Cost-benefit analysis in its "efficiency prices" version uses the PPI as the criterion for quantifying changes in "social welfare". In this section, a sum-mary of the various positions maintained in this regard will pave the way for those topics that are dealt with in later chapters. For that purpose, the example of alternatives A\ andA2 of project^, presented above, will be used, together with an additional one summarized in Table 1.3. There, B{ and B2 are also mutually exclusive alternatives for a project carried out by the Government, which would be financed by imposing additional taxes on the beneficiaries P and R for amounts of 20 and 80 respectively. In the situation without the project such taxes would not be levied, from which we deduce that B, is a strict Pareto improvement and B2 is a potential Pareto improvement, in both cases compared with the project not being carried out.
The first position, supported only implicitly in most cases, recommends using the distributional value judgment that attaches equal weights to the marginal income variations of all persons.7 In other words, presenting the results in the form of a single present value figure of net economic benefits valued at efficiency prices (the Total column). It is enough to know that the gainers receive more than enough to compensate the losers. In such cases, there is no need to worry about who the beneficiaries (losers) are nor, as a
7. The distributional problems would be tackled through fiscal policy. This is the position adopted by Harberger (1971b and 1973). However, see also Harberger (1978).
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PRINCIPLES AND DISTRIBUTIONAL VALUE JUDGMENTS
Table 1.3. Mutually Exclusive Alternatives for Project "B"
Alternative
result, what their net benefit (loss) is. Thus, in the case of project B the analyst would recommend that it be carried out, since both Bl and B2 are potential Pareto improvements. He would however go a step further and recommend that alternative B2 be carried out, since this represents a potential Pareto improvement in relation to B1. To do this, in his report he would only need to show the present value of the net economic benefits of both alterna-tives. In the case of project A (Table 1.2) he would recommend that the project be carried out and would say that both alternatives are equal from the
"economic" point of view. What is important to point out here is that even if the analyst agreed with Harberger (1971b) that economists are not profession-ally qualified to pronounce on the distributional aspects, he could not share that author's opinion that the interpersonal sum of the present values of indi-vidual CVs should be presented as the result of the analysis, since this would imply precisely what he would be trying to avoid.
A second position suggests that the gainers and the losers be identified and that the figure for the present value of changes in income, calculated the same way as in the previous case, be given together with the respective distribution.
In this way, this distributional effect would not remain hidden behind a single figure for the present value of the changes in net income. On the contrary, it would represent additional information for decision makers.8 Thus, in the case of project A, the analyst would present the results in a form similar to that given in Table 1.2, indicating that the alternatives differ only in the distribu-tion of the changes in income brought about between P and & In the case of project B, the analyst would restrict himself to submitting the results of Table 1.3 without recommending one alternative over the other, but leaving open the options of the decision maker to exercise distributional value judgments.
However, the reader must note that this procedure involves an infringement of
8. For example, Meade (1972) and Mishan (1982, Chapters 24 & 27, Section 2). However, making distributional effects explicit does not allow us to concur with Mishan (1982, p. 164) that
"the quantitative outcome of a cost-benefit calculation (based on the PPI, author's note) itself carries no distributional significance. It shows that the total of gains exceeds the total of losses, no more." As pointed out at the beginning of the chapter, calculating "total gains" requires a value judgment on which the aggregation criterion is based. Furthermore, given two situations without the project, which differ only in income distribution, the total of CVs of a project will depend on which of the two situations without the project is used as a basis for comparison.
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the potential Pareto improvement criterion, since B2 is one of these in relation to 5,.
A derivative of the position above, based on the principle of compensation implied in the concept of potential Pareto improvement, goes a step further by opening up the possibility for the project analyst to propose procedures that make compensation effective in order to convert the project into a strict Pareto improvement.9 In this way, the losers in both alternatives of project A (A\ and A2) can be compensated and the choice will depend probably on the compen-sation mechanism. In the case of project B, the analyst would recommend carrying out alternative B2, but at the same time he could propose compensa-tion mechanisms whose implementacompensa-tion costs would be less than 1. In other words, open up the possibility that a strict Pareto improvement be carried out.
