expansion The Makar
Port Project in the Philippines

• Basic Facts
• Makar Port, located in General Santos City at the
  northern side of Sarangani Bay, a well-protected
  bay in Mindanao, lies along the main north-south
  trading axis which skirts Mindanao on its western
  shore.
• The objectives of the project are to increase the
  capacity and improve the efficiency of cargo
  handling facilities at the port to accommodate
  future flows.
• The project will cost approximately 635 million
  pesos (about US23.5 million).
• 75 of the total project cost will be provided as
  a grant by the US Agency for International
  Development (USAID) and the other 25 will be
  provided from counterpart contribution by the
  Philippine government.

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Port Rehabilitation and Expansion The Makar
Port Project (contd)

• Project Outcome (with Project)
• Deterministic case appeared good with partial
  financial analysis
• - NPV Financial (with Project) 10.76 million
  pesos
• Analysis shows project provide a negative
  economic performance (-105.58 million pesos)
• Project was implemented

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Port Rehabilitation and Expansion The Makar
Port Project (Contd) Incremental
Financial-Economic Analysis
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Economic Benefits of the Makar Port Project

• Additional port revenue from expansion in traffic
  including foreign exchange premium.
• Additional rental income from containers yards.
• Reduction in waiting time of ships.
• Reduction in animal weight loss from waiting on
  ship.

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Stakeholder Analysis

• Key Question
• Why was this BAD project implemented?
• The Philippines wasted 131.3 million pesos in
  order to transfer income to a few
  ship-owners/shippers.

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• BASIC NEEDS
• ANALYSIS

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Basic Needs Appraisal

1. Financial analysis considers the views of all
   those who have a financial interest in the
   project owners, buyers, sellers.
2. Normally the economic appraisal evaluates
   additional consumption by the demanders
   willingness to pay, and any displacement of other
   suppliers by the economic value of resources
   saved by these suppliers.
3. The attainment of the basic needs of poorer
   members of the community may also generate an
   increase in the total satisfaction of other
   better off members of the community.
4. This public good externality needs to be included
   in the benefits of investments that lead to
   satisfying of the basic needs by disadvantaged
   members of the community.

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Hierarchy of Minimum Basic Needs

• Survival Needs food and nutrition, health, water
  and sanitation, and clothing
• Security Needs shelter, peace, income,
  employment
• Enabling Needs basic education and literacy,
  family care and psychosocial needs

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Basic Needs Externality Approach

• This is a practical approach for evaluating
  community wide externalities arising from the
  increased level of basic needs achievement by the
  less fortunate members of society.
• Basic needs externality (BNE) approach was
  introduced by Harberger (1984) to measure this
  social dimension of a project.
• The rationale for BNE approach is not just that
  the poor should have more income, but that they
  should have better nutrition, medical care,
  housing, education, etc.

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Figure 1 Basic Needs Externalities Associated
With Each Decile of Poor
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Figure 2 Basic Need Externality Caused by
Project Lowering Cost of Service(Example
Potable Water Project Lowers Coping Cost)
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Figure 3 Basic Needs Externality Caused by
Increased Demand due to the Income Effect of an
Investment Project
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• An Application of Basic Needs Externality
  Estimation
• Olifants-Sand Water Transfer Scheme
• Basic Facts
• The project considered here is Olifants-Sand
  Water Transfer Scheme, which can be best
  described as a regional bulk water supply system.
  
• It includes a raising of the existing Flag
  Boshielo (Arabie) dam by 5 meters, construction
  of the Rooipoort dam and the construction of the
  Water Transfer Scheme from Rooipoort to Polokwane
  via Lebowakgomo.
• The region affected is the Sekhukhune Cross
  Border District of Limpopo Province.
• This region has an unemployment rate of
  approximately 68, compared to the average of 46
  in Limpopo Province.
• Only about 40 of the households have access to
  the minimum water supply for drinking, cooking
  and critical hygiene of 25 liters per capita a
  day (l/c/d), which is set by the Reconstruction
  and Development Program of the National
  Government of South Africa.

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Olifants-Sand Water Transfer Scheme

• The economic analysis indicates that the project
  has a highly positive NPV.
• In the analysis of the basic needs externality,
  focus is on the improved availability of water
  and the incomes of the poorest households
  affected by the project, namely the rural
  communities.
• We assume that the health impact of consuming
  more clean water is primary due to its use for
  drinking, cooking and critical hygiene.
• The increased availability of potable water is
  accompanied by a dramatic fall in the costs of
  water for reasons that has an impact on health,
  thereby causing the total amount of consumption
  for these purposes to increase.
• With the present very low volumes of water
  consumption, it is estimated that approximately
  80 percent of the incremental potable water
  provided to poor households by the project would
  be used for drinking, cooking and critical
  hygiene.

