COST-BENEFIT ANALYSIS FOR INVESTMENT DECISIONS, CHAPTER 1: THE INTEGRATED ANALYSIS OF INVESMENT PROJECTS Glenn P. Jenkins Queen’s University, Kingston, Canada and Eastern Mediterranean University, North Cyprus Chun-Yan Kuo Queen’s University, Kingston, Canada Arnold C. Harberger University of California, Los Angeles, USA Development Discussion Paper: 2011-1 ABSTRACT The goal of a proper project evaluation is to stop bad projects and to prevent good projects from being rejected. This book on Cost-Benefit Analysis for Investment Decisions is aimed at helping public officials and private analysts develop and evaluate investment projects to promote economic and social well-being of the country in question.
The book proceeds from the formulation and definition of a project to the data requirements for an evaluation, then to the criteria used for accepting a good or rejecting a bad project from both the financial and the economic viewpoints, and finally to the analysis and management of many types of uncertainty faced by various stakeholders. These components are integrated into the analysis in a consistent manner. This chapter contains an overview of the book and of the components of such an integrated appraisal. The forward, table of contents and preface of the book are included with chapter 1.
To be Published as: Jenkins G. Harberger, “The Integrated Analysis” Chapter 1, Cost-Benefit Analysis for Investment Decisions. (2011 Manuscript) JEL code(s): H43 Keywords: Integrated Analysis, Project Definition, Project Cycle COST-BENEFIT ANALYSIS FOR INVESTMENT DECISIONS By Glenn P. Jenkins Queen’s University, Kingston, Canada and Eastern Mediterranean University, North Cyprus Chun-Yan Kuo Queen’s University, Kingston, Canada Arnold C.
Harberger University of California, Los Angeles, USA August 2011 © Copyrighted: Glenn P. Jenkins, Chun-Yan Kuo and Arnold C. Harberger COST-BENEFIT ANALYSIS FOR INVESTMENT DECISIONS ABOUT THE AUTHORS Dr. Jenkins Professor of Economics, Queen's University, Canada & Eastern Mediterranean University, Institute Fellow Emeritus, Harvard University He founded the Program on Investment Appraisal and Management at Harvard University, and was its Director from 1985 to 2000.
Since 2000 he has been the Director of the Program of Investment Appraisal and Risk Analysis, at Queen’s University, Canada. He has conducted numerous seminars and courses on this subject for governments, private organizations and for professional staff of major international organizations. His research and advisory work has been primarily in the area of public finance. He has been Assistant Deputy Minister of Finance, Government of Canada (1981-84) and President of the Society for Benefit Cost Analysis (2011) Dr.
Chun-Yan Kuo Senior Fellow, John Deutsch International, and Adjunct Professor of Cost Benefit Analysis Queen’s University, Canada He is a leading author and practitioner in the field of the project appraisal. He has served as an advisor to a wide range of developed and developing countries. He has held senior positions with the Department of Finance, Government of Canada, The International Program, Harvard University and was the National Science Council Visiting Professor, National Chiao Tung University, Taiwan, (2004 -5). In 2007 he was one of the experts who prepared the Cost Benefit Analysis Guidelines: Regulatory Proposals for the Treasury Board of the Federal Government of Canada.
Harberger Professor of Economics, University of California, Los Angeles and Gustavus F. Swift Distinguished Service Professor Emeritus, University of Chicago He is one of the pioneering academicians and professionals in this field. His writings have formed the analytical principles found in the state-of-the-art methodology for applied investment appraisal. He has acted as an economic consultant to many governments and international agencies including serving as the Chief Economic Advisor to USAID for the period 2005-2010.
He is a Member: National Academy of Sciences of the U., Fellow: American Academy of Arts and Sciences, Fellow: Econometric Society, President: Western Economic Association (1989-90), Vice President: American Economic Association (elected for 1992) President: American Economic Association, 1997, Distinguished Fellow: American Economic Association, 1999 FOREWORD Few published works have histories as long or as convoluted as this book. It all began with the awakening of my interest in cost-benefit analysis and applied welfare economics during my own graduate studies (1946-49) at the University of Chicago. This interest was nurtured by work in Latin America (starting in 1955) sponsored by USAID and its predecessor ICA, and in India starting in 1961-62 under the sponsorship of MIT’s Center for International Studies in collaboration with India’s cabinet-level Planning Commission. Out of these experiences came a series of professional papers which formed the background of a graduate course in Project Evaluation at the University of Chicago starting in 1965.
Many of these papers were collected in my book, Project Evaluation, first published in 1972 and currently available as a Midway Reprint from the University of Chicago Press. Jenkins took that course as a graduate student, and almost immediately began to put it to practical use. Even while still a graduate student he consulted on these matters with branches of the government in his native Canada. He continued these Canadian exercises during his appointment as Assistant Professor of Economics at Harvard University, culminating in a year of leave from Harvard, working with the Canadian Government’s Ministry of Industry, Trade, and Commerce and its Department of Regional Economic Expansion.
