The concept of Project Evaluation

Reading

The textbook for this part of the course is Guidelines for Project Evaluation (found in the Fronter archive for the course). You have to be logged onto the Fronter classroom  to obtaine the pdf-files.

Start to read from the first three chapters (yellow background indicates compulsory reading):

• Chapter 1: The rationale for social benefit-cost analysis
  1.1 Project choice and national planning
  1.2 Basic differences between commercial calculations and social benefit cost analysis
  1.3 National parameters
  1.4 Significance of social benefit-cost analysis
  1.5 Institutional framework
  
• Chapter 2: Commercial profitability and its limitations
  2.1 Commercial profitability
  2.2 Limitations of commercial profitability
  2.3 Profit maximization and efficiency
  
• Chapter 3: National economic profitability
  3.1 Social benefit-cost analysis and national economic profitability
  3.2 Goals, objectives, benefits and costs
  3.3 Aggregate national economic profitability
  

Have a look at the advise on practical cost and benefit measurement:

• Chapter 4: Aggregate-consumption objective: measurement of direct benefits
• Chapter 5: Aggregate-consumption objective: measurement of direct costs
• Chapter 6: Measurement of indirect benefits and costs
  

   Basics:

• A project is an investment activity where labour and/or capital is spent to create producing asset from which we can expect future benefits. A project is characterised by
  
  
  • Specific starting and ending points
  • Its major costs and returns are measurable
  • It should have a specific geographic location
  • It should have a specific clientele group
  • It should have a well defined time sequence of investment and production activities
    
    
• IMPORTANT: 
• Discounting
• Externalities
  
  

A project overview is often presented by Gantt charts, as in the figure below, where the different activities are planned in time.

From the introduction of chapter 1:

Project choice and national planning

For a private commercial entrepreneur project choice is a rather simple exercise. If he knows his own objectives, which seems to be a reasonable assumption, all he has to do is to ascertain which projects satisfy his objectives best. For a planner the picture is somewhat more complex. In choosing projects he has to ascertain which ones best satisfy the interests and objectives of the nation. His personal objectives are fairly unimportant; he must choose the best thing for the society. This is complex not merely because the national interests are not easy to define, but also because the reading of these interests by different planners may well be different. If different planners pursue different national objectives, the result may be unsatisfactory and conceivably disastrous.

The main reason for doing social benefit-cost analysis in project choice is to subject project choice to a consistent set of general objectives of national policy. The choice of one project rather than another must be viewed in the context of their total national impact, and this total impact has to be evaluated in terms of a consistent and appropriate set of objectives. The avoidance of a complete dichotomy between project choice and national planning is one of the main reasons for doing social benefit-cost analysis. When one project is chosen rather than another, the choice has consequences for employment, output, consumption, savings, foreign exchange earning, income distribution and other things of relevance to national objectives. The purpose of social benefit-cost analysis is to see whether these consequences taken together are desirable in the light of the objectives of national planning.

Basic differences between commercial calculations and social benefit-cost analysis

A commercial firm faces specific prices (or demand and supply conditions) and does not need to go into the question of what these prices represent for the nation as a whole. If a specific soap costs 1 shilling a bar, or if a particular type of cigarette sells at 2 shillings a packet, the manufacturer of the soap or cigarettes gets some hard information from this. For a planner, however, this information is really very "soft", and he needs to go deeper to ascertain what these prices mean. Does the price of cigarettes take account of the smokers' higher probability of heart disease or cancer? Does the price of soap take note of the benefits that others receive from people's use of soap, e.g., the reduced risk of spread of disease, or the advantage of not having to travel with dirty fellow passengers? For the commercial entrepreneur these questions may be interesting as a pastime, but for a public-project planner they are crucial questions that should influence his decisions.

By the very nature of his work a commercial entrepreneur can confine his thoughts to a rather limited range of effects, but a planner on behalf of the country must, of necessity, take a wider view. This point is simple enough, but it is often overlooked when one contrasts the quick and clear-cut decisions of private entrepreneurs with the rather slow and cumbersome exercises of public-project evaluation. The two jobs are not really comparable. This is not to say that multiplicity of objectives is an exclusive characteristic of public-project evaluation. Most economic agents have many objectives. An entrepreneur may try to get more profits, but may also be interested in being big and having a large volume of sales. A worker may wish to earn more, but may also desire more leisure. While the reconciliation of these different objectives does involve problems, the job is likely to be much more complex for a planner who has to seek an appropriate compromise between the various divergent objectives and goals of national planning. These objectives may severely conflict with each other, since the nation is a collection of diverse groups with different interests. The problem cannot be casually dismissed, and social benefit-cost analysis must face the problem of multiple objectives of diverse types.

Even the choice of a rate of interest to discount future social benefits reflects a particular compromise of the conflicting interests of different generations. For a commercial firm the rates of interest may simply reflect the rates at which it can lend or borrow. But to a planner interest rates must be viewed as a method of apportioning benefits and costs to different time periods, and possibly between different generations. He has to compare the value of benefits today with that of benefits in the future. Thus, the contrast between commercial decision making and the planning of projects on behalf of the nation is simple but important. The latter would appear usually to be a much more complex exercise than the former, and the techniques used in the former exercise may be unhelpful in the latter. The approach of social benefit-cost analysis is aimed precisely at systematizing the complex problems of project planning from the point of view of the society or the nation.

Random article on Economics from Encyclopedia Britannica: