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2. Identifying Project Costs and Benefits

We undertake economic analyses of agricultural projects to compare costs with benefits and determine which among alternative projects have an acceptable return. The costs and benefits of a proposed project therefore must be identified. Furthermore, once costs and benefits are known, they must be priced, and their economic values determined. All of this is obvious enough, but frequently it is tricky business.

What costs and benefits in agricultural projects are, and how we can define them in a consistent manner, are the topics of this chapter. In chapter 3 we will examine how we can obtain market prices. After the financial analyses are discussed in chapters 4-6, the economic analysis is addressed in chapter 7 with a discussion of how to adjust market prices to reflect the real resource flows.

Objectives, Costs, and Benefits

In project analysis, the objectives of the analysis provide the standard against which costs and benefits are defined. Simply put, a cost is anything that reduces an objective, and a benefit is anything that contributes to an objective.

The problem with such simplicity, however, is that each participant in a project has many objectives. For a farmer, a major objective of participating is to maximize the amount his family has to live on. But this is only one of the farmer's interests. He may also want his children to be educated; as a result, they may not be available to work full time in the fields. He may also value his time away from the fields: a farmer will not adopt a cropping pattern, however remunerative, that requires him to work ten hours a day 365 days a year. Taste preference may lead a farmer to continue to grow a traditional variety of rice for home consumption even though a new, high-yielding variety might increase his family income more. A farmer may wish to avoid risk, and so may plan his cropping pattern to limit the risk of crop failure to an acceptable level or to reduce the risk of his depending solely on the market for the food grains his family will consume. As a result, although he may be able to increase his income over time if he grows cotton instead of wheat or maize, he would rather continue growing food grains to forestall the possibility that in any one year the cotton crop might fail or that food grains might be available for purchase in the market only at a very high price. All these considerations affect a farmer's choice of cropping pattern and thus the income-generating capacity of the project. Yet all are sensible decisions in the farmer's view. In the analytical system presented here, we will try to identify the cropping pattern that we think the farmer will most probably select, and then we will judge the effects of that pattern on his incremental income and, thus, on the new income generated by the project.

For private business firms or government corporations, a major objective is to maximize net income, yet both have significant objectives other than simply making the highest profit possible. Both will want to diversify their activities to reduce risk. The private store owner may have a preference for leisure, which leads him to hire a manager to help operate his store, especially during late hours. This reduces the income-since the manager must be paid a salary-but it is a sensible choice. For policy reasons, a public bus corporation may decide to maintain services even in less densely populated areas or at off-peak hours and thereby reduce its net income. In the analytical system here, we first identify the operating pattern that the firms in the project will most likely follow and then build the accounts to assess the effects of that pattern on the income-generating capacity of the project.

A society as a whole will have as a major objective increased national income, but it clearly will have many significant, additional objectives. One of the most important of these is income distribution. Another is simply to increase the number of productive job opportunities so that unemployment may be reduced-which may be different from the objective of income distribution itself. Yet another objective may be to increase the proportion of savings in any given period so there will be more to invest, faster growth, and, hence, more income in the future. Or, there may be issues to address broader than narrow economic considerations-such as the desire to increase regional integration, to upgrade the general level of education, to improve rural health, or to safeguard national security. Any of these objectives might lead to the choice of a project (or a form of a project) that is not the alternative that would contribute most to national income narrowly defined.

No formal analytical system for project analysis could possibly take into account all the various objectives of every participant in a project. Some selection will have to be made. In the analytical system here, we will take as formal criteria very straightforward objectives of income maximization and accommodate other objectives at other points in the process of project selection. The justification for this is that in most developing countries increased income is probably the single most important objective of individual economic effort, and increased national income is probably the most important objective of national economic policy.

For farms, we will take as the objective maximizing the incremental net benefit-the increased amount the farm family has to live on as a result of participating in the project-derived as outlined in chapter 4. For a private business firm or corporation in the public sector, we will take as the objective maximizing the incremental net income, to which we will return in chapter 5. And for the economic analysis conducted from the standpoint of the society as a whole, we will take as the objective maximizing the contribution the project makes to the national income-the value of all final goods and services produced during a particular period, generally a year. This is virtually the same objective, except for minor formal variations in definition, as maximizing gross domestic product (GDP). It is important to emphasize that taking the income a project will contribute to a society as the formal analytical criterion in economic, analysis does not downgrade other objectives or preclude our considering them. Rather, we will simply treat consideration of other objectives as separate decisions. Using our analytical system, we can judge which among alternative projects or alternative forms of a particular project will make an acceptable contribution to national income. This will enable us to recommend to those who must make the investment decision a project that has a high income-generating potential and also will make a significant contribution to other social objectives. For example, from among those projects that make generally the same contribution to increased income, we can choose the one that has the most favorable effects on income distribution, or the one that creates the most jobs, or the one that is the most attractive among those in a disadvantaged region.

