Social Pricing, Distribution and the Public Sector^

In what follows, an outline of the general convention for the inclusion of income distribution in project selection is provided. The manner in which this aspect of the analysis can be brought into the standard appraisal methods is also briefly discussed.

If income distribution is ignored, an increase in real resources (E) to the economy might be considered an adequate measure of project benefits. But if income distributional consideration are to be taken into account, the determination of resource distribution is required and the resources that accrue to each group in a society are weighted in conformity with an appropriate social welfare function and summed to give a measure of the project's social worth.

It should be noted that financial benefits accrue either to the public or the private sector and within the latter, they accrue either to the rich or poor. For instance, as a result of the project, private sector benefits are increased by C and this increase is wholly allocated to consumption. The financial measure of the increased consumption C is then adjusted by

3 given the prevailing distortion in both the product and factor markets

of LDCs • The real value of private sectors consumption increase becomes

C3 while that of the public sector,which retains control over the remainder becomes E - C3-

Furthermore, given that the increase in social welfare resulting from a marginal increase in the availability of real resource and increased consumption to the particular private sector income group are Wg and W < ,

respectively, the 'net social benefits' (NSB) of a project is expressed as:

NSB = (E -

c3)

where

E = net economic (efficiency) benefits;

C = project financial benefits to the private sector;

3 = summary consumption conversion factor;

Wg = marginal social value of foreign exchange in the public sector; and

Wc = marginal social value of private sector consumption accruing to the particular income group.'*"

Following the numeraire adopted in the methodology, (E - C|3) is assigned a weight of unity by dividing the above equation throughout by Wg. Expressed in the chosen numeraire, the net social benefits become:

NSB* = (E - C3) + CO) (2.06)

where

NSB* = net social benefits in terms of public income at world prices; and

Wc

00 = — = social welfare from increased private sector

Wg ^

consumption.

Thus, a unit of private consumption expressed in domestic prices C has to be revalued by oo to express it in the numeraire. Finally, to

1 Wg is defined for real resources while Wc is defined for

consumption at market prices. This reflects the fact that the

public sector is concerned primarily with increases in real resources, whereas the private sector derives its utility from consumption

distinguish between efficiency and social benefits, equation (2.06) is rewritten as: NSB* = E - C (3 - 03) Net social benefits Net efficiency -

Net social cost of increased benefits ■w — private sector consumption - — (2.07)

Having considered both the growth and equity objective simultaneously in the above equation, the derivation of 3, w and related social value

parameters is dealt with in the subsequent sub-sections of the chapter.

2.1.4.1 Consumption Conversion Factor^ (3)

The value of 3 is determined by estimating the increase in the

value of consumption of domestic prices if one more unit of foreign exchange is committed to consumption. Where practical, a different 3 is estimated for each income group as different income groups may have markedly different consumption patterns with respect to the differential pattern of relative border/domestic prices arising from trade taxes, subsidies and

quantitative restrictions. A separate 3 for rich and poor income groups may, however, be sufficient in practice.

2

2.1.4.2 Social Value of Private Consumption (^ )

The social value of private consumption (oo) is a measure of the value of a marginal increase in private consumption, Wc (measured at domestic prices) in terms of the value of public income, Wg (measured

1 See SVT (1975, pp. 58-59)

at border prices). It can be expressed as:

00 = — (2.0 8)

Wg

where U) = value of private sector consumption at consumption level c relative to the numeraire;

Wc = marginal social value of private sector consumption at consumption level c; and

Wg = marginal social value of foreign exchange in the public sector.

Values of Wc and Wg may be directly estimated, however the methodology oroposes the estimation of the parameter in two stages for purposes of convenience. First, with respect to W c , the marginal

social value or simply the social welfare value of private consumption at consumption level c and is related to the welfare of someone at the

average level of consumption W c ; that is:

where d = value of private sector consumption at consumption level c relative to that at the average level of consumption c;

Wc,Wc = as defined above.

To put it in another way, a marginal increase in consumption (at domestic prices) accruing to someone having a consumption of c is worth d times as much as a marginal increase in consumption accruing to someone at the average level of consumption (c).

The second stage in deriving go is to define the value of a marginal increase in public income measured in free foreign exchange

(Wg) divided by the value of a marginal increase in consumption at domestic prices to someone at the average level of consumption (WO), i.e.,

v = Wg/Wb (2.10)

where v = value of the numeraire relative to private sector