Estimating accounting prices for project appraisal: tudies in the Little-Mirrlees/Squire-van der Tak method

Estimating Accounting Prices

for Project Appraisal

Case Studies in the Little-Mirrlees/Squire-van der Tak Method

Editor

Terry A. Powers

Other Contributors

Ernesto S. Castagnino

Gregorio Donoso R.

Elio H. Londero

Luis Morales Bayro

Jorge Tejada (Researcher)

Inter-American Development Bank

W ashington, D.C.

1981

The research results of the case studies presented in this book

are the exclusive responsibility of the authors and do not neces￾sarily reflect the official policies or positions of the Inter￾American Development Bank.

Library of Congress

Catalog Card No.: 81-82413

ISBN 0-940602-00*8

FOREWORD

Accounting prices are a vital element in the appraisal of development

projects because they give a more accurate measure of the net contribution

of investment projects to national economic development objectives than

do market prices. Moreover, by utilizing accounting prices in project ap￾praisals, a government establishes greater consistency between its invest￾ment program and its national development policies.

This book presents results from four national accounting price studies

carried out by the Inter-American Development Bank in recent years. The

work is part of a broader program at the Bank in accounting prices. The

program was initiated in recognition of the important role that these

prices have in project appraisal, and of the need to develop practical

estimation techniques for them.

The Inter-American Development Bank has published this volume with

the hope that it makes an effective contribution to economic planning and

project appraisal techniques used by institutions at the national, as well as

international, levels.

Antonio Ortiz Mena

President

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GENERAL CONTENTS

Page

F O R E W O R D ................................................................................................. Hi

IN TR O D U C T IO N ........................................................................................ ix

1. AN OVERVIEW O F TH E LITTLE-M IRRLEES/SQUI RE￾VAN DER TAK ACCOUNTING PRICE SY STEM ................... 1

C o n ten ts........................................................................................................... 3

Introduction..................................................................................................... 5

Basic Concepts of the Accounting Price S y stem ...................................... 9

Efficiency Accounting Prices for Goods and Services............................. 16

Efficiency Accounting Prices for L a b o r ..................................................... 34

Marginal Product of Public In vestm ent..................................................... 45

Social Accounting Prices .............................................................................. 49

Summary ......................................................................................................... 59

List of References .......................................................................................... 60

2. USING INPUT-OUTPUT ANALYSIS TO CALCULATE

SECTORAL A P R s.................................................................................. 61

C o n ten ts........................................................................................................... 63

Introduction..................................................................................................... 65

Calculating APRs with an Input-O utput Table ...................................... 69

Deriving APRs with a Semi Input-O utput T a b le .................................... 95

Summary .......................................................................................................... 114

A n n ex ................................................................................................................ 115

List of References ........................................................................................... 121

3. SUMMARY OF R ESU LTS.................................................................. 123

C o n ten ts............................................................................................................ 125

Introduction...................................................................................................... 127

Calculation Methods for the Accounting P ric e s ...................................... 129

Results O b tain ed ............................................................................................. 135

4. PA R A G U A Y ............................................................................................. ....147

C ontents................................................................................................................149

P re fa c e ..................................................................................................................153

Overview of the Paraguayan E conom y....................................................... ....155

Construction of the Semi Input-O utput Table

for Paraguay............................................................................................. ....157

Accounting Price Ratios for Primary F actors.................................................190

Results .............................................................................................................. ....204

Opportunity Cost of C apital...............................................................................210

Final Com m ents....................................................................................................219

List of References ................................................................................................221

5. EL SA LV A D O R........................................................................................... 225

C o n ten ts................................................................................................................ 227

P re fa c e .................................................................................................................. 231

Characteristics of the Salvadoran Econom y...................................................233

Preparation of the Semi Input-O utput T a b le ........................................... ...236

Accounting Price Ratio of L a b o r......................................................................273

Results Obtained and Their U s e ......................................................................294

The Discount Rate .......................................................................................... ...310

A n n ex ................................................................................................................. ...317

List of References ................................................................................................319

6. ECUADOR ...................................................................................................323

C ontents............................................................................................................. ..325

P re fa c e ............................................................................................................... ..327

Introduction.........................................................................................................329

Calculation of Conversion Factors Based

Exclusively on Foreign Trade D a ta ........................................................330

Calculation of Sectoral APRs Based on the

Input-O utput T a b le ............................................................................... ..339

Economic Efficiency Price of Labor in E c u a d o r.........................................355

Discount Rate .................................................................................................. ..353

Some Comments for the E v alu ato r.............................................................. 35^

List of References ............................................................................................ 357

7. BARBADOS .............................................................................................. 369

C ontents............................................................................................................. 371

P re fa c e ............................................................................................................... 375

Conceptual Framework .................................................................................. 377

Specification of the Model Applied to Barbados

Results .....................................................................