Thus, in the system of economic analysis discussed here, anything that reduces national income is a cost and anything that increases national income is a benefit. Since our objective is to increase the sum of all final goods and services, anything that directly reduces the total final goods and services is obviously a cost, and anything that directly increases them is clearly a benefit. But recall, also, the intricate workings of the economic system. When the project analyzed uses some intermediate good or service-something that is used to produce something else-by a chain of events it eventually reduces the total final goods and services available elsewhere in the economy. On the one hand, if we divert an orange that can be used for direct consumption-and thus is a final good-to the production of orange juice, also a final good, we are reducing the total available final goods and services, or national income, by the value of the orange and increasing it by the value of the orange juice. On the other hand, if we use cement to line an irrigation canal, we are not directly reducing the final goods and services available; instead, we are simply reducing the availability of an intermediate good. But the consequence of using the cement in the irrigation project is to shift the cement away from some other use in the economy. This, in turn, reduces production of some other good, and so on through the chain of events until, finally, the production of final goods and services, the national income, is reduced. Thus, using cement in the project is a cost to the economy. How much the national income will be reduced by using the cement for the project is part of what we must estimate when we turn, in chapter 7, to deriving economic values. On the benefit side, we have a similar pattern. Lining a canal increases available water that, in turn, may increase wheat production, and so on through a chain of events until in the end the total amount of bread is increased.

By this mechanism, the project leads to an increase in the total amount of final goods and services, which is to say it increases the national income. Again, part of the analyst's task in the economic analysis is to estimate the amount of this increase in national income available to the society; that is, to determine whether, and by how much, the benefits exceed the costs in terms of national income. If this rather simple definition of economic costs and benefits is kept in mind, possible confusion will be avoided when shadow prices are used to value resource flows, a matter taken up in chapter 7.

Note that, by defining our objective for economic analysis in terms of change in national income, we are defining it in real terms. (Real terms, as opposed to money terms, refer to the physical, tangible characteristics of goods and services.) To an important degree, economic analysis, in contrast to financial analysis, consists in tracing the real resource flows induced by an investment rather than the investment's monetary effects.

With these objectives defined, we may then say that in financial analysis our numeraire-the common measurement used as the unit of account-is a unit of currency, generally domestic currency, whereas in economic analysis our numeraire is a unit of national income, generally also expressed in domestic currency. We will return to this topic in our discussion of determining economic values in chapter 7.

In the economic analysis we will assume that all financing for a project comes from domestic sources and that all returns from the project go to domestic residents. [This is one reason why we identify our social objective with the gross domestic product (GDP) instead of the more familiar gross national product (GNP).] This convention-almost universally accepted by project analysts-separates the decision of how good a project is in its income-generating potential from the decision of how to finance it. The actual terms of financing available for a particular project will not influence the evaluation. Instead, we will assume that the proposed project is the best investment possible and that financing will then be sought for it at the best terms obtainable. This convention serves well whenever financing can be used for a range of projects or even versions of roughly the same project. The only case in which it does not hold well is the rather extreme case in which foreign financing is very narrowly tied to a particular project and will be lost if the project is not implemented. Then the analyst may be faced with the decision of implementing a lower-yielding project with foreign financing or choosing a higher-yielding alternative but losing the foreign loan.

"With" and "Without" Comparisons

Project analysis tries to identify and value the costs and benefits that will arise with the proposed project and to compare them with the situation as it would be without the project. The difference is the incremental net benefit arising from the project investment. This approach is not the same as comparing the situation "before" and "after" the project. The before-and-after comparison fails to account for changes in production that would occur without the project and thus leads to an erroneous statement of the benefit attributable to the project investment.

A change in output without the project can take place in two kinds of situations. The most common is when production in the area is already growing, if only slowly, and will probably continue to grow during the life of the project. The objective of the project is to increase growth by intensifying production. In Syria at the time the First Livestock Development Project was appraised, for example, production in the national sheep flock was projected to grow at about 1 percent a year without the project. The project was to increase and stabilize sheep production and the incomes of seminomadic flock owners and sheep fatteners by stabilizing the availability of feed and improving veterinary services. With the project, national flock production was projected to grow at the rate of 3 percent a year. In this case, if the project analyst had simply compared the output before and after the project, he would have erroneously attributed the total increase in sheep production to the project investment. Actually, what can be attributed to the project investment is only the 2 percent incremental increase in production in excess of the 1 percent that would have occurred anyway (see figure 2-1).

