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3. Pricing Project Costs and Benefits
Once costs and benefits have been identified, if they are to be compared they must be valued. Since the only practical way to compare differing goods and services directly is to give each a money value, we must find the proper prices for the costs and benefits in our analysis.
Prices Reflect Value
Underlying all financial and economic analysis is an assumption that prices reflect value-or can be adjusted to do so. In this chapter we will discuss how to find these prices. Before proceeding, however, it is necessary to define two economic concepts crucial to project analysis: marginal value product and opportunity cost.
Consider a Filipino farmer who applies nitrogenous fertilizer to his rice. In the 1979-80 season this fertilizer cost him P3.98 per kilogram of elemental nitrogen (N), and he received P1.050 for every kilogram of paddy rice he sold. (The symbol for Philippine pesos is P.) Table 3-1 shows the responsiveness of his rice to fertilizer. At low levels of application, fertilizer has a great effect on rice yield. Increasing the application from no fertilizer to 10 kilograms of elemental nitrogen increased the farmer's
Personal communication from Pedro R. Sandoval, University of the Philippines at Los Banos, September 1980. Rice responses are based on Changes in Rice Farming in Selected Areas of Asia (Manila: International Rice Research Institute, 1978), p. 61. Maize responses are based on University of the Philippines at Los Banos Experiment Station records. Prices are from the Bureau of Agricultural Economics, Ministry of Agriculture, Republic of the Philippines.
a. The farm-gate price of elemental nitrogen (N) in 1979-80 was F3.98 per kilogramb. The farmgate price of paddy rice in 1979-80 was F1.050 per kilogram.c. The marginal value product is the extra revenue that comes from increasing the quantity of an input used by one unit, all other quantities remaining constant. In this instance, the marginal value product is the increased value of paddy rice or shelled maize from using 1 additional kilogram of elemental nitrogen. Note that in this table the interval between levels of elemental nitrogen is 10 kilograms. Thus, the marginal value product of elemental nitrogen applied to rice between the 60- and 70-kilogram levels of application is the difference in value of output between the two levels divided by 10, or P8.80 [(4,957 - 4,869) - 10 = 8.80].d. The farm-gate price of shelled yellow maize in 1979-80 was P1.034 per kilogram.e. Beyond application of 100 kilograms of elemental nitrogen, all marginal value products for paddy rice are negative; therefore, figures for these applications of nitrogen to rice are not reported.
yield from 3,442 kilograms to 3,723 kilograms per hectare and increased the value of his output by P295, from P3,614 to P3,909. Thus, for every additional kilogram of elemental nitrogen the farmer applied at this level, he received P29.50 in return [(3,909 - 3,614) _ 10 = 29.50]. The extra revenue from increasing the quantity of an input used, all other quantities remaining constant, is the marginal value product of the input. In this case, then, the marginal value product of a kilogram of fertilizer is P29.50.
If the farmer could buy fertilizer for P3.98 a kilogram and use it to increase output by PP9.50, it obviously would have paid him to apply more. But as the intensity of application increases, each additional kilogram of fertilizer has less and less effect on production. If the farmer had increased his application from 80 to 90 kilograms per hectare, he would have increased the value of his production by only P20, from P5,011 to P5,031, and the marginal value product of a kilogram of fertilizer would have fallen to only P2.00 [(5,031 - 5,011) - 10 = 2.00]. Since he would have had to pay P3.98 per kilogram, it clearly would not have been worthwhile to apply fertilizer at this rate. In fact, it would only have paid the farmer to apply fertilizer up to the rate at which the marginal value product just equaled the price. For this Filipino farmer, it would have paid him to apply approximately 80 kilograms of nitrogen: between 70 and 80 kilograms the marginal value product of each additional kilogram was some P5.40, whereas between 80 and 90 kilograms it fell to P2.00. Thus, the farmer would have expanded his fertilizer use until he reduced the marginal value product of the fertilizer to its market price, and the market price, therefore, is an estimate of the marginal value product of the fertilizer.
The optimal amount of fertilizer to use will change, of course, when the price of fertilizer changes relative to the price of rice. If the relative price of fertilizer were to rise, the farmer would respond by reducing the amount of fertilizer he applies, increasing the marginal value product of the fertilizer (but reducing the total amount and value of production) until the marginal value product of the fertilizer again just equals its price. Suppose fertilizer were to double in price to P8.00 per kilogram of elemental nitrogen, and rice prices remained unchanged. Then, table 3-1 indicates the farmer should reduce the amount of fertilizer applied to a hectare from 80 kilograms to 70 kilograms, since between 60 and 70 kilograms the marginal value product was some P8.80 but between 70 and 80 kilograms it was only some P5.40.
