1. 0 Updated:09/03/2007 Lecture Notes ECON 622: ECONOMIC COST-BENEFIT ANALYSIS Lecture 4

2. 1 ECONOMIC VALUATION OF TRADABLE GOODS & SERVICES

3. 2 Tradable Commodities Classification of a Project’s Inputs and Outputs A good or service is considered tradable when an increase in demand (or supply) by a project does not affect the amount demanded by domestic consumers An increase in demand for an IMPORTABLE commodity results in an increase in demand for imports An increase in demand for an EXPORTABLE commodity results in a reduction in exports An increase in supply of a tradable commodity by a project will cause either a reduction in imports or an increase in exports An Importable commodity includes imported goods and domestically produced goods that are close substitutes for imported goods An Exportable commodity includes exported goods and close substitutes for exported goods

4. 3 Measuring the Economic Values of Tradable Goods: Four Cases 1.Economic value of importable good production 2.Economic cost of importable input 3.Economic cost of exportable input 4.Economic value of export production

5. 4 Importable Good Distorted World Supply Price Price Q Quantity per year Domestic Supply Domestic Demand D S E m * P CIF * (1+T m ) + F m dodo soso Q PmPm Imports = Q - Q E m = Market Exchange Rate T m = Rate of Import Tariff F M = Domestic Freight to Market soso dodo P CIF = Price of imports at entry point to country, including international freight and insurance charges expressed in units of foreign currency

6. 5 Project Supplies More of an Importable Good Project reduces quantity imported. No change in domestic consumption. Price Quantity S domestic S w/ project Q s 0 Q s 1 Q d 0 D domestic S world E m * P CIF * (1+T m ) + F m

7. 6 Estimating The Economic Prices of Tradable Goods 1. Adjust for commodity - specific trade distortions Financial prices for the commodities demanded (or supplied) by a project must be adjusted for commodity-specific distortions and costs that drive a wedge between their international prices and their domestic market prices Taxes and Subsidies are transfers between consumers, producers, and the government. Therefore, they are not part of the real resources consumed or produced by a project. 2. Value the foreign exchange at the economic (shadow) exchange rate (E e ) Multiply the CIF and FOB prices at the border by the economic price of foreign exchange (E e ). Alternatively, add a foreign exchange premium [(E e /E m ) - 1], or [(E e /OER) - 1], per unit of foreign exchange demanded (or supplied) by a project. 3. Adjust for handling and transportation costs The economic costs of handling and transportation that are necessary to move commodities to or from the point of entry must be included. In the case of imported commodities, these costs should be added to the CIF price. In the case of exported commodities, these costs should be subtracted from the FOB price.

8. 7 Visayas Communal Irrigation Project Basic Facts The National Irrigation Administration (Philippine National Agency) proposes to rehabilitate 55 damaged communal irrigation systems and to build 25 new systems in Visayas. The project’s additional components include water protection and erosion control, the strengthening of irrigation association, and the development of agricultural extension services. The goal of the project is to alleviate poverty, while improving environmental sustainability of the region. The life of project is 20 years. The economic benefits arise from the increased production of rice and corn, which must otherwise be imported. The foreign exchange premium is 24.6%. The project is expected to cost approximately 480.910 million pesos (US$19.78 million). The project will be financed with US$15.1 million loan from the International Fund for Agricultural Development, and remaining funding would be provided by the Philippine government.

9. 8 Table 1: Project Supplies an Importable Good (Rice)

10. 9 Measuring the Economic Values of Tradable Goods: Four Cases 1.Economic value of importable good production 2.Economic cost of importable input 3.Economic cost of exportable input 4.Economic value of export production

11. 10 Project Demands More of an Importable Good Project requirements will be met by additional imports (world supply). Domestic consumption is not affected. Price Quantity S domestic Q s 0 Q d 0 Q d 1 D domestic D w/ project S world E m * P CIF * (1+T m ) + F m

12. 11 Project Purchases Importable Inputs Input subject to Import Tariff Financial cost is E m P w (1+t) (Q 1 d -Q 0 d ) Economic cost is E m P w (Q 1 d – Q 0 d ) + Foreign exchange premium World Supply Q s 0 Price P d P w (1+t) P w S 0 Quantity World Supply After Tariff D 0 D 0+P 0 d 1 Q Q d 0 = E m EmEm

13. 12 Economic cost of Importable Goods: With Tariff, Trade Margin and Domestic Freight EmEm