A change in output can also occur without the project if production would actually fall in the absence of new investment. In Guyana, on the north coast of South America, rice and sugarcane are produced on a strip of clay and silt soil edging the sea. The coast was subject to erosion from wave action. Under the Sea Defense Project, the government of Guyana has built seawalls to prevent the erosion. The benefit from this project, then, is not increased production but avoiding the loss of agricultural output and sites for housing. A simple before-and-after comparison would fail to identify this benefit (figure 2-2).

In some cases, an investment to avoid a loss might also lead to an increase in production, so that the total benefit would arise partly from the loss avoided and partly from increased production. In Pakistan, many areas are subject to progressive salinization as a result of heavy irrigation and the waterlogging that is in part attributable to seepage from irrigation canals. Capillary action brings the water to the surface where evaporation occurs, leaving the salt on the soil. If nothing is done to halt the process, crop production will fall. A project is proposed to line some of the canals, thus to reduce the seepage and permit better drainage between irrigations. The proposed project is expected to arrest salinization, to save for profitable use the irrigation water otherwise lost to seepage, and to help farmers increase their use of modern inputs. The combination of measures would not only avoid a loss but also lead to an increase in production. Again, a simple before-and-after comparison would fail to identify the benefit realized by avoiding the loss (figure 2-3).

Of course, if no change in output is expected in the project area without the project, then the distinction between the before-and-after comparison and the with-and-without comparison is less crucial. In some projects the prospects for increasing production without new investment are minimal. In the Kemubu Irrigation Project in northeastern Malaysia, a pump irrigation scheme was built that permitted farmers to produce a second rice crop during the dry season. Without the project, most of the area was used for grazing, and with the help of residual moisture or small pumps some was used to produce tobacco and other cash crops. Production was not likely to increase because of the limited amount of water available. With the project now in operation, rice is grown in the dry season. Of course, the value of the second rice crop could not be taken as the total benefit from the project. From this value must be deducted the value forgone from the grazing and the production of cash crops. Only the incremental value could be attributed to the new investment in pumps and canals (figure 2-4).

Another instance where there may be no change in output without the project is the obvious one found in some settlement projects. Without the project there may be no economic use of the area at all. In the Alto Turi Land Settlement Project in northeastern Brazil, settlers established their holdings by clearing the forest, planting upland rice, and then establishing pasture for production of beef cattle. At the time the settlers took up their holdings the forest had not been economically exploited-nor was it likely to be, at least for many years, in the absence of the project. In this case, the output without the project would be the same as the output before the project (figure 2-5).

Direct Transfer Payments

Some entries in financial accounts really represent shifts in claims to goods and services from one entity in the society to another and do not reflect changes in national income. These are the so-called direct transfer payments, which are much easier to identify if our definition of costs and benefits is kept in mind. In agricultural project analysis four kinds of direct transfer payments are common: taxes, subsidies, loans, and debt service (the payment of interest and repayment of principal).

Take taxes, for example. In financial analysis a tax payment is clearly a cost. When a farmer pays a tax, his net benefit is reduced. But the farmer's payment of tax does not reduce the national income. Rather, it transfers income from the farmer to the government so that this income can be used for social purposes presumed to be more important to the society than the increased individual consumption (or investment) had the farmer retained the amount of the tax. Because payment of tax does not reduce national income, it is not a cost from the standpoint of the society as a whole. Thus, in economic analysis we would not treat the payment of taxes as a cost in project accounts. Taxes remain a part of the overall benefit stream of the project that contributes to the increase in national income.

Of course, no matter what form a tax takes, it is still a transfer payment-whether a direct tax on income or an indirect tax such as a sales tax, an excise tax, or a tariff or duty on an imported input for production. But some caution is advisable here. Taxes that are treated as a direct transfer payment are those representing a diversion of net benefit to the society. Quite often, however, government charges for goods supplied or services rendered may be called taxes. Water rates, for example, may be considered a tax by the farmer, but from the standpoint of the society as a whole they are a payment by the farmer to the irrigation authority in exchange for water supplied. Since building the irrigation system reduces national income, the farmer's payment for the water is part of the cost of producing the crop, the same as any other payment for a production input. Other payments called taxes may also be payments for goods and services rendered rather than transfers to the government. A stevedoring charge at the port is not a tax but a payment for services and so would not be treated as a duty would be. Whether a tax should be treated as a transfer payment or as a payment for goods and services depends on whether the payment is a compensation for goods and services needed to carry out the project or merely a transfer, to be used for general social purposes, of some part of the benefit from the project to the society as a whole.