List of References ..................................................

393

421

429

MATRICES (Included at the end of the book)

Semi Input-O utput Matrix of Paraguay

Semi Input-O utput Matrix of El Salvador

Input-O utput Matrix of Ecuador

Semi Input-O utput Matrix of Barbados

INTRODUCTION

During the last several years, significant advances have been made in proj￾ect appraisal systems for linking macroeconomic analysis to the selection

of investment projects in developing countries. Much of this work has

been either sponsored, or carried out directly, by international develop￾ment agencies such as the World Bank (IBRD), the Inter-American De￾velopment Bank (IDB), the United Nations, especially the UN Industrial

Development Organization (UNIDO), and the Organization for Economic

Cooperation and Development (OECD).

The link between project evaluation and the macroeconomy is national

accounting prices. This book explores the application of one of the

methods for calculating national accounting prices as a means of ensuring

proper valuation of the benefits and costs of a proposed investment from a

national perspective. Economywide accounting prices can be estimated

from economic data available in most countries without an unreasonable

expenditure of time, money, and manpower. This book presents the

methodology for deriving national accounting prices, with special

reference to the economies of four Latin American countries—Paraguay,

El Salvador, Ecuador, and Barbados—which were selected as case studies

by the Project Methodology Unit of the Inter-American Development

Bank.

This research effort has a long history. In 1973 the IDB and UNIDO

sponsored a symposium to discuss and compare alternative appraisal

schemes linking macroeconomic goals and project selection. 1 The sym￾posium brought Bank economists together with the leading proponents of

all schools, in particular those representing the UNIDO method (Stephen

Marglin and Partha Dasgupta), the OP^H-W orlH Rank method (I.M .D .

Little), and the "Chicago" method (Arnold Harberger). The symposium

'T h e symposium proceedings were published in: H. Schwartz and R. Bemey. eds.. Social

and Economic Dimensions o / Project Evaluation (W ashington. D .C .: Inter-American Devel￾opm ent Bank. 1977).

itself resulted in no recommendations, but provided the Bank an addi￾tional basis for selecting a suitable appraisal system.

The method chosen for more extensive testing was a variation of the

system developed by I.M .D . Little and James Mirrlees for the OECD

(LM) and by Lyn Squire and Herman van der Tak (ST) of the World

Bank. There were two reasons for selecting the LMST system. First, a

relatively greater amount of empirical work had been done by the World

Bank and the OECD in developing practical ways of estim ating the key

national parameters. Second, the World Bank offered to collaborate with

the IDB in working out additional technical details of the appraisal

m ethod. This arrangement had obvious advantages for saving staff time

and for building on the work already done at the World Bank.

The results of the year-and-one-half testing program, in which national

accounting param eters were estimated for three countries and applied to

three projects, were published in 1977.2 The IDB has carried out seven ad￾ditional accounting price studies since then, as well as collaborating with

the World Bank on an eighth study for Colombia.3

The four case studies in this volume—of Paraguay, El Salvador, E cua￾dor, and Barbados—were financed in part by an IDB Regional Technical

Cooperation grant (ATN/SF-1684-RE). Each planning agency p ar￾ticipating in the study provided funding and facilities for local activities,

and assigned counterpart personnel to work with the IDB consultant. In

addition to the main objective of deriving national accounting prices, the

regional program emphasized building support for their use in project ap￾praisals and for maintaining the accounting prices up to date. Seminars

on the subject were given for economic planners and project analysts, and

all com puter programs and data used to estim ate the accounting prices

were transferred to the participating agencies.

The studies were supervised by the Project Methodology U nit, which is

part of the ID B’s Country Studies Division in the Economic and Social

Development D epartm ent. W ork began in the first quarter of 1979 and

was finished at the end of that year. Each study averaged six to seven

months, with two to three months devoted to training and dissemination

activities. The latter included special sessions to enable the consultants to

coordinate estimation strategies, orientation of national counterpart per￾sonnel (usually two to four persons assigned full-time to the project), and

general seminars for persons from other government agencies.

2Pablo G uerrero et a i. Pilot Study on National A ccounting Parameters: Their Estim ation

and Use in Chile, Costa Rica and Jamaica. Papers on Project Analysis No. 6 (W ashington,

D .C .: Inter-American Development Bank. 1977).

