Project Analysis in Developing Countries, Study notes of Project Management

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Project Analysis in

Developing Countries

Steve Curry and John Weiss

PROJECT ANALYSIS IN DEVELOPING COUNTRIES

Project Analysis in

Developing Countries

Steve Curry Lecturer, Development and Project Planning Centre University of Bradford

and

John Weiss Senior Lecturer, Development and Project Planning Centre University of Bradford

M

© Steve Curry and John Weiss 1993

All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission.

No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 90 Tottenham Court Road, London WIP 9HE.

Any person who does any unauthorised act in relation to this publication may be liable to criminal prosecution and civil claims for damages.

First published 1993 by THE MACMILLAN PRESS LTD Houndmills, Basingstoke, Hampshire RG21 2XS and London Companies and representatives throughout the world

Reprinted (with corrections) 1994

ISBN 0-333-49450-4 hardcover ISBN 0-333-61204-3 paperback

A catalogue record for this book is available from the British Library.

Printed in Great Britain by Antony Rowe Ltd Chippenham, Wiltshire

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Contents

List of Figures xii

List of Tables xiii

Preface xvi

1 Introduction 1 Basic ideas 1 Application of project analysis 3 Project analysis and national planning 5 The project planning process 6 Outline of the book 8

2 Main Features of Projects, Project Resource Statements and Financial Statements 11 Project viewpoints Prices Types of project Conventions used in drawing up project resource statements Some project resource flows Resource statements and financial statements Discounting Estimating an appropriate discount rate Conclusion

Appendix 2.1 Discount Factors, Annuity Factors and Capital Recovery Factors 41

3 Project Criteria 44 Project criteria for single projects 44 Project alternatives 53 Conclusion 71

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Contents IX

Approximations in both systems 137 Traded goods in a domestic price system 140 Non-traded goods in a domestic price system 141 Unskilled labour in a domestic price system 145 Skilled labour in a domestic price system 146 Land and the discount rate in a domestic price system 147 Future devaluation of the domestic currency 148 Conclusion 149

Appendix 6.1 PSF Case Study in a Domestic Price Analysis 150 Appendix 6.2 Domestic Resource Cost (DRC) Ratio 160

7 Non-traded Outputs and External Effects 164 Benefit valuation in non-traded activities Willingness to pay Benefit valuation - an example from transport Benefits from generated output - an illustration from irrigation External effects Linkages Labour training Technical progress Environmental effects Illustration of externalities Conclusion

Appendix 7.1 Demand Curve Estimation for Benefit Valuation 183

8 Uncertainty 187

Sensitivity analysis 188 Risk analysis 193 Reducing risk 197 Conclusion 198

X Contents

List of Figures

List of Tables xv

• Appendix 3.1 Estimation of Internal Rate of Return - Return More than One Internal Rate of
  • Prices 4 National Economic Returns and the Use of Shadow
• Transfers and other adjustments
• values Shadow prices: the use of trade opportunity cost
• An illustration using conversion factors
• Shadow pricing and the numeraire
  • Decision-making with alternative sets of prices
• Conclusion
• 5 World Price System of Economic Analysis
  • Traded and non-traded commodities
  • Valuation of traded goods
    • Border parity pricing
  • Valuation of non-traded goods
  • Non-traded inputs in variable supply
  • Non-traded inputs in fixed supply
  • Standard or average conversion factor (ACF)
    • Labour in a world price system
  • Workers in excess supply
    • Workers in excess demand
    • Land in a world price system
  • The discount rate - alternative approaches
  • Conclusion - Plant Appendix 5.1 Case Study Polyester Staple Fibre
• 6 Domestic Price System of Economic Analysis
  • Choice of price units
  • Shadow exchange rate
    • Equivalence of world and domestic price systems
  • 9 Income Distribution Effects of Projects - Estimating income flows from financial statements - Estimating income flows from resource statements - Regional income effects - Foreign participation in projects - Projects with important distributional effects - Conclusion
• 10 Savings and Income Distribution - Constraints and objectives - The numeraire - Mechanics of savings and distributional adjustments - The savings premium - Consumption weighting - Weights and the numeraire - Adjusted discount rate - Limitations of weighting systems - Conclusion
• 11 National Economic Parameters - approach Conversion factors in a semi-input-output (SIO) - Illustration of a SIO application - Advantages of the SIO approach - Data requirements - The discount rate - Some national parameter studies - Conclusion - Appendix 11.1 Semi-Input-Output System - Analysis Appendix 11.2 Weighted Conversion Factors in SIO
• 12 Limitations and Conclusions - The value system in project analysis - World prices and dynamic effects
• 2.1 Project benefits and costs: different types of project - (E) life 2.2 Project life: technical (7), market (M) and economic
• 2.3 Economic life of a project
• 2.4 Operating costs
• 2.5 Project resource profiles 29-
• 3.1 Benefit-cost ratio lines
• 3.2 Net present value curves
• 3.3 NPV curves: different points of view
• 3.4 NPV curves: project alternatives
• 3.5 Project cost alternatives
• 3.6 Incremental resource flow
• 3.7 Incremental resource cost flow - calculations 4.1 Conflicting decisions: market and shadow price - calculations 4.2 Alternative results: market and shadow price - pricing 5.1 Transport and distribution element in border parity
• 6.1 Equivalence of world and domestic price system
• 7.1 Willingness to pay
• 7.2 Demand for transport
  • 7A.1 Identifying a demand curve from the price elasticity - elasticity 7A.2 A shift in the demand curve at a constant price
  • 7A.3 A shift in the demand curve with a constant slope
  • 10.1 Dimensions of the numeraire
    • 11.1 SIO table - direct coefficients
    • 2.1 Project perspectives and statements List of Tables
  • 2.2 Project investment costs
  • 2.3 Working capital calculation
  • 2.4 Carton project - resource flow statement
  • 2.5 Project financial statement
  • 2.6 Applying a discount factor as a weight
  • 2.7 Discounting a net benefit stream
  • 2.8 Discounted resource statement
  • 2.9 Discounting and time profiles
  • 2A.1 Discounting a constant annual amount
  • 3.1 Resource statements: project criteria
  • 3.2 Textile plant: different points of view
  • 3.3 Resource statements: project alternatives
  • 3.4 Comparison of NPV and BCR criteria
  • 3.5 Inconsistent results: NPV and IRR - statements 3.6 Cost effectiveness: pipeline alternatives cost
  • 3.7 Incremental resource statement
  • 3.8 Incremental resource cost statement
  • 3.9 Resource statements and investment constraint
• 3.10 Project criteria: investment fund constraint
• 3.11 Project criteria: adjusted discount rate - internal rate of return 3A.1 Illustration of a resource flow with more than one
• 4.1 Application of conversion factors
• 4.2 Alternative numeraires for shadow price values
• 4.3 Decision combinations at market and shadow prices - activity - electricity 5.1 Illustration of conversion factor for non-traded
• 5.2 Estimated returns to land at world prices
• 5.3 Use of world prices
• 5A.1 Market prices of key traded goods
• 5A.2 Resource statement for PSF project
• 5A.3 Estimated ACF
• 5A.4 Conversion factors for main traded commodities
  • 9.5 Regional income effect
  • 9.6 New income changes with foreign financing - foreign investment 9.7 New income changes with foreign financing and
• 9.8 Income changes operating profit with foreign labour - investment and foreign labour 9.9 New income changes with foreign financing, foreign - Investment, foreign Labour and foreign management 9.10 New income changes with foreign financing, foreign
  • 10.1 Project example: income flows
  • 10.2 Sensitivity of v to / (using equation 10.3)
    • and c/c'j 10.3 Consumption weights for different values of n
  • 10.4 Project beneficiaries consumption weights
  • 10.5 Income adjustment: consumption numeraire
  • 10.6 Income adjustment: savings numeraire
  • 11.1 SIO - direct coefficients
    • productive sectors 11.2 Total primary factors per unit of output in
  • 11.3 Full CF results
  • 11.4 Net return to capital (g) Jamaica 1980-82
  • 11.5 Results of NEP studies
  • 11A.1 Revised SIO table - direct coefficients
• 11 A.2 Weighted full CF results