Subsidies are simply direct transfer payments that flow in the opposite direction from taxes. If a farmer is able to purchase fertilizer at a subsidized price, that will reduce his costs and thereby increase his net benefit, but the cost of the fertilizer in the use of the society's real resources remains the same. The resources needed to produce the fertilizer (or import it from abroad) reduce the national income available to the society. Hence, for economic analysis of a project we must enter the full cost of the fertilizer.

Again, it makes no difference what form the subsidy takes. One form is that which lowers the selling price of inputs below what otherwise would be their market price. But a subsidy can also operate to increase the amount the farmer receives for what he sells in the market, as in the case of a direct subsidy paid by the government that is added to what the farmer receives in the market. A more common means to achieve the same result does not involve direct subsidy. The market price may be maintained at a level higher than it otherwise would be by, say, levying an import duty on competing imports or forbidding competing imports altogether. Although it is not a direct subsidy, the difference between the higher controlled price set by such measures and the lower price for competing imports that would prevail without such measures does represent an indirect transfer from the consumer to the farmer.

Credit transactions are the other major form of direct transfer payment in agricultural projects. From the standpoint of the farmer, receipt of a loan increases the production resources he has available; payment of interest and repayment of principal reduce them. But from the stand-point of the economy, things look different. Does the loan reduce the national income available? No, it merely transfers the control over resources from the lender to the borrower. Perhaps one farmer makes the loan to his neighbor. The lending farmer cannot use the money he lends to buy fertilizer, but the borrowing farmer can. The use of the fertilizer, of course, is a cost to the society because it uses up resources and thus reduces the national income. But the loan transaction does not itself reduce the national income; it is, rather, a direct transfer payment. In reverse, the same thing happens when the farmer repays his loan. The farmer who borrowed cannot buy fertilizer with the money he uses to repay the loan his neighbor made, but his neighbor can. Thus, the repayment is also a direct transfer payment.

Some people find the concept of transfer payments easier to understand if it is stated in terms of real resource flows. Taking this approach in economic analysis, we see that a tax does not represent a real resource flow; it represents only the transfer of a claim to real resource flows. The same holds true for a direct subsidy that represents the transfer of a claim to real resources from, say, an urban consumer to a farmer. This line of reasoning also applies to credit transactions. A loan represents the transfer of a claim to real resources from the lender to the borrower. When the borrower pays interest or repays the principal, he is transferring the claim to the real resources back to the lender-but neither the loan nor the repayment represents, in itself, use of the resources.

Costs of Agricultural Projects

in almost all project analyses, costs are easier to identify (and value) than benefits. In every instance of examining costs, we will be asking ourselves if the item reduces the net benefit of a farm or the net income of a firm (our objectives in financial analysis), or the national income (our objective in economic analysis).

Physical goods

Rarely will physical goods used in an agricultural project be difficult to identify. For such goods as concrete for irrigation canals, fertilizer and pesticides for increasing production, or materials for the construction of homes in land settlement projects, it is not the identification that is difficult but the technical problems in planning and design associated with finding out how much will be needed and when.

Labor

Neither will the labor component of agricultural projects be difficult to identify. From the highly skilled project manager to the farmer maintaining his orchard while it is coming into production, the labor inputs raise less a question of what than of how much and when. Labor may, however, raise special valuation problems that call for the use of a shadow price. Confusion may also arise on occasion in valuing family labor. Valuing family labor will be discussed with farm budgets in chapter 4, and the overall question of valuing unskilled labor will be taken up in chapter 7.

Land

By the same reasoning, the land to be used for an agricultural project will not be difficult to identify. It generally is not difficult to determine where the land necessary for the project will be located and how much will be used. Yet problems may arise in valuing land because of the very special kind of market conditions that exist when land is transferred from one owner to another. These valuation problems will also be considered with farm budgets in chapter 4 and with determining economic values in chapter 7.