3T he seven additional countries for which national accounting prices have been calculated

by IDB include the four discussed in this volume plus the Dom inican Republic. Bolivia, and

Nicaragua.

The first two chapters present the methodology followed in the country

studies. Chapter 1 outlines the essential points of the LMST appraisal

system for both efficiency accounting prices and social at-mnnting p n rc ;

The chapter emphasizes efficiency prices since those are the objective of

the case studies. C hapter 2 explains how matrix methods are used to

derive accounting price/m arket price ratios and conversion factors in a

national study.

C hapter 3 summarizes the results. It includes a brief discussion of

techniques used in each study to estimate the three principal accounting

price groups: goods and services, labor, and the discount rate. This over￾view is followed by tables showing the results for each country, and a

general statistical profile of sectoral accounting price ratios.

The last four chapters are the case studies. Each begins with an in￾troduction to the national economy and discusses the construction of the

accounting price matrix, the valuation of labor and other nonproduced in￾puts and transfer payments, and the results obtained. The terminology

and notation used by each author vary somewhat, but where possible they

have been standardized to avoid confusion. The theoretical portion of each

study is brief, since the essence of the methodology has been presented in

the first two chapters.

Acknowledgments

Discussions with World Bank staff over several years, particularly those

with Lyn Squire and Anandarup Ray, were very helpful in clarifying

aspects of the general accounting price system. So, too, were the com￾m ents of Gordon Hughes, Professor of Economics at Cambridge Univer￾sity, on the construction and use of semi input-output tables in national

accounting price studies.

Preparation of the case studies was a cooperative effort by the Inter￾American Development Bank and the governments of Paraguay, El Salva￾dor, Ecuador, and Barbados. Institutions and persons associated with the

accounting price program are noted in the Preface to each country report.

Finally, we recognize and appreciate the support of numerous persons

who translated, edited, and typed the Spanish and English versions of the

m anuscript. Any errors, omissions, or other shortcomings that remain are

the sole responsibility of the authors.

Terry A. Powers

Editor

Organization of the Book

Chapter 1

An Overview of the LMST

Accounting Price System

Terry A. Powers

Mr. Powers has a Ph.D. in Economics from the University of Texas. He joined the

IDB in 1971. and is presently Senior Economist in the Country Studies Division of

the Economic and Social Development Department; he has directed the Bank 's

national accounting price program since 1976. He is the author of several works on

benefit-cost analysis in developing countries, and has conducted numerous

seminars on the subject throughout Latin America.

CONTENTS

Page

IN T R O D U C T IO N ........................................................................................ 5

I. BASIC CONCEPTS OF TH E ACCOUNTING PRICE

S Y S T E M ..................................................................................................... 9

The Discount Rate and the N um eraire...................................................... 10

The Consumption Numeraire and the C R I .......................................... 10

The Public Income Numeraire and the ARI ........................................ 12

Efficiency and Social Accounting Prices .................................................. 13

II. EFFICIENCY ACCOUNTING PRICES FOR GOODS

AND SE R V IC E S.................................................................................... 16

Accounting Prices for Traded G o o d s........................................................ 17

Imported Goods at Constant Prices ...................................................... 18

Exported Goods at Constant Prices ...................................................... 20

Traded Goods with Variable International Prices................................... 21

Imports with Variable P ric e s................................................................... 21

Exports with Variable P ric e s................................................................... 22

Accounting Prices for Nontraded G o o d s ................................................... 23

Marginal Supply C o st................................................................................ 24

Marginal Value of Decreased Consumption ........................................ 28

Small Change in M arket Price............................................................. 28

Large Change in Market Price............................................................. 29

Reference Price L ev el................................................................................ 31

Some Further Points on Pricing Nontraded G oods............................. 31

Accounting Prices from a National Perspective........................................ 32

III. EFFICIENCY ACCOUNTING PRICES FOR L A B O R ........... 34

Economic Cost of L a b o r................................................................................ 34

Accounting Price of Unskilled L a b o r......................................................... 35

4 O V E R V IE W O F T H E LM ST SY ST EM

Rural Unskilled L a b o r.............................................................................. ...... 35

Urban Unskilled Labor ............................................................................ ...... 38

Accounting Price of Skilled L abor............................................................... ...... 41

Labor and National Accounting Price S tudies.......................................... ...... 42

IV. MARGINAL PRODUCT OF PUBLIC IN V ESTM EN T................. 45

Estimating the Marginal Product of Public Investm ent......................... ...... 45

V. SOCIAL ACCOUNTING PRICES ......................................................... 49

General Expression of Social Accounting Price for an In p u t................. ......50