In practice, because of risk and limited resources, the farmer would probably not have applied the amounts indicated here. We may consider that the farmer reduces his expected return by some "risk discount." Even so, the principle we are illustrating remains the same: the farmer equates the expected marginal value product less some risk discount to the price of fertilizer.
If this farmer also grew maize, for which in 1979-80 he would have received P1.034 per kilogram of shelled grain, table 3-1 indicates it would have paid him (in the absence of risk) to apply some 100 kilograms of elemental nitrogen to each hectare, because between 90 and 100 kilograms the marginal value product of a kilogram of nitrogen applied to maize was P5.20, whereas between 100 and 110 kilograms the marginal value product fell to P3.10, below the price of fertilizer.
Now, suppose the farmer had limited resources and could not obtain sufficient credit to increase his fertilizer application on both rice and maize to where the marginal value product equaled the price. Suppose the farmer had only 2 hectares, 1 planted in rice and 1 in maize, and resources sufficient to purchase just 80 kilograms of nitrogen. How should he have used it? Should he have put it all on rice and none on maize? If he did, he would have applied fertilizer to his rice at the level where the marginal value product was just about equal to its market price. But suppose he had shifted some fertilizer, instead, to maize. If he had shifted 10 kilograms, he would have reduced the value of his rice production by P54- from P5,011 to P4,957, or by P5.40 for each kilogram shifted-but he could have obtained some P238 for the 10 kilograms applied to maize, since the marginal value product between 0 and 10 kilograms was some P23.80 per kilogram. In other words, at these levels each kilogram of nitrogen shifted would reduce the rice value by P5.40 but increase the value of maize output by some P23.80. In the language of economics, the opportunity cost of fertilizer shifted from rice to maize was P5.40. Opportunity cost, thus, is the benefit forgone by using a scarce resource for one purpose-in this case applying fertilizer to maize-instead of for its best alternative use-in this case using the fertilizer to produce rice. Said another way, the opportunity cost is the return a resource can bring in its next best alternative use. What would be the opportunity cost if the farmer were to move a kilogram of fertilizer in the other direction, back from maize to rice? He would have given up P23.80 to gain only P5.40-not a very attractive proposition-and the opportunity cost, obviously, would be some P23.80.
Given his limited resources, it would pay the farmer to shift fertilizer from rice to maize until the marginal value product of fertilizer applied to both crops is the same. In the case of the Filipino farmer who could buy only 80 kilograms of fertilizer, if on the one hand he were to move 40 kilograms to maize, reducing his application on rice from 80 kilograms to 40 kilograms, he would have increased the marginal value product of the fertilizer on his rice to some P15. On the other hand, the 40 kilograms shifted away from rice and put on maize would have decreased the marginal value product of nitrogen applied to maize also to about P15. At these levels, there would be no advantage in shifting fertilizer between the two crops-the opportunity cost of shifting more fertilizer from rice to maize would be about P15, but the gain would also be only about P15-and the farmer would have reached the optimal level of application to both crops.
Note, however, that if the farmer could somehow have bought as much fertilizer as he wanted at the market price of P3.98 per kilogram-perhaps through a credit program-then the market price of fertilizer would have become its opportunity cost, and (in the absence of a risk discount) he should have increased his application to 80 kilograms on rice and 100 kilograms on maize.
From a single farmer to the economy as a whole, the same principles apply. In a "perfect" market-one that is highly competitive, with many buyers and sellers, all of whom have perfect knowledge about the market-every economic commodity would be priced at its marginal value product, since every farmer will have expanded his fertilizer use to where its marginal value product equals its price, and the same will have happened for every other item in the economy. That is, the price of every good and service would exactly equal the value that the last unit utilized contributes to production, or the value in use of the item for consumption would exactly balance the value it could contribute to additional production. If a unit of goods or services could produce more or bring greater satisfaction in some activity other than its present use, someone would have been willing to bid up its price, and it would have been attracted to the new use. When this price system is in "equilibrium," the marginal value product, the opportunity cost, and the price will all be equal. Resources will then have been allocated through the price mechanism so that the last unit of every good and service in the economy is in its most productive use or best consumption use. No transfer of resources could result in greater output or more satisfaction.