Contingency allowances

In projects that involve a significant initial investment in civil works, the construction costs are generally estimated on the initial assumption that there will be no modifications in design that would necessitate changes in the physical work; no exceptional conditions such as unanticipated geological formations; and no adverse phenomena such as floods, landslides, or unusually bad weather. In general, project cost estimates also assume that there will be no relative changes in domestic or international prices and no inflation during the investment period. It would clearly be unrealistic to rest project cost estimates only on these assumptions of perfect knowledge and complete price stability. Sound project planning requires that provision be made in advance for possible adverse changes in physical conditions or prices that would add to the baseline costs. Contingency allowances are thus included as a regular part of the project cost estimates.

Contingency allowances may be divided into those that provide for physical contingencies and those for price contingencies. In turn, price contingency allowances comprise two categories, those for relative changes in price and those for general inflation. Physical contingencies and price contingencies that provide for increases in relative costs underlie our expectation that physical changes and relative price changes are likely to occur, even though we cannot forecast with confidence just how their influence will be felt. The increase in the use of real goods and services represented by the physical contingency allowance is a real cost and will reduce the final goods and services available for other purposes; that is, it will reduce the national income and, hence, is a cost to the society. Similarly, a rise in the relative cost of an item implies that its productivity elsewhere in the society has increased; that is, its potential contribution to national income has risen. A greater value is forgone by using the item for our project; hence, there is a larger reduction in national income. Physical contingency allowances and price contingency allowances for relative changes in price, then, are expected-if unallocated-project costs, and they properly form part of the cost base when measures of project worth are calculated.

General inflation, however, poses a different problem. As we will note in chapter 3 in discussing future prices, in project analysis the most common means of dealing with inflation is to work in constant prices, on the assumption that all prices will be affected equally by any rise in the general price level. This permits valid comparisons among alternative projects. If inflation is expected to be significant, however, provision for its effects on project costs needs to be made in the project financing plan so that an adequate budget is obtained. Contingency allowances for inflation would not, however, be included among the costs in project accounts other than the financing plan.

Taxes

Recall that the payment of taxes, including duties and tariffs, is customarily treated as a cost in financial analysis but as a transfer payment in economic analysis (since such payment does not reduce the national income). The amount that would be deducted for taxes in the financial accounts remains in the economic accounts as part of the incremental net benefit and, thus, part of the new income generated by the project.

Debt service

The same approach applies to debt service-the payment of interest and the repayment of capital. Both are treated as an outflow in financial analysis. In economic analysis, however, they are considered transfer payments and are omitted from the economic accounts.

Treatment of interest during construction can give rise to confusion. Lending institutions sometimes add the value of interest during construction to the principal of the loan and do not require any interest payment until the project begins to operate and its revenues are flowing. This process is known as "capitalizing" interest. The amount added to the principal as a result of capitalizing interest during construction is similar to an additional loan. Capitalizing interest defers interest cost, but when the interest payments are actually due, they will, of course, be larger because the amount of the loan has been increased. From the standpoint of economic analysis, the treatment of interest during construction is clear. It is a direct transfer payment the same as any other interest payment, and it should be omitted from the economic accounts. Often interest during construction is simply added to the capital cost of the project. To obtain the economic value of the capital cost, the amount of the interest during construction must be subtracted from the capital cost and omitted from the economic account.

In economic analysis, debt service is treated as a transfer within the economy even if the project will actually be financed by a foreign loan and debt service will be paid abroad. This is because of the convention of assuming that all financing for a project will come from domestic sources and all returns from the project will go to domestic residents. This convention, as noted earlier, separates the decision of how good a project is from the decision of how to finance it. Hence, even if it were expected that a project would be financed, say, by a World Bank loan, the debt service on that loan would not appear as a cost in the economic accounts of the project analysis.

Sunk costs

Sunk costs are those costs incurred in the past upon which a proposed new investment will be based. Such costs cannot be avoided, however poorly advised they may have been. When we analyze a proposed investment, we consider only future returns to future costs; expenditures in the past, or sunk costs, do not appear in our accounts.

In practice, if a considerable amount has already been spent on a project, the future returns to the future costs of completing the project would probably be quite attractive even if it is clear in retrospect that the project should never have been begun. The ridiculous extreme is when only one dollar is needed to complete a project, even a rather poor one, and when no benefit can be realized until the project is completed. The "return" to that last dollar may well be extremely high, and it would be clearly worthwhile to spend it. But the argument that because much has already been spent on a project it therefore must be continued is not a valid criterion for decision. There are cases in which it would be preferable simply to stop a project midway or to draw it to an early conclusion so that future resources might be freed for higher-yielding alternatives.