Preface

Project analysis has grown up in the last thirty years and has been widely adopted particularly in the external funding of public sector projects. Analyses are undertaken from different points of view, the scope varying according to different applications. The focus of this book is on economic project analysis in developing countries, and is complementary to financial and more recent environmental or social analyses. There are several reasons for concentrating only on the economic analysis of projects. First, there is a relatively coherent body of economic theory to rely on. Secondly, existing texts on the economic analysis of projects are too theoretical in their approach. Here we have tried to combine the application of project analysis methods with their theoretical underpinnings. Finally, in recent years there has been considerable progress in the estimation of national parameters for use in the economic analysis of projects, which gives a firmer base to their application in developing countries. In addition, it is the authors' view that the identification of projects that are economically worthwhile is the appropriate basis for their selection, to which the analysis of other project effects must be related. Some of the developments in this area have been facilitated by the development of microcomputing. The ways in which microcomput- ing techniques can be used for project analysis is again a subject in its own right, and although it is not dealt with here the application of the methods we discuss can be done most accurately using microcomputers. This book arises not only from the consideration of developments in the economic analysis of projects of the last few years, but also from a sizeable period of applying and teaching the methods described. Several groups of postgraduate and post-experience students at the Development and Project Planning Centre of the University of Bradford have been subjected to expositions of the material in different forms, and their reactions to it have been much appreciated. The authors have benefited also from the general interest in the subject by several colleagues.

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1 Introduction

Project analysis involves estimating and comparing the beneficial effects of an investment with its costs. Such a comparison is done within a broader economic framework that provides the basis on which full costs and benefits are identified and valued. Project analysis originated more than fifty years ago, the main ideas developing simultaneously in different places. The last thirty or so has witnessed an extensive application of project analysis methods, particularly in developing countries. This introductory chapter provides a brief outline of the basic ideas of project analysis, and the way in which their application has developed. These basic ideas are also situated in the broader process of project planning.

BASIC IDEAS

The basic ideas of project analysis have a long history, but they became clear only with the first applications. These occurred simultaneously in different economic contexts. In the United States in the 1930s a problem was formulated in relation to water resource investments. The costs of investing in and running such projects were relatively straightforward to estimate; what was not so straightforward was an estimate of the benefits water resource investments would generate. The beneficial effects distributed between many different types of user first had to be identified and then valued. Moreover, there was no market in water provision which could yield an appropriate price to value water. At this time, guidelines were established for estimating the benefits and costs of water resource projects. In the context of a capitalist economy in recession, this use of project analysis can be described as extending quasi-market criteria to an area of infrastructure services where the full characteristics of a competitive market could not be established. This can also be viewed from a closely related but different perspective. It is no accident that this application was in the provision of services within the public sector. In a capitalist economy there is competition for resources between the public