Without moving further into price theory, we can consider some direct implications for agricultural projects of the assumption that prices reflect value.
First, as everyone knows, markets are not perfect and are never in complete equilibrium. Hence, prices may reflect values only imperfectly. Even so, there is a great deal of truth in this price theory based on the model of perfect markets. In general, the best approximation of the "true value" of a good or service that is fairly widely bought and sold is its market price. Somebody in the economy is willing to pay this price. One can presume that this buyer will use the item to increase output by at least as much as its price, or that he is willing to exchange something of value equal to the price to gain the satisfaction of consuming the item. Hence, the market price of an item is normally the best estimate of its marginal value product and of its opportunity cost, and most often it will be the best price to use in valuing either a cost or a benefit. In financial analysis, as we have noted, the market price is always used. But in economic analysis some other price-a "shadow price"-may be a better indicator of the value of a good or service; that is, a better estimate of its true opportunity cost to the economy. When prices other than market prices are used in economic analysis, however, the burden of proof is on the analyst.
Finding Market Prices
Project analyses characteristically are built first by identifying the technical inputs and outputs for a proposed investment, then by valuing the inputs and outputs at market prices to construct the financial accounts, and finally by adjusting the financial prices so they better reflect economic values. Thus, the first step in valuing costs and benefits is finding the market prices for the inputs and outputs, often a difficult task for the economist.
To find prices, the analyst must go into the market. He must inquire about actual prices in recent transactions and consult many sources-farmers, small merchants, importers and exporters, extension officers, technical service personnel, government market specialists and statisticians, and published or privately held statistics about prices for both national and international markets. From these sources the analyst must come up with a figure that adequately reflects the going price for each input or output in the project.
Point of first sale and farm-gate price
In project analysis, a good rule for determining a market price for agricultural commodities produced in the project is to seek the price at the "point of first sale." If the point of first sale is in a relatively competitive market, then the price at which the commodity is sold in this market is probably a relatively good estimate of its value in economic as well as financial terms. If the market is not reasonably competitive, in economic analysis the financial price may have to be adjusted better to reflect the opportunity cost or value in use of the commodity.
For many agricultural projects in which the objective is increased production of a commodity, the best point of first sale to use is generally the boundary of the farm. We are after what the farmer receives when he sells his product-the "farm-gate" price. The increased value added of the product as it is processed and delivered to a market arises as a payment for marketing services. This value added is not properly attributed to the investment to produce the commodity. Rather, it arises from the labor and capital engaged in the marketing service. Usually the price at point of first sale can be accepted as the farm-gate price; even if this point is in a nearby village market, the farmer sells his output there and thus earns for himself any fee that might be involved in transporting the commodity from the farm to the point of first sale. But if any new equipment is necessary to enable the farmer to do this-say, a new bullock cart or a new truck-then that new equipment must be shown as a cost incurred to realize the marketing benefit in the project.
In projects producing commodities for well-organized markets, the farm-gate price may not be too difficult to determine. This would be true for most food grains traded domestically in substantial quantities. One may think of wheat in most countries of the Middle East and South Asia, of rice in South and Southeast Asia, and of maize in much of Latin America. It would also be true of farm products for which the processor is generally the first buyer (such as fresh fruit bunches for palm oil in Malaysia or milk in Jamaica), where the price quoted to the farmer is the price on his farm, and the firm responsible for the marketing comes to the farm to pick up the product.
In many cases, however, the prices in a reasonably competitive market or in the price records kept by the government statistical service will include services not properly attributable to the investment in the project itself. This may happen, for instance, when the only price series available for a product records the prices at which it has been sold in a central market-such as the price for eggs in Madras, for melons in Tehran, or for vegetables in Bogota. In that case, the project analyst will have to dig deeper to find out how to value the marketing services. Then he can adjust the central market price to reduce it to the farm-gate price.
The farm-gate price is generally the best price at which to value home-consumed production. In some cases it may be extremely difficult to determine just what a realistic farm-gate price is for a crop produced primarily for home consumption because so little of the crop appears on markets. This is the case, for example, for manioc and cocoyam in Africa. On the one hand, some argue that the true value of the crop is overstated if the market price is used as a basis for valuation because such a small proportion of the product is actually sold. On the other hand, the same crop in different situations may not be so difficult to value. Manioc is sold extensively in Nigeria to make gari flour, and it is commonly traded in local markets in tropical Latin America and the Caribbean.
The farm-gate price may be a poor indicator of the true opportunity cost we want to use in economic analysis. In Ghana the Marketing Board takes some proportion of the cocoa price as a tax for development purposes. In Thailand, a rice "premium"-that is, a tax on rice exports-effectively keeps the domestic price well below what the international market would pay. In these cases, when the commodity is traded its economic value would have to be considered higher than the actual farm-gate price, and this price distortion will have to be corrected in the economic analysis. In other cases, just the opposite happens. In Mexico the price of maize is maintained at a high level to transfer income to ejidatarios, the small farmers. In Malaysia, the price of rice is supported above world market levels to encourage local production and to reduce imports. In these cases, part of the price does not really reflect the economic value of the product-its cost if it could be imported-but rather an indirect income transfer to small farmers. Again, this price distortion will have to be corrected in the economic analysis.
Pricing intermediate goods
By emphasizing the point of first sale as a starting point for valuing the output of our projects, we are also implying that imputed prices should be avoided for intermediate goods in our analysis. An intermediate good is an item produced primarily as an input in the production of another good. If an intermediate good is not freely traded in a competitive market, we cannot expect to obtain a price established by a range of competitive transactions. Fodder produced on a farm and then fed to the dairy animals on the farm is an example of such an intermediate product. If increased fodder production is an element in the proposed agricultural project, the analyst would avoid valuing it. Instead, the analyst would treat the whole farm as a unit and value the milk produced at its point of first sale or value the calves sold as feeder cattle. Treatment of intermediate products will vary from project to project depending on the particular marketing structures. In some countries it would hardly make sense in an egg production project to value the pullets produced in a pullet production enterprise and then "sell" these pullets to the egg production enterprise on the same farm. But in other countries there might be an active market in pullets, which would mean that we could expect to find a reasonably competitive price to use in the economic analysis. To avoid most of the problems that might be introduced by trying to impute values for intermediate products, the financial accounts in agricultural projects are based on budgets for the whole farm instead of on budgets for individual activities on the farm; that is, on the budget for the egg farm as a whole rather than on the budget for a pullet production activity.
A frequently encountered intermediate good in agricultural projects is irrigation water. The "product" of an irrigation system-water-is, of course, really intended to produce agricultural commodities. The price farmers are charged for the water is generally determined administratively, not by any play of competitive market forces. If the analyst were to try to separate the irrigation system from the production it makes possible, he would be faced with a nearly impossible task of determining the value of irrigation water. Hence, it is not surprising that the economic analyses of most irrigation projects take as the basis for the benefit stream the value of the agricultural products that are offered in a relatively free market at the point of first sale.
Other problems in finding market prices
Considerable confusion often arises in determining the values for two important inputs in agricultural projects, land and labor. This happens primarily when the analysis moves from the financial project accounts to the economic analysis (to which we will turn in chapter 7). In the accounts prepared for the financial analysis, the treatment of prices for land and labor is quite straightforward: the price used is the price actually paid. Thus, if the farmers in a settlement project are expected to pay the project authority a price for the land they acquire, perhaps through a series of installments, then the actual price in the year it is paid is entered in the project accounts. In the financial analysis, we do not question whether this is a "good" price in economic terms. Similarly, if land must be bought for the right-of-way for canals in an irrigation project, the actual price to be paid is entered in the project accounts in the financial analysis. Or, if the project includes tenant farmers who will receive help in increasing wheat production, then in the financial accounts for these tenant farmers the analyst will enter the rent paid each year at the amount actually paid, or at the farm-gate value of the wheat delivered to the landowner if the tenants pay rent in kind.
If farm accounts are laid out on a with-and-without basis following the format suggested in chapter 4, in those instances where the project involves only changing the cropping pattern (say, a shift from pasture to irrigated sorghum), the cost of the land (in this instance an opportunity cost) need not be separately entered because of the form of the account. When the net benefit without the project is subtracted from the net benefit with the project, the contribution of the land to the old cropping pattern is also subtracted and only the incremental value remains.