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Present Value of Basic Needs Externality from
Increased Consumption of Water by Poor due to
Lower Prices
Types of Consumer PV of volume of increased water consumption (million cubic meters)b PV of Externality (Millions of Rand)
Olifants Rural Centersa 52.66 80.04
Lebalelo Rural 15.65 23.79
Total (Poor communities with water shortages) 68.31 (20.77 of Total Demand) 103.83
Note The poor are defined as those in the
bottom 40 percent of the income distribution. The
two rural communities included in this analysis
fall well below this threshold. aProportion of
total increment water used for drinking, cooking
and critical hygiene 80. The economic cost of
supply is estimated to be equal to R1.9 per M3.
Value of basic needs externality of target
consumption for Olifants Rural can be estimated
as R1.952.660.80 m. bThe water volumes are
taken from the demand analysis of Cambridge
Resources International, Evaluation of the
Olifants-Sand WaterTransfer Scheme in the Limpopo
Province of South Africa, Cambridge, MA, (2004).
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Stakeholder Impacts on Earnings of the
Olifants-Sand Water Transfer Scheme in the
Northern Province of South Africa
Stakeholder Present Value of Impact (millions of Rand)
Lebowakgomo Area 74.0
Rural Users 338.7
Mining 271.7
Polokwane 26.6
Irrigation 77.0
Labor 13.2
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Basic Needs Externality from Improved Housing,
Nutrition, Health, Education of Poor from
Increased Real Income
Stakeholder Value of Impact (millions of Rand)(1) Basic needs externality 30 premium(2)
Rural Areas Usersa 338.7 76.21
Laborb 10.56 2.38
Total 423.26 78.59
Note The poor are defined as those in the
bottom 40 percent of the income
distribution. aPoor receive 100 of income
change proportion of income spent on basic needs
75 basic needs externality 30 of value of
additional private expenditures on basic
needs. bPoor receive 80 (suppose 80 are the
unskilled labor) of income change proportion of
income spent on basic needs 75 basic needs
externality 30 of value of additional private
expenditures on basic needs.
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Importance of Basic Needs Externalities
Present Value (Millions of Rand)
PV basic needs externality due to price effect 103.83
PV basic needs externality due to income effect 78.59
Total basic needs externality 182.42
PV total cost of project 714.1
Ratio of basic needs externality to total investment costs 25.55
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Magnitude of Government Assistance

• NPV of the net economic benefits of a private
  sector project is positive.
• NPV of the net financial cash flow is negative.
  However, the government may want to assist the
  project since its positive economic NPV will
  increase the well-being of all people in society.
• The government should offer the project the
  smaller amount required for the project to be
  undertaken or the value of the positive net
  economic externalities generated by the project.

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ECONOMIC ASPECTS OF FOREIGN FINANCING
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Questions to be addressed

• At the project level, how do we account for the
  economic cost of foreign financing?
• A. Case where all financing is incremental.
• B. Case where all financing is non-incremental.

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Marginal Economic Cost Of Foreign Financing
Negative externality from foreign financing
ABCD
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• MC Marginal economic cost of funds
• rf real cost of foreign financing
• tw effective withholding tax rate
• ? ratio of total foreign debt whose interest
  rate is responsive to changes in the current
  amount of foreign borrowing to total stock of
  foreign financing
• ?fs the supply elasticity of foreign funds to a
  country with respect to the cost of funds the
  country pays for its foreign financing

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Incremental Foreign Investment

• In an open economy, the net economic benefits
  from the project are going to be shared by
• the government (g)
• other residents of the country (p)
• foreigners (f)
• The NPV of an investment project, using the
  economic cost of funds, can be expressed as
• NPVe Bg Bp Bf Cg Cp Cf
• If the project financed from foreign sources is
  entirely incremental, the net benefits of the
  project accrued to the host country will be
• NPVe host NPVe (1?)(Cf Bf)
• where ? stands for the foreign exchange premium.

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Non-Incremental Foreign Investment

• When none of the foreign investment is
  incremental to the host country, the opportunity
  cost of the investment for the foreigners is the
  stream of benefits that they would have received
  from the alternative investment forgone.
• Let the stream of dividends, interest and loan
  repayments, discounted at the EOCK that actually
  flows from the project to foreigners be (Bft),
  t0.n
• Let the stream of benefits that foreigner would
  have been paid by the alternative investments
  within the host country if this project not
  undertaken be (Baft), t0.n.
• Thus, the net cost to the host country will be
  measure by Bft - Baft.

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Non-Incremental Foreign Investment (contd)

• We can estimate parameter Z, which is the the
  ratio of the present value (discounted at rf )
  of the stream of foreign equity and debt invested
  in the project to the present value of the actual
  stream of the foreign dividends, debt repayment
  and interest received.
• rf refers to the normal rate of return to the
  total foreign capital in the host country.

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Non-Incremental Foreign Investment (contd)

• PV (foreign equity foreign debt) at rf discount
  rate

• If Z 1, the foreign investment owners will
  receive a normal return (rf).
• If Z gt 1, then foreigners would be earning less
  than a rf return by investing in the project.
• If Z lt 1, then foreigners would be earning more
  than a rf real return.

Z
PV (foreign dividend foreign interest foreign
repayment) for project at rf discount rate
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Non-Incremental Foreign Investment (contd)

• By multiplying this ratio (Z) by the actual
  stream of dividends, debt repayment, and interest
  received by foreigners from the project, we can
  estimate the stream of payments to foreigners
  that is sufficient to generate a normal rate of
  return to the foreigners. Baft (Z)(Bft), t0n.
  Thus, the stream of additional economic costs
  created by foreign financing is Eft (Bft
  Baft), t0,1,..
• The total adjustment is to subtract (1?)PV(Ef)
  using the economic opportunity cost of capital as
  the discount rate.
• NPVe host NPVe (1 ?)PV(Ef)

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Financial NPV of Utility to Percentage Change in
Tariff Structure A case in Panama

• Tariff Structure FNPV_at_15 (000 Balboas)
• -40 -2,058
• -25 27,999
• -20 37,229
• -15 46,066
• -10 54,508
• -5 62,556
• 0 70,210
• 5 77,470
• 10 84,336
• Z .1242, PV(Ef) _at_9.3 -142,109

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Sensitivity of Economic NPV to Change in Water
Tariffs
Change in Water Tariffs (percent) Economic NPV (B thousands)
-15 53,658
-10 45,766
-5 37,495
0 28,845
5 19,815
10 10,406
15 618
20 -9,549
NPV econ _at_ 9.3 10,406

• If accounting for foreign financing, then the
  Economic NPV 10,406 142,109 - 131,703

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Stakeholder Analysis without taking account of
foreign financing
Pe Pf SEi NPVee NPVfe SPVe (EXTi)
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Project Net Benefits without Accounting for
Foreign Financing (thousand Balboas)
Metered
Metered Customers (unmetered with 24-hour
supply w/o project)
Commercial Industrial Customers
Government
Customers

(also w/o
project)
NPV Externalities
-24,260
-18,227
-9,486
- 1,568
Economic _at_d.r. 9.3
Unmetered
Metered Customers (unmetered with intermittent
water and cope with tanks w/o project)
Metered Customers (unmetered with intermittent
water and dont cope with tanks w/o project)
Non-revenue consumers w/o project
Customers



W/ o project
NPV Externalities
-2,244
5,594
-107,258
27,678
Economic _at_d.r. 9.3
SUM EXT. -129,772

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Stakeholder Analysis with Taking Account of
Foreign Financing
Pe Pf SEi NPVee NPVfe SPVe (EXTi)
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Project Net benefits with Accounting for Foreign
Financing (thousand Balboas)
Metered
Metered Customers (unmetered with 24-hour
supply w/o project)
Commercial Industrial Customers
Government
Customers

(also w/o
project)
NPV Externalities
-24,260
-18,227
-9,486
- 1,568
Economic _at_d.r. 9.3
Unmetered
Metered Customers (unmetered with intermittent
water and cope with tanks w/o project)
Metered Customers (unmetered with intermittent
water and dont cope with tanks w/o project)
Loss to Economy from foreign financing
Non-revenue consumers w/o project
Customers




W/ o project
NPV Externalities
-2,244
-142,109
5,594
-107,258
27,678
Economic _at_d.r. 9.3
SUM EXT. -271,881

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Concluding Remarks

• In the vast majority of cases, a project that is
  being financed from foreign sources will be
  simply reallocating the total amount of foreign
  investment available to the country.
• Public-Private partnerships that are carried out
  either through non-arms-length arrangements or by
  suboptimal risk management will generate either
  large wealth transfers or payments to foreign
  entities.

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Concluding Remarks (contd)

• Such transfers to foreigners are always an
  economic cost, but if a necessary compensation
  for special risks associated with the foreign
  financing they are an economic cost to host
  country.
• Guarantees that are provided by the government to
  domestic investors may alter behavior and help or
  hurt a project.
• Triggering of the guarantee is essentially a
  transfer from the government to the domestic or
  foreign financial institutions. In case of
  foreign investment it is guaranteeing the value
  of the economic cost of the investment.