However, once again this means an infringement of the potential Pareto improvement criterion each time that the cost of effecting compensation is positive. In the case of project B, alternative B2 is recommended as a potential Pareto improvement in relation to B,.
Let us now suppose that an exact compensation procedure is proposed whose cost is 0.10, with this alternative being indicated by B2C in Table 1.3.Then it is necessary for^? to transfer 10.1, of which 10 is used to compen-sate P and 0.1 to cover the costs of compensation. Since the potential Pareto improvement criterion does not require compensation to be made, B2 is one of these improvements in relation to B2C. In addition, it must be noted that there is no reason why compensation for the losers (P) should be exact (10), since one or more "over-compensation" mechanisms could also be proposed and two or more B2C{ obtained, each one of which would be an SPI whenever the cost of compensation was less than 1. Once again, it is impossible to avoid bringing distributional value judgments into: a) the definition of the compen-sation mechanisms; and b) the choice between PPIs and compensated PPIs. In a later work, Hicks (1975, Section 1) appears inclined to restrict the choice set to all the SPI and the compensated PPI which does not, as already mentioned, avoid distributional value judgments either. All this is without even consider-ing the possibility of discussconsider-ing redistribution mechanisms within SPIs.
In summary, it is not generally possible to effect a single ordering of alternatives without introducing distributional value judgments, among which is included "I don't care what happens with distribution." What has been presented so far has led to the discussion of ways of explicitly including distributional value judgments in, inter alia, the field of cost-benefit analysis.
Two of the best known ones will be presented here with the discussion being limited to project appraisal.
9. Hicks (1939, Section 7) and Mishan (1982, Chapter 27, Section 2).
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PRINCIPLES AND DISTRIBUTIONAL VALUE JUDGMENTS
The first approach within this second group proposes that either of the previous two be used, together with the task of identifying and explaining the value judgments revealed by the political authority in making decisions.10 If between At and A2 the second were chosen, it would be inferred that
meaning that wp > wr and consequently wp/wr > 1. If then fi, and B2 were considered and B2 were chosen, it could be inferred that
meaning that llwr > lOvv^ and consequently wp/wr < 1.1. In other words, and assuming that the decision had been taken for distributional reasons, after considering these two projects, the analyst would know that one additional unit of income for P is more valuable than for/?, but not by more than 10%. If the political authority is consistent in its distributional value judgments, after a number of decisions—not too many—the interval in which wp/wr would lie would have narrowed enough for all practical purposes to around a certain number u. From then on, the value found in this way could be used by the analyst, who would simply report the value of the net economic benefits calculated for wp/wr = u.
Finally, a welfare function W could be made explicit, depending on the utility functions of P and R,
in which C is the person's level of consumption, or, directly on individual consumption, W = f(Cr; Cp). In this way it would be possible to define how much "social welfare" increases by, when small changes occur in the income of each person or group of persons:
From this the values u = wp/wr would be extracted, which the analyst would use, then proceeding just as in the previous case."
10. See Weisbrod (1968), UNIDO (1972) and critiques by Stewart (1975) and Kornai (1979).
11. For example, Little and Mirrlees (1974), Squire and van der Tak (1977) and Lai (1980).
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1.6 Summary
At the beginning of this chapter, we suggested that efficiency analysis is based on a distributional value judgment that can be summarized as follows: an additional unit of income is equally valuable whatever the income level of the beneficiary. By using simple examples of the distribution of costs and benefits of hypothetical projects, it has proved possible to demonstrate this, and also to show, though only in outline form, the most widespread alternative criteria.
In Part III we shall return to the topic of distributional value judgments that are different from the one that assigns the same weights to the marginal income changes of all persons.
What is of interest to point out, is that all the alternatives to efficiency analysis require that the distribution of the income changes brought about by the project in question be estimated. This estimate is based on the principles of economic valuation used in cost-benefit analysis. In the following chapters the reasoning on which this valuation process is based will be discussed in some detail, with particular attention to those topics that are more often neglected in texts on efficiency analysis.