For evaluating past investment decisions, it is often desirable to do an economic and financial analysis of a completed project. Here, of course, the analyst would compare the return from all expenditures over the past life of the project with all returns. But this kind of analysis is useful only for determining the yield of past projects in the hope that judgments about future projects may be better informed. It does not help us decide what to do in the present. Money spent in the past is already gone; we do not have as one of our alternatives not to implement a completed project.

Tangible Benefits of Agricultural Projects

Tangible benefits of agricultural projects can arise either from an increased value of production or from reduced costs. The specific forms in which tangible benefits appear, however, are not always obvious, and valuing them may be quite difficult.

Increased production

Increased physical production is the most common benefit of agricultural projects. An irrigation project permits better water control so that farmers can obtain higher yields. Young trees are planted on cleared jungle land to increase the area devoted to growing oil palm. A credit project makes resources available for farmers to increase both their operating expenditures for current production-for fertilizers, seeds, or pesticides-and their investment-for a tubewell or a power thresher. The benefit is the increased production from the farm.

In a large proportion of agricultural projects the increased production will be marketed through commercial channels. In that case identifying the benefit and finding a market price will probably not prove too difficult, although there may be a problem in determining the correct value to use in the economic analysis.

In many agricultural projects, however, the benefits may well include increased production consumed by the farm family itself. Such is the case in irrigation rehabilitation projects along the north coast of Java. The home-consumed production from the projects increased the farm families' net benefit and the national income just as much as if it had been sold in the market. Indeed, we could think of the hypothetical case of a farmer selling his output and then buying it back. Since home-consumed production contributes to project objectives in the same way as marketed production, it is clearly part of the project benefits in both financial and economic analysis. Omitting home-consumed production will tend to make projects that produce commercial crops seem relatively high-yielding, and it could lead to a poor choice among alternative projects. Failure to include home-consumed production will also mean underestimating the return to agricultural investments relative to investments in other sectors of the economy.

When home-consumed crops will figure prominently in a project, the importance of careful financial analysis is increased. In this case, it is necessary to estimate not only the incremental net benefit-including the value of home-consumed production and money from off-farm sales-but also the cash available to the farmer. From the analysis of cash income and costs, one can determine if farmers will have the cash in hand to purchase modern inputs or to pay their credit obligations. It is possible to have a project in which home-consumed output increases enough for the return to the economy as a whole to be quite attractive, but in which so little of the increased production is sold that farmers will not have the cash to repay their loans.

Quality improvement

In some instances, the benefit from an agricultural project may take the form of an improvement in the quality of the product. For example, the analysis for the Livestock Development Project in Ecuador, which was to extend loans to producers of beef cattle, assumed that ranchers would be able not only to increase their cattle production but also to improve the quality of their animals so that the average live price of steers per kilogram would rise from S/5.20 to S/6.40 in constant value terms over the twelve-year development period. (The symbol for Ecuadorian sucres is S/.) Loans to small dairy farmers in the Rajasthan Smallholder Dairy Improvement Project in India are intended to enable farmers not only to increase output but also to improve the quality of their product. Instead of selling their milk to make ghee (cooking oil from clarified butter), farmers will be able to sell it for a higher price in the Jaipur fluid milk market. As in these examples, both increased production and quality improvement are most often expected in agricultural projects, although both may not always be expected. One word of warning: both the rate and the extent of the benefit from quality improvement can easily be overestimated.

Change in time of sale

In some agricultural projects, benefits will arise from improved marketing facilities that allow the product to be sold at a time when prices are more favorable. A grain storage project may make it possible to hold grain from the harvest period, when the price is at its seasonal low, until later in the year when the price has risen. The benefit of the storage investment arises out of this change in "temporal value."

Change in location of sale

Other projects may include investment in trucks and other transport equipment to carry products from the local area where prices are low to distant markets where prices are higher. For example, the Fruit and Vegetable Export Project in Turkey included provision for trucks and ferries to transport fresh produce from southeastern Turkey to outlets in the European Common Market. The benefits of such projects arise from the change in "locational value."

In most cases the increased value arising from marketing projects will be split between farmers and marketing firms as the forces of supply and demand increase the price at which the farmer can sell in the harvest season and reduce the monopolistic power of the marketing firm or agency. Many projects are structured to ensure that farmers receive a larger part of the benefit by making it possible for them to build storage

facilities on their farms or to band together into cooperatives, but an agricultural project could also involve a private marketing firm or a government agency, in which case much of the benefit could accrue to someone other than farmers.

Changes in product form (grading and processing)

Projects involving agricultural processing industries expect benefits to arise from a change in the form of the agricultural product. Farmers sell paddy rice to millers who, in turn, sell polished rice. The benefit to the millers arises from the change in form. Canners preserve fruit, changing its form and making it possible at a lower cost to change its time or location of sale. Even a simple processing facility such as a grading shed gives rise to a benefit through changing the form of the product from run-of-the-orchard to sorted fruit. In the Himachal Pradesh Apple Marketing Project in northern India, the value of the apples farmers produce is increased by sorting; the best fruit is sold for fresh consumption while fruit of poorer quality is used to make a soft drink concentrate. In the process, the total value of the apples is increased.

Cost reduction through mechanization

The classic example of a benefit arising from cost reduction in agricultural projects is that gained by investment in agricultural machinery to reduce labor costs. Examples are tubewells substituting for hand-drawn or animal-drawn water, pedal threshers replacing hand threshing, or (that favorite example) tractors replacing draft animals. Total production may not increase, but a benefit arises because the costs have been trimmed (provided, of course, that the gain is not offset by displaced labor that cannot be productively employed elsewhere).

Reduced transport costs

Cost reduction is a common source of benefit wherever transport is a factor. Better feeder roads or highways may reduce the cost of moving produce from the farm to the consumer. The benefit realized may be distributed among farmers, truckers, and consumers.

Losses avoided

In discussing with-and-without comparisons in project analyses earlier in this chapter, we noted that in some projects the benefit may arise not from increased production but from a loss avoided. This kind of benefit stream is not always obvious, but it is one that the with-and-without test tends to point out clearly. In Jamaica, lethal yellowing is attacking the Jamaica Tall variety of coconut. The government has undertaken a large investment to enable farmers to plant Malayan Dwarf coconuts, which are resistant to the disease. Total production will change very little as a result of the investment, yet both the farmers and the economy will realize a real benefit because the new investment prevents loss of income. The Lower Egypt Drainage Project involves the largest single tile drainage system in the world. The benefit will arise not from increasing production in the already highly productive Nile delta, but from avoiding losses due to the waterlogging caused by year-round irrigation from the Aswan High Dam.

Sometimes a project increases output through avoiding loss-a kind of double classification, but one that in practice causes no problem. Proposals to eradicate foot-and-mouth disease in Latin America envision projects by which the poor physical condition or outright death of animals will be avoided. At the same time, of course, beef production would be increased.

Other kinds of tangible benefits

Although we have touched on the most common kinds of benefits from agricultural projects, those concerned with agricultural development will find other kinds of tangible, direct benefits most often in sectors other than agriculture. Transport projects are often very important for agricultural development. Benefits may arise not only from cost reduction, as noted earlier, but also from time savings, accident reduction, or development activities in areas newly accessible to markets. If new housing for farmers has been included among the costs of a project, as is often the case in land settlement and irrigation projects, then among the benefits will be an allowance for the rental value of the housing. Since this is an imputed value, there are valuation problems that will be noted later.

Secondary Costs and Benefits

Projects can lead to benefits created or costs incurred outside the project itself. Economic analysis must take account of these external, or secondary, costs and benefits so they can be properly attributed to the project investment. (Of course, this applies only in economic analysis; the problem does not arise in financial analysis.)

When market prices are used in economic analysis, as has been the custom in the United States for water resource and other public works projects, it is necessary to estimate the secondary costs and benefits and then add them to the direct costs and benefits. This is a theoretically difficult process, and one easily subject to abuse. There is an extensive and complex literature on secondary costs and benefits that specifically addresses this analytical approach. For those who would like to review this literature, a good place to begin is the article by Prest and Turvey (1966), which outlines the historical development of the discussion. A highly technical review of the arguments can be found in Mishan (1971).

Instead of adding on secondary costs and benefits, one can either adjust the values used in economic analysis or incorporate the secondary costs and benefits in the analysis, thereby in effect converting them to direct costs and benefits. This is the approach taken in most project analyses carried out by international agencies, in the systems based on shadow prices proposed in more recent literature on project analysis, and in the analytical system presented here.

Incorporating secondary costs or benefits in project analysis can be viewed as an analytical device to account for the value added that arises outside the project but is a result of the project investment. In the analytical system here, as will be explained in more detail in chapter 7, every item is valued either at its opportunity cost or at a value determined by a consumer's willingness to pay for the item. The effect is to eliminate all transfers-both the direct transfers discussed earlier in this chapter and the indirect transfers that arise because prices differ from opportunity costs. By this means we attribute to the project investment all the value added that arises from it anywhere in the society. Hence, it is not necessary to add on the secondary costs and benefits separately; to do so would constitute double counting.