General Expression for Social Price of an O u tp u t.................................... ......52

Social Valuation W eight ( D ) ...............................................................................54

The Discount Rate at Social P ric e s....................................................................58

VI. SU M M A RY .............................................................................................. ......59

LIST O F R EFER EN C ES............................................................................. ......60

LIST OF TABLES

1.1 Accounting Price for Im ported Good with Constant Import

P ric e .............................................................................................................19

1.2 Accounting Price of Export with Constant Export Price................. ......21

1.3 Accounting Price for Electricity Valued at Marginal Cost

of S u p p ly ....................................................................................................25

1.4 Accounting Price Ratios for O utput Forgone at Purchasers'

P ric e s .................................................................................................... ......38

1.5 Possible Sources of Unskilled L a b o r................................................... ......39

INTRODUCTION

Investment projects can be evaluated from several points of view, depend￾ing upon who makes the investment decision. A private enterprise, forex￾ample, looks primarily at an investment from the point of view of financial

profitability. Hence, it uses market prices to value inputs purchased and

output sold during the project's lifetime. A public agency, on the other

hand, is mainly interested in the investment’s profitability from the point

of view of the economy as a whole and this may not be reflected in market

prices. The concern for national economic profitability i i introduced into

the appraisal by using special "accounting prices" Jo value project inputs

and output.

The term "accounting price" refers to a price that has been calculated

with certain objectives in mind, such as maximizing economic growth, im￾proving the balance of payments, and promoting employment oppor￾tunities, and that is consistent with a country’s development policies and

resource endowments. The accounting price of a good or service is thus a

measure of its real worth to the economy as a whole in terms of these ob￾jectives.

Market prices in developing economies are generally unreliable in￾dicators of the real worth of goods and services because of distortions in

markets where these products are bought and sold. For example, the

market price of foreign exchange typically understates its true value

because of government intervention in setting the exchange rate and

because of import controls and trade taxes. This situation leads to market

price distortions in all goods that enter foreign trade directly, and in

domestically produced goods that use traded inputs in their m anufacture.

Wage rates are another example: such factors as government legislation

and union bargaining often lead to a wage structure that is out of line with

the true cost of labor. Even when the market for an input or output func￾tions reasonably well, the m arket price may have to be replaced by an ac￾counting price if the project is so large relative to the market served that it

causes a price change. Neither the price that ruled before the project

5

6 O V E R V IE W O F T H E LM ST SY ST EM

started nor the new price that prevails afterward is the correct measure of

the good’s economic worth; the accounting price is somewhere in between.

The use of an accounting price to value a commodity or service is not

conditioned on the prior existence of a m arket price. Some outputs do not

have a readily identifiable market price, but still require valuation; a

classic example is the cost of environmental pollution stemming from in￾dustrial projects. A more conventional use of accounting prices is to value

the economic worth of public-sector projects that provide services without

charging a fee to the users—public highways, for example.

The structure of accounting prices has two levels: accounting prices for

resources whose value remains constant for all projects (often referred to

as national accounting prices or parameters); and accounting prices for

specific goods and services that are estimated by the economist in apprais￾ing a particular project. The national accounting prices are estimated by

agencies responsible for the overall management of public investment,

that are in a position to evaluate the macroeconomic situation and policies

of the country. This approach ensures a certain degree of consistency for

the national accounting prices. Consistency within the assortment of proj￾ect-specific accounting prices can be achieved by applying the same set of

estimation procedures to all pricing situations, and by making use of the

national param eters whenever the occasion warrants it. Viewed in this

way, the structure of accounting prices links the national development

plan to the decentralized process of evaluating and selecting projects that

implement the plan.

The accounting price system set forth in this chapter dates from the

work of I. M. D. Little and J. A. M irrlees1 and from the later efforts of

Lyn Squire and Herman G. van der T ak 2. The approach is referred to as

the L M S T accounting price m ethod; it is, with minor departures, the ap￾proach followed in the Inter-American Development Bank’s country

studies on national accounting param eters.

The LMST system distinguishes between two kinds of accounting

prices. The first kind is efficiency accounting prices. These prices are cal￾culated on the assumptions that an extra unit of consumption is as valu￾able as an extra unit of investment and that the marginal utility o l an ex￾tra unit of consumption does not vary with income level. The objective is

to value inputs and outputs so as to obtain the greatest amount of net

economic worth from each project financed, without regard to whom the

net benefits accrue.

The second kind of accounting prices is social accounting prices These

differ from efficiency accounting prices in that they incorporate the array

'L ittle and Mirrlees ( 1%8. 1974).

2Squire and van der T ak (1975).