In valuing labor for the financial analysis accounts, again, the problems arise when the financial accounts are adjusted to reflect economic values. For financial analysis, the analyst enters the amounts actually paid to hired labor, either in wages or in kind, in the farm budgets or project accounts. Family labor is treated differently. It is not entered as a cost; instead, the "wages" for the family become a part of the net benefit. Thus, if our project increases the net benefit, it also in effect increases the family's income or "wages" for its labor. Again, if we follow the format suggested in chapter 4, the account will automatically value the family labor at its opportunity cost, and the incremental net benefit will reflect any increased return the family may receive for its labor.
Prices for agricultural commodities generally are subject to substantial seasonal fluctuation. If this is the case, some decision must be made about the point in the seasonal cycle at which to choose the price to be used for the analysis. A good starting point is the farm-gate price at the peak of the harvest season. This is probably close to the lowest price in the cycle. The line of reasoning here is that as prices rise during the cycle at least some part of that rise is a result not of the production activities of the farmer but of the marketing services embodied in storing the crop until consumers want it. But, markets being what they are, there may be an element of imperfection in the harvest price level. Market channels may become so glutted that merchants try actively to discourage farmers from immediately bringing their crop to the market by offering a price that even the merchants themselves would admit is too low. Even so, the need to sell immediately to meet debt obligations may force farmers to offer their crops despite these artificially low, penalty prices. In some cases, therefore, a price higher than the farm-gate price in the harvest season may be selected. But there is an obligation here to justify the price chosen as more valid than the lowest seasonal price. One way to resolve this problem may be to include an element of credit in the project design. This would permit farmers to withhold their product from the market until prices have had a chance to rise from their seasonal lows but at the same time to have enough money to meet their cash obligations and family living expenses. The credit element may also include credit for building on-farm storage so that farmers will have a safe place to store their production until they decide to market it at a better price.
Prices vary among grades of product, of course, and picking the proper price for project analysis may involve making some decisions about quality of the product. In general, it can be assumed that farmers will produce in the future much the same quality as they have in the past and will market their product ungraded. In many agricultural projects, however, one objective is to upgrade the quality of production as well as to increase the total output. Small dairy farmers, for instance, may be able with the help of the project investment to meet the sanitation standards of the fluid milk market and to command a higher price; or reduced time for delivery may hold down sucrose inversion in sugarcane; or better pruning will increase the average size of the oranges Moroccan farmers can offer European buyers. In such cases, the proper price to select is the average price expected for the quality to be produced.
A special problem occurs in pricing housing. If project investment includes housing construction, as would be the case for a settlement project, then one benefit arising from the investment is the rental value of the house. Since the rental value will usually be an imputed value rather than a real market price, care must be exercised in determining it. No more should be allowed for the rental value than would normally be paid by a prospective tenant family. Nor should more rental value be allowed than the family would be expected to pay for a comparable house in the vicinity or in a similar area elsewhere (if the new settlement is in a distant locale). In particular, the temptation should be avoided to take as a rental value some arbitrary proportion of the housing cost. Otherwise, overly elaborated housing construction might be justified simply by assigning it an unrealistically high imputed value.
Project boundary price
Prices used in analyzing agricultural projects are not necessarily farm-gate prices. The concept of a farm-gate price may be expanded to a "project boundary" price if a project has a marketing component or if it is a purely marketing project. Many projects have a marketing component, perhaps because there is no competitive channel reaching down to the farm-gate level for the unprocessed product. Of concern in these projects are both the farm-gate price (on which to base the estimates of the net benefit to the farmer) and the price at which the processed product is sold in the market (after being handled in the facilities financed by the project). Such a case is found in the Rahad project in the Sudan. There the Roseires dam on the Blue Nile will provide irrigation water for the production of cotton, which will be ginned in new facilities financed by the project. The analyst, of course, is interested in the price of cotton paid to the farmers so that their incomes can be estimated. But, since this price is set administratively, it could not be used directly in the economic analysis of the project. The analyst is also interested in the price of ginned cotton because that is the first product the project will actually sell in a reasonably competitive market. In this case, the point of first sale is f.o.b. (free on board) Port Sudan, and the price there becomes the basis for the benefit stream.
Predicting Future Prices
Since project analysis is about judging future returns from future investment, as analysts we are immediately involved in judging just what future prices may be. This is a matter of judgment, not mechanics. No esoteric mathematical model exists to come to the aid of the project analyst; like everyone else he must take into consideration all the facts he can find, seek judgments from those he respects, and then come to a conclusion himself. It tends to be a rather unsettling process. The only consolation is that careful, considered judgment about the course of future prices is better than giving the matter no thought at all and wasting scarce resources on incompletely planned projects.
We have been discussing how to find market prices, and it is from these current prices that we begin. The best initial guess about future prices is that they will retain the present relationships, or perhaps the average relationship they have borne to each other over the past few years. We must consider, however, whether these average relationships will change in the future and how we will deal with a general increase in the level of prices owing to inflation.
Changes in relative prices
We may first raise the question of whether relative prices will change. Will some inputs become more expensive over time in relation to other commodities? Will some prices fall relatively as supplies become more plentiful? Not easy questions to deal with, but some approaches to answers can be made. In financial analysis, of course, a change in a relative price means a change in the market price structure that producers face either for inputs or for outputs. A change in a relative price, then, is reflected directly in the project's financial accounts. A rise in the relative price of fertilizer reduces the incremental net benefit-the amount the farm family has to live on. It is thus clearly a cost in the farm account. The same line of reasoning can be applied in the financial analysis for any other group participating in the project.
A change in the relative price of an item implies a change in its marginal productivity-that is, a change in its marginal value product-or a change in the satisfaction it contributes when it is consumed. In economic analysis, where maximizing national income is the objective, a change in the relative price of an input implies a change in the amount that must be forgone by using the item in the project instead of elsewhere in the economy; it is therefore a change in the contribution the output of the project makes to the national income. Thus, changes in relative prices have a real effect on the project objective and must be reflected in project accounts in the years when such changes are expected.
There are several kinds of commodities subject to future changes in relative prices. Most agricultural project analysts would probably agree that the relative price of energy-intensive agricultural inputs is likely to continue to rise over the next several years, just as it has done over the past few years. Thus, on the input side the project accounts might show an annual increase, at least for the first decade or so, in the cost of fuel for tractors, for transporting the harvested crop, for drying grain, and for such petroleum-based inputs as fertilizers and chemical pesticides. On the output side, there may be some commodities that will probably continue to be in short supply and whose prices will rise as incomes increase-one might think of mutton from fat-tailed sheep in Iran, or, for that matter, of most meat products worldwide. How much will prices increase relative to those of other products? Certainly a difficult question, but one the project analyst must confront. For a range of products-from industrial crops such as fibers or oilseeds to food grains and vegetables-judgments will have to be made on the best possible basis.
In some countries, relative wages of rural labor may rise as economic development proceeds during the life of a project. This will have implications not only for the prices assumed for hired labor, but also for the incentive effect exerted by a given change in net benefit and for the technology assumed as a basis for projections in the farm budgets and project accounts.
Inflation
In the past few years, virtually every country has experienced inflation, and the only realistic assessment is that this will continue. No project analyst can escape deciding how to deal with inflation in his analysis.
The approach most often taken is to work the project analysis in constant prices. That is, the analyst assumes that the current price level (or some future price level-say, for the first year of project implementation) will continue to apply. It is assumed that inflation will affect most prices to the same extent so that prices retain their same general relations. The analyst then need only adjust future price estimates for anticipated relative changes, not for any change in the general price level. By comparing these estimates of costs and benefits with the constant prices, he is able to judge the effects of the project on the incomes of participants and its income-generating potential for the society as a whole. Although the absolute (or money) values of the costs and benefits in both the financial and the economic analyses will be incorrect, the general relations will remain valid, and so the measures of project worth discussed in chapter 9 may be applied directly. Working in constant prices is simpler and involves less calculation than working in current prices; for the latter, every entry has to be adjusted for anticipated changes in the general price level.
It is quite possible, however, to work the whole project analysis in current prices. This has the advantage that all costs and benefits shown would be estimates of what the real prices will be in each year of the project. Furthermore, estimates of investment costs will be in current terms for the year in which they are expected to occur, so that the finance ministry can more easily anticipate these needs and budget the amounts necessary to finance the project on schedule. The problem in this approach is that it involves predicting inflation rates. For items to be imported, some help is available in the World Bank report on Price Prospects for Major Primary Commodities (1982a), which is published biennially and updated in six-month intervals and includes an estimate of inflation in developed countries. For domestic inflation rates in developing countries, other sources will have to be consulted, but obtaining an estimate in which one can place even minimal confidence will be difficult, to say the least. Even casting the project analysis in current terms may raise problems for the project analyst. Many governments have policy goals that call for greatly reduced inflation, and they cannot permit the circulation of official documents that assume rapid inflation will continue.
