Social Cost Benefit Analysis of an Auto Ancillary Project

Abstract

The national development financial institutions (DFIs) carry out social cost benefit analysis (SCBA) using partial Little and Mirrlees' methodology for projects costing over Rupees five crores. They compute Economic rate of return (ERR) Domestic resource cost (DRC), and Effective rate of protection (ERP) in respect of these projects. A widespread feeling is that the information requirements for a full-fledged SCBA on the basis of either UNIDO Guidelines or Little and Mirrlees' Manual are so large that these cannot be applied in case of the developing economies. Thus State Industrial Development Corporations (SIDCs) do no carry out SCBA at all, while DFIs do it only selectively and partially.

This paper is the result of a belief that an operational methodology along with a suitable computer program can be formulated for either of the two approaches, which can be used to appraise projects of DFIs. It carries out a detailed SCBA of an Auto-Ancillaries Project of an SIDC on the basis of UNIDO Guidelines (1972) in three stages. In stage I the benefits and cost are calculated at shadow prices without making adjustment for the project's impact on savings and investment. In the second stage an adjustment is made for the project's impact on savings and investment; and in the third stage a premium is given for the benefits flowing to the backward area in which the project is located. Sensitivity analysis has been performed with respect to the social rate of discount, premium on foreign exchange, premium on skilled labour component, premium on unskilled labour component, marginal productivity of capital, marginal propensity to save, input prices, output prices, capacity utilization and redistribution premium.

The Auto-Ancillary project in the present form is an outcome of diversification and expansion programmes. Three clear stages of diversification can be identified in response to the dynamic charges in the techno-economic environment.

The SCBA reveals that the project at stage I is not socially desirable under the original estimates. A high premium of 4.86 on redistribution benefits is necessary to make the project socially viable under original estimates, taking the most favorable combinations of the values of national parameters. By expanding its operations, the project at stage II becomes socially desirable by assigning a small premium of 0.22 to the redistribution benefits, under the most favorable combinations of national parameters. By diversifying the operations, the project at stage III becomes still more attractive socially. It yields a minimum social return of 10.78% and a maximum of 27.25%, even when no premium is assigned to the redistribution benefits. Thus, the project becomes socially and economically viable by expanding and diversifying its operations.

Keywords: Social Cost Benefit Analysis, Auto-Ancillary Project, India

JEL Classification: G20, G21, G28