where v = value of public income Social Wage Rate

The social wage rate (SWR) differs from the EWR in that a further element of 'cost' to society of using labor on the project must be

included. Adjustments have to be made for other attendant factors such as disutility of effort and migration effect.^ The term 'social' in this context also underlies the necessity of explicitly taking into account the two 'subjective' parameters for valuation of SWR, i.e., inter­ temporal and intra-temporal distributional parameters.

For instance, project employment in most cases provides high wages, especially if the source is unskilled rural labor. Depending on whether the worker saves little or none of his income, the increased consumption involved could either be a cost or a benefit or both from the standpoint of the objectives. Furthermore, the increased effort called for in the new job may drive people to prefer unemployment and such circumstances will tend to adjust the social wage rate relative to the economic wage.

1 It has traditionally been assumed that in labor-surplus economies,

additional demand for labor anywhere in the economy will ultimately be met by drawing upon the 'surplus' labor in agriculture, and hence the flow of labor is assumed to be from the rural to the other

sectors. This simplifying assumption is overshadowed by Scott's assumption that part of the increase in demand for labor of type j is met from within the industry using that type of labor by bidding up its wages. This complication is analyzed by him in M.FG. Scott, J.D. MacArthur and D.M.G. Newberry: Project Appraisal in Practice:

The Little Mirrlees Method Applied in Kenya, (London, Heinemann,


The desire for an improvement in income distribution encourages present employment of labor from the low income group against future

consumption and employment promised by growth. While there may be opposing adjustments in estimating shadow wage rates when growth and equity are considered, the contradiction is deliberate as what is needed is to trade-off the social costs against the social benefits of increased cons u m p t i o n .

The LM/ST methodology considers the case of an unskilled worker being drawn from a perfect labor market into employment that

pays a fixed wage, w in the derivation of a formula for social wage

rate. This, however, does not preclude the fact that wage varies consider­ ably according to skill, location and the general operation of the

relevant labor market. Despite these variations, the formula has a fairly wide application, thus:

SWR = m.a (w-m) (3 - d/v) + (w-m) cf»e d/v2 (2.25) where ma w m e <P (w-m)

= EWR as earlier defined in section = wage rate in project employment

= foregone marginal product

= ratio of the private value of foregone leisure to the market value of increased consumption

= ratio of the social value to the private evaluation of the disutility of effort; and

= increase in consumption (in market p r i c e s ) .

The quantity (w-m) is multiplied by 3 to express in terms of foregone

(j)e d/v to reflect the social value of increased consumption and the social cost of reduced leisure. Social Accounting Rate of Interest (SARI)

The 'social, accounting rate of interest' (SARI) is treated as a rationing device along similar lines suggested for the EARI. The main difference is that SARI allows for the distributional impact of public investment on the private sector. Thus,

SARI = qa - h (2.26)

where qa = marginal product of capital at border prices; h = distributional impact of public investment on

private sector consumption,


h = (l-s)q (l-l/v3). (2.27)

Substituting equation 2.27 into equation 2.26, SARI can finally be written as:

SARI = sq + (1-s) q/v3 (2.28)

wherein q is brokendown into its private consumption and savings element and the former is in turn revalued in terms of public income by dividing by v, the social value of public income.

2.2 The Harberger Approach

The evolution of the Harberger approach to project evaluation essentially follows these introductory remarks put forward by

Layard (1972):

"If we wish to use the very restrictive Pareto

criterion of a welfare improvement, we shall support a project if some people gain and nobody losses. But if some people gain while others lose, the Pareto criterion provides no guidance. If we follow it, we can add up the net benefits of all the parties concerned and support the project if they are

positive, only if compensation will be paid to the losers. However, there is almost no case where it is feasible to compensate everybody, and if the Pareto rule were applied no project would ever get done. Therefore, many cost-benefit analysts have fallen back on the Hicks-Kaldor criterion, which says that a

project can be supported provided the gainers

could compensate the losers, even if they do not" (p.16).

Note that the Hicks-Kaldor position is one which represented an attempt to separate the production aspects of economic policy from their distributional by-products. A key assumption underlying this

principle is that lump-sum transfers can be effected at will and without any cost in terms of economic efficiency. That this assumption justifies Harberger's traditional cost-benefit procedure (which neglect distributional

considerations) is found in the basic postulates advanced by him as providing a conventional framework for applied welfare economics, viz:

(1) the competitive demand price for a given unit measures the value of that unit to the demander; (2) the competitive supply price for a given unit measures the value of the unit to the supplier; and (3) when

evaluating the net benefits or costs of a given project, the costs and benefits accruing to each member of the relevant group should normally be added without regard to the individual to whom they accrue (Harberger,


In this section, the convention for the Harberger methodology will be outlined and subsequent discussions will draw heavily from Harberger (1971a, 1971b, 1972 and 1978).

In document Welfare implications in the appraisal of projects : a case study of the fishpond estate project in the Philippines (Page 45-49)