The mere mechanics of using current prices presents no analytical problem in project analysis, although it does complicate the computations. When we consider measures of project worth, some means of deflating future prices must be adopted for comparing future cost and benefit streams in terms that are free from the effects of general price increases. We will illustrate the methodology in chapter 10 in the section "Calculating Measures of Project Worth Using Current Prices."
Even when constant prices are used in the more conventional approach to project analysis, a table estimating the budgetary effects of the project in current terms that will prevail at least during the investment phase should be included either in the analysis or as a separate memorandum. It would list in current prices domestic currency needs, foreign exchange requirements, and subsidies. The finance ministry would then have better estimates to work with, and delays because of budgetary shortfalls could more easily be avoided.
Prices for Internationally Traded Commodities
For commodities that enter significantly in international trade, whether inputs or outputs, project analysts usually obtain price information from various groups of specialists who follow price trends and make projections about relative prices in the future. In many countries where agricultural exports are important, there are groups in the agriculture ministry or the finance ministry whose help may be sought.
There are also several international organizations and trade groups to which the analyst may turn. The World Bank, for instance, publishes its projections under the title Price Prospects forMajorPrimary Commodities. The Food and Agriculture Organization (FAO) sponsors intergovernmental groups that publish price information on rice; grains (other than rice); citrus; hard fibers; fibers (other than hard fibers); oilseeds, oils and fats; bananas; wine and wine products; tea; meat; and cocoa. Information may be obtained from the secretary of the relevant intergovernmental group at the FAo headquarters in Rome or from the FAo representative in individual countries.
Several international commodity organizations keep detailed price information for the products of their interest. These include the International Tea Committee, the International Cocoa Organization, the International Wool Secretariat, the International Coffee Organization, the International Association of Seed Crushers, the International Rubber Study Group, and the International Sugar Organization, all with headquarters in London; the International Olive Oil Council in Madrid; and the International Cotton Advisory Committee in Washington.
Some individual nations systematically collect production and price information for crops and livestock products of interest to them, and they often are willing to share this information with analysts in other countries without charge or restriction. The United States Department of Agriculture-probably the most important of these-publishes detailed studies about most major crops traded in international markets. Information may be obtained from agricultural attaches in American embassies, or directly from the department's Foreign Agriculture Service. The Commonwealth Secretariat in London publishes information about price trends for commodities of interest to its member nations. A detailed list of "Sources of Information on World Prices" is available from the World Bank (Woo 1982).
Financial Export and Import Parity Prices
In projects that produce a commodity significant in international trade, the price estimates are often based on projections of prices at some distant foreign point. The analyst must then calculate the appropriate price to use in the project accounts, either at the farm gate or at the project boundary.
If the farm-gate or project boundary prices for the internationally traded commodities in the project are already known, and the prices in the particular country tend to follow world market prices, the farm-gate prices may be adjusted by the same relative amount as indicated, say, by the medium trend projected in the future relative prices supplied by one or another international organization. Also, in financial analysis, if the farm-gate price is set administratively and is not allowed to adjust freely to world prices, the relevant price to use is the administratively set price.
Simply adjusting domestic prices by the same relative amount as foreign prices often arrives at figures too rough for project analysis. The approach ignores the fact that marketing margins in commodity trade tend to be less flexible than the commodity prices themselves. There are also many instances in estimating the economic value of a traded commodity that involve deriving a shadow price based on international prices. In such instances it is necessary to calculate export or import parity prices. (See chapter 7, the subsection "Economic export and import parity values.") These are the estimated prices at the farm gate or project boundary, which are derived by adjusting the c.i.f. (cost, insurance, and freight) or f.o.b. prices by all the relevant charges between the farm gate and the project boundary and the point where the c.i.f. or f.o.b. price is quoted. The elements commonly included in c.i.f. and f.o.b. are given in table 3-2.
Source: William A. Ward, “Calculating Import and Export Parity Prices,” training materials of the Economic Development Institute, CN-3 (Washington, D.C.: World Bank, 1977), p.8.