Chun-Yan Kuo was a member of the team which evaluated a number of important Canadian government projects at that time. I, too, was involved with these Canadian entities at that time and subsequently, but in the meantime was also accumulating cost-benefit experience in Colombia, Panama, the Philippines, Spain and Uruguay, as well as at the World Bank where I served steadily with its i teaching arm, the Economic Development Institute, from 1962 through the 1960s and most of the 1970s. Professor Jenkins’s Harvard appointment evolved into a senior position with the Harvard Institute for International Development. His first foreign assignment in this role was to Malaysia, where his first task was to give a full-length course in economic project appraisal, under the sponsorship of the National Institute for Public Administration and the Economic Planning Unit of the prime minister’s office.
This course was very well received, so much so that Jenkins was asked to develop a manual on the subject, following the main lines of that course. It was in the resulting monograph that my name first appeared, placed there by Jenkins in an act of pure kindness, recognizing the role of my Chicago graduate course in the development of his own subsequent thinking. In the mid-1980s the resulting manuscript began to be used as the main text of an intensive summer course (for participants from developing countries) that HIID offered, under Professor Jenkins’s direction. Our separate collaborations with the Canadian government continued, nearly always dealing with project evaluation and often overlapping (i., with the two of us working jointly on a given problem).
This phase of our work reached something of a climax when Jenkins was appointed Assistant Deputy Minister (ADM) of Finance in Canada’s government, a post he held from 1981 to 1984. During this period I consulted regularly with the Department of Finance as well as with other branches of the Canadian government. In some of these activities, Kuo, then a senior Department of Finance official, also collaborated. It was in this period that I first learned that I had been (since 1977) the co-author of this manual.
And it was here that I first began to actually participate in successive revisions of and additions to the book’s text. On completing his service as ADM, Professor Jenkins returned to Harvard, and soon started the HIID course ii referred to above. I ended up making brief appearances in this course every single year. More important, perhaps, was a tradition that developed of my staying on for a week or so after each of these visits, in order to work jointly with Professor Jenkins, continuously editing and updating one part or another of the book.
Out of these sessions, and of other work that each of us was doing in other contexts and/or under other auspices, many new ideas were incorporated as time went by. Among them were the analyses connected with distributional weights, the concept of basic needs externalities, the formalization of stakeholder analysis and the introduction of the notion of a shadow price of government funds. Perhaps the story of one such new idea is worth telling in detail. Around 1998 Professor Jenkins, Kuo and I were contracted by the World Bank and the bi-national commission in charge of the project to undertake a certain component of the research needed for the evaluation of a major bridge project, a planned linkage of Argentina and Uruguay, across the Rio de la Plata, going between the cities of Buenos Aires and Colonia.
Our job was to advise concerning the so- called “national parameters” of the two countries. What were the relevant opportunity costs of capital in Argentina and Uruguay? What about the corresponding opportunity costs of foreign exchange? And, finally, of labor? It was in pursuing the economic opportunity cost of foreign exchange that we ran into a snag. The almost-standard way of handling this question seemed straightforward enough. The project authority was assumed to go into the foreign exchange market and buy the necessary divisas (say, dollars) using local currency (say, pesos).
As we pursued this standard model in one of our post-course sessions in Cambridge, we found that it was not consistent with a full general equilibrium of the economy. The new demand for foreign exchange was assumed to arise because of an increased demand for tradable goods. As a result the real price of the dollar would rise, and with it the price level of tradables. Hence the supply iii of tradables would increase.
But the rise in the price level of tradables would stimulate the demand for nontradables, the output of which would then also increase. Increases in the output of both tradables and nontradables did not jibe with economic theory (except under conditions of recession or depression) so something was wrong. As we tried to resolve this paradox, we found that the “standard” analysis suffered from a missing link. It did not incorporate the way in which the pesos were raised, which were then to be spent on tradables.
The raising of these pesos (presumably in the capital market) would displace both consumption and investment, and hence reduce the demand for both tradables and nontradables. Starting from this reduced demand for both, one could then contemplate the demand for both of these aggregates increasing, thus resolving our paradox. No paradox was present in both tradables and nontradables increasing if we measured these moves from a position where both had been reduced from their starting position. This end result laid bare the fact that the whole idea of an economic opportunity cost of foreign exchange was not a stand- alone concept.
This concept had a natural and unavoidable twin, which we called the shadow price of nontradables outlays, and which we from that point on built into our book’s analysis.1 This concept captured the economic costs involved when money was raised in the capital market and spent on nontradable goods or services. It performed exactly the same function as the economic opportunity cost of foreign exchange, differing only in that it traced a scenario where the spending was on nontradables rather than tradables. 1 There had been earlier writings which sensed the underlying problem, but none in which its solution was fully developed. See Blitzer, Dasgupta and Stiglitz (1981) and Jenkins and Kuo (1985).
The joint work outlined above is described in detail in Harberger & Jenkins (eds.) Cost- Benefit Analysis (“Introduction,” pp. See also Harberger, Jenkins, Kuo and Mphahelele, “The Economic Cost of Foreign Exchange in South Africa,” South Africa Journal of Economics, 2004 and Harberger “Some Recent Advances in Economic Project Evaluation,” Cuadernos de Economia, 2003 (v. iv The evolution of the book continued, but it was occurring too slowly, even for our own satisfaction. This led to our inviting Chun-Yan (George) Kuo to join us as a third co-author.