Benefit-Cost Analysis: Introduction and Overview
Social benefit-cost analysis is a process of identifying, measuring and comparing the social benefits and costs of an investment project or program. A program is a series of projects undertaken over a period of time with a particular objective in view. The project or projects in question may be public projects – undertaken by the public sector – or private projects. Both types of projects need to be appraised to determine whether they represent an efficient use of resources. Projects that represent an efficient use of resources from a private viewpoint may involve costs and benefits to a wider range of individuals than their private owners. For example, a private project may pay taxes, provide employment for the otherwise unemployed, and generate pollution. These effects are termed social benefits and costs to distinguish them from the purely private costs and returns of the project. Social benefit-cost analysis is used to appraise private projects from a social viewpoint as well as to appraise public projects.
It should be noted that the technique of social benefit-cost analysis can also be used to analyse the effects of changes in public policies such as the tax/subsidy or regulatory regimes. However a very broad range of issues can arise in this kind of analysis and, for ease of exposition, we adopt the narrower perspective of project analysis in this study.
Public projects are often thought of in terms of the provision of physical capital in the form of infrastructure such as bridges, highways and dams. However there are other less obvious types of physical projects that augment environmental capital stocks and involve activities such as land reclamation, pollution control, fishery management and provision of parks. Other types of projects are those that involve investment in forms of human capital, such as health, education, and skills, and social capital through drug-use and crime prevention, and the reduction of unemployment. There are few, if any, activities of government that are not amenable to appraisal and evaluation by means of social benefit-cost analysis.
Investment involves diverting scarce resources – land, labour and capital – from the production of goods for current consumption to the production of capital goods which will contribute to increasing the flow of consumption goods available in the future. An investment project is a particular allocation of scarce resources in the present which will result in a flow of output in the future: for example, land, labour and capital could be allocated to the construction of a dam which will result in increased electricity output in the future (in reality there are likely to be additional outputs such as irrigation water, recreational opportunities and flood control but we will assume these away for the purposes of the example). The cost of the project is measured as an opportunity cost – the value of the goods and services which would have