Answer
The essence of the theory of social cost-benefit analysis is that it does not accept that the actual receipts of a project adequately measure social benefits and actual expenditures measure social costs. The reason is that actual prices may be an inadequate indicator of economic benefits and costs. For example, in developing countries like India, the prices of necessities are set low, despite their economic importance, while the prices of less essential goods are set high (through a system of taxes and duties). As a result, some projects which appear very profitable when their outputs and inputs are valued at actual prices are, in fact, unattractive from the viewpoint of the national economy, while other apparently unprofitable projects have high economic returns. But the theory accepts that actual receipts and expenditures can be suitably adjusted so that the difference between them, closely analogous to ordinary profit, will properly reflect the social gain.
In Social-Cost Benefit Analysis (SCBA) the focus is on social costs and benefits of a project. These often tend to differ from the costs incurred in monetary terms and benefits earned in monetary terms by the project. The principal reasons for discrepancy are:
- Market imperfections: Market prices, which form the basis for computing the monetary costs and benefits from the point of view of project sponsor, reflect social values only under conditions of perfect competition, which are rarely, if ever, realized by developing countries. When imperfections obtain, market prices do not reflect social values.
The common market imperfections found in developing countries are: (i) rationing, (ii) prescription of minimum wage rates, and (iii) foreign exchange regulation. Rationing of a commodity means control over its price and distribution. The price paid by a consumer under rationing is often significantly less than the price that would prevail in a competitive market. When minimum wage rates are prescribed, the wages paid to labour are usually more than what the wages would be in a competitive labour market free from such wage legislations. The official rate of foreign exchange in most of the developing countries, which exercise close regulation over foreign exchange, is typically less than the rate that would prevail in the absence of foreign exchange regulation. This is why foreign exchange usually commands premium in unofficial transactions.
- Externalities: A project may have beneficial external effects. For example, it may create certain infrastructural facilities like roads which benefit the neighbouring areas. Such benefits are considered in SCBA, though they are ignored in assessing the monetary benefits to the project sponsors because they do not receive any monetary compensation from those who enjoy this external benefit created by the project. Likewise, a project may have a harmful external effect like environmental pollution. In SCBA, the cost of such environmental pollution is relevant, though the project sponsors do not incur any monetary costs.
It may be emphasized that externalities are relevant in SCBA because in such analysis all costs and benefits, irrespective to whom they accrue and whether they are paid for or not, are relevant.
- Taxes and subsidies: From the private point of view, taxes are definite monetary costs and subsidies are definite monetary gains. From the social point of view, however, taxes and subsidies are generally regarded as transfer payments and hence considered irrelevant.
- Concern for savings: Unconcerned about how its benefits are divided between consumption and savings, a private firm does not put differential valuation on savings and consumption. From a social point of view, however, the division of benefits between consumption and savings (which leads to investment) is relevant particularly in capital-scarce developing countries. A rupee of benefits saved is deemed more valuable than a rupee of benefits consumed. The concern of society for savings and investment is duly reflected in SCBA wherein a higher valuation is placed on savings and lower valuation is put on consumption.
- Concern for redistribution: A private firm does not bother how its benefits are distributed across various groups in the society. The society, however, is concerned about the distribution of benefits across different groups. A rupee of benefit going to a poor section is considered more valuable than a rupee of benefit going to an affluent section.
- 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 adult education or a balanced nutrition programme for school-going children even though these are not sought by consumers in the market place. While merit wants are not relevant from the private point of view, they are important from the social point of view.