One qualification must be made. If a project has a substantial effect on the quantity other producers are able to sell in imperfect markets-and most markets are imperfect-there may be gains or losses not accurately accounted for. Squire and van der Tak (1975, p. 23) cite the example of an improved road that diverts traffic from a railway that charges rates below marginal cost. This diversion entails a social gain from reduced rail traffic (in avoiding the social losses previously incurred on this traffic) in addition to the benefits to the road users measured directly. In agricultural projects, this is a rather infrequent case because prices generally are more flexible than in other sectors of the economy. In any event, in the practice of contemporary project analysis the size of these gains or losses is generally assumed to be insignificant, and no provision is made for them in the analysis.

Although using shadow prices based on opportunity costs or willingness to pay greatly reduces the difficulty of dealing with secondary costs and benefits, there still remain many valuation problems related to goods and services not commonly traded in competitive markets. One way to avoid some of these problems is to treat a group of closely related investments as a single project. For example, it is common to consider the output of irrigation projects as the increased farm production, since valuing irrigation water is difficult. Another example is found in development roads built into inaccessible areas. It is argued that the production arising from the induced investment activities of otherwise unemployed new settlers should be considered a secondary benefit of the road investment. One way of avoiding the problem is to view this case as a land settlement project in which the road is a component. New production is then properly included among the direct benefits of the project and can be included in the project accounts at market or shadow prices, and no attempt need be made to allocate the benefits between road investment and the other kinds of investment that must be made by settlers and government if settlement is to succeed.

Another group of secondary costs and benefits has been called "technological spillover" or "technological externalities." Adverse ecological effects are a common example, and the side effects of irrigation development are often cited as an illustration. A dam may reduce river flow and lead to increased costs for dredging downstream. New tubewell development may have adverse effects on the flow of existing wells. Irrigation development may reduce the catch of fish or may lead to the spread of schistosomiasis. When these technological externalities are significant and can be identified and valued, they should be treated as a direct cost of the project (as might be the case for reduced fish catches), or the cost of avoiding them should be included among the project costs (as would be the case for increased dredging or for investment to avoid pollution).

It is sometimes suggested that project investments may give rise to secondary benefits through a "multiplier effect." The concept of the multiplier is generally thought of in connection with economies having excess capacity. If excess capacity exists, an initial investment might cause additional increases in income as successive rounds of spending reduce excess capacity. In developing countries, however, it is shortage of capacity that is characteristic. Thus, there is little likelihood of excess capacity giving rise to additional benefits through the multiplier. In any event, most of the multiplier effect is accounted for if we shadow-price at opportunity cost. Since the opportunity cost of using excess capacity is only the cost of the raw materials and labor involved, only variable costs will enter the project accounts until existing excess capacity is used up.

It is also sometimes suggested that there is a "consumption multiplier effect" as project benefits are received by consumers. Consumption multipliers are very difficult to identify and value. In any case, they presumably would be much the same for alternative investments, so omitting them from a project analysis would not affect the relative ranking of projects.

Intangible Costs and Benefits

Almost every agricultural project has costs and benefits that are intangible. These may include creation of new job opportunities, better health and reduced infant mortality as a result of more rural clinics, better nutrition, reduced incidence of waterborne disease as a result of improved rural water supplies, national integration, or even national defense. Such intangible benefits are real and reflect true values. They do not, however, lend themselves to valuation. How does one derive a figure for the long-term value of a child's life saved, or for the increased comfort of a population spared preventable, debilitating disease? Benefits of this kind may require a modification of the normal benefit-cost analysis to a least-cost type of analysis, a topic we will take up when we discuss valuation. Because intangible benefits are a factor in project selection, it

is important that they be carefully identified and, where at all possible, quantified, even though valuation is impossible. For example, how many children will enroll in new schools? How many homes will benefit from a better system of water supply? How many infants will be saved because of more rural clinics?

In most cases of intangible benefits arising from an agricultural project, the costs are tangible enough: construction costs for schools, salaries for nurses in a public health system, pipes for rural water supplies, and the like. Intangible costs, however, do exist in projects. Such costs might be incurred if new projects disrupt traditional patterns of family life, if development leads to increased pollution, if the ecological balance is upset, or if scenic values are lost. Again, although valuation is impossible, intangible costs should be carefully identified and if possible quantified. In the end, every project decision will have to take intangible factors into account through a subjective evaluation because intangible costs can be significant and because intangible benefits can make an important contribution to many of the objectives of rural development.


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