14. 13 Table 2: Project Uses an Importable Good (PESTICIDES). Financial AdjustmentTradableNon-TradableEconomic Price For Taxes Adjusted Value Content Value (A)(B)(C= A*B)(D)(E) (F=C*D*0.246)(G=C*E*0.01) (H=C+F+G) CIF World (US$) 166 CIF per 1000 liters of pesticides40381 100%993.355031 PLUS Tariff201000%0.000 Port charges, handling and transportation to Manila 1551 30%70%11.441.09168 Importer Price, Manila 43945199 PLUS Transport cost, Manila to local market5151 30%70%38.013.61557 Dealer's margin2010.6813710%90%3.361.23141 Price at local market51105897 PLUS Local transport cost1201 30%70%8.860.84130 Price at farm gate52306026 Conversion Factor1.15 Value of Forex Premium Value of SPNTO Premium

15. 14 Measuring the Economic Values of Tradable Goods: Four Cases 1.Economic value of importable good production 2.Economic cost of importable input 3.Economic cost of exportable input 4.Economic value of export production

16. 15 Exportable Good Quantity per year Distorted World Demand Price Price Q Domestic Supply Domestic Demand D S E m * P FOB * (1-t x ) - F x dodo soso Q PmPm Exports = Q - Q E m = Market Exchange Rate t x = Export Tax F x = Freight and Trading Costs to Port dodo soso P FOB = Price of exports at point of export from country in units of foreign currency

17. 16 Project Demands More of an Exportable Good Project requirements will reduce quantity exported. Consumption of previous consumers remains unchanged. Price Quantity S domestic Q d 0 Q d 1 Q s 0 D w/ Project D domestic D world E m * P FOB * (1-t x ) - F x

18. 17 Table 3: Project Uses anExportable Good (Seeds) LESS FinancialTradableNon-TradableEconomic PriceContent Value (A)(B)(C= A*B)(D)(E)(F=C*D*0.246)(G=C*E*0.01)(H=C+F+G) FOB per ton of PADDY SEED (pesos/ton) 63261 100.00%0.00%1556.200.007882 Port Handling and Transportation1551 30.00%70.00%11.441.09168 From IRRI to port of Manila IRRI Exporter Price61717715 PLUS 0.00 Transport Cost, IRRI to local market5151 30.00%70.00%38.013.61557 Dealer's margin2350.6816010.00%90.00%3.931.44165 Price at Local Market69218436 PLUS Local transport cost from Market to farm (Project site)1201 30.00%70.00%8.860.84130 Price at Farm Gate70418566 Conversion Factor1.22 Adjustment For Taxes Adjusted Value Value of Forex Premium Value of SPNTO Premium

19. 18 Measuring the Economic Values of Tradable Goods: Four Cases 1.Economic value of importable good production 2.Economic cost of importable input 3.Economic cost of exportable input 4.Economic value of export production

20. 19 Project Supplies More of an Exportable Good Project increases exports. Domestic consumption remains unchanged. Price Quantity S domestic S w/ Project Q d 0 Q s 0 Q s 1 D domestic D world E m * P FOB * (1-t x ) - F x

21. 20 Project Produces Exportable Goods subject to Export Tax (No domestic transportation costs) Financial benefit is E m P w (1-t) (Q 1 s -Q 0 s ) Economic benefit is E m P w (Q 1 s – Q 0 s ) + Foreign exchange premium EmEm P d =E m P w (1-t) Economic values of exportable goods are based on the FOB values of demand for exports

22. 21 Table 4: IRRI Supply an Exportable Good (Seeds) Financial Tradable Non-Tradable Economic PriceContent Value (A)(B)(C= A*B)(D)(E)(F=C*D*0.246) (G=C*E*0.01) (H=C+F+G) FOB Port (US$)260 FOB Port (Pesos/ton)63261 100.00%0.00%1556.200.007882 LESS Port Charges and transportation1551 30.00%70.00%11.441.09168 from IRRI to Port IRRI Gate Price61717715 Conversion Factor (EV/PV)1.25 Adjustment For Taxes Adjusted Value Value of Forex Premium Value of SPNTO Premium

23. 22 SUMMARY Economic Value of Importable Good Production = CIF (adj. For Economic Exchange Rate) + Economic Cost of Local Freight from Port to Market - Economic Cost of Local Freight from Project to Market Economic Cost of Imported Input = CIF (adj. For Economic Exchange Rate) + Economic Cost of Freight from Port to Project Economic Cost of Exportable Input = FOB (adj. For Economic Exchange Rate) + Economic Cost of Local Freight from Export Producer to Project - Economic Cost of Local Freight from Export Producer to Port Economic Value of Exportable Production = FOB (adj. For Economic Exchange Rate) - Economic Cost of Local Freight from Project to Port