One common case for which an export parity price has to be calculated is that of a commodity produced for a foreign market. Table 3-3 gives an example based on the Rahad project in the Sudan. It shows the generalized elements for calculating export parity prices so that the same methodology can be applied in other cases. As noted earlier, the Rahad project included cotton gins. Since the gins produce lint and cottonseed for export and scarto, a by-product of very short fibers not suitable for export and sold locally, the analyst needed three prices. For the lint and seed estimates, he began with forecasts of the 1980 c.i.f. prices in current terms at Liverpool, which were available from World Bank publications. From these c.i.f. prices, he then deoucted insurance, ocean freight, export duties, port handling costs, and rail freight from the cotton gin at the project site to Port Sudan, thus obtaining the export parity prices at the project boundary: LSd 178.650 for lint and LSd18.097 for seed. (The symbol for Sudanese pounds is LSd.) The price for scarto, which was not exported, was based on the prevailing domestic price.
To illustrate, we may continue to calculate the export parity price at the farm gate, although in the Rahad example, where the farm-gate price was set administratively, this calculation was not made. The computations are laid out in the part of table 3-3 that continues from the entry for "Equals export parity price at project boundary." Here a new issue arises. The three products that the gin produces-lint, seed, and scarto-must be converted into their seed cotton equivalents, since it is seed cotton that the farmer sells. Similar conversions have to be made in many other instances-for example,
,
LSd Sudanese pounds. US$ U.S. dollarsSource: Adapted from World Bank, “Appraisal of the Rahad Irrigation Project,” PA-139b (Washington, D.C., 1973; restricted circulaton) annex 16, table 6. The format of the table is adapted from Ward, “Calculating Import and Export Parity Prices,” p.9a. Scarto is a by-product of very short, soiled fibers not suitable for export and is sold locally at a price of LSd 110.200 per ton.b. Seedcotton is converted into lint, seed, and scarto assuming 1 ton of seed cotton yields 400 kilograms seed, and 10 kilograms scarto.
rice milling or groundnut decortication. For the Rahad project, a weighted price of LSd83.239 forthe seed cotton was calculated using a ginning outturn of 40 percent lint, 59 percent seed, and 1 percent scarto. From this weighted price were deducted the ginning, baling, and storage charges and the costs of collection and transport from the farm gate to the gin, thus arriving at the farm-gate export parity price of LSd66.946.
A parallel computation leads to the import parity price. Here the issue is the price at which an import substitute can be sold domestically if it must compete with imports. Table 3-4 illustrates this issue with the example of maize production in Nigeria. The same example is presented diagrammatically in figure 3-1. Nigeria is a net maize importer, and the project is to produce maize for domestic consumption to replace imported maize.
N = Nigerian nairaSource: Adapted from World Bank, “Supplementary Annexes to Central Agricultural Development Projects,” 1370-UNI (Washington, D.C., 1976; restricted circulsation), supplement 11, appendix 2, table 4. The format of the table is adpated from Ward, “Calculating Import and Export Parity Prices,” p. 10.a. Forecast from World Bank, Price Prospects for Major Primary commodities, 814/76 (Washington, D.C., 1976), annex 1, p. 12.
We begin with the f.o.b. price at the point of export-in this case U.S. ports on the Gulf of Mexico-derived from World Bank commodity estimates. To this we add freight and insurance to obtain the c.i.f. price at either Lagos or Apapa, the two Nigerian ports concerned. Then we would add any tariffs and subsidies (in this case there are none); add local port charges for harbor dues, fumigation, handling, and the like; and add local transport to the relevant inland market. The result is the wholesale price of imported maize. It is this wholesale price of maize in the inland market that is the focal point of our calculation. The alternative to project production is not to import the maize and transport it to the project area. Rather, the alternative is to import it and market it directly on the inland market. Thus the price the farmer can expect to receive in the absence of tariffs, subsidies, or an import ban is the wholesale price less the cost of moving his maize to the market. If the project had included processing facilities, then the relevant project boundary price would have been this wholesale price less handling costs from the processing facility to the wholesale market. In the Nigerian project, no processing facilities were included, so the relevant import parity price is the farm-gate price. As we move back from the wholesale market to the farm gate, we would have to provide for any conversion allowance. In this case none is necessary, since it is assumed that the farmer will sell shelled maize. From the wholesale price, then, we deduct local marketing costs including assembly, bags, and intermediary margins, transport from the farm to the market, and storage losses, thus obtaining the import parity price at the farm gate of N90. (The symbol for Nigerian naira is N.) This is the maximum price the farmer could expect to receive, again in the absence of tariffs, subsidies, or an import ban.
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