Cost–benefit analysis and the European union cohesion fund: On the social cost of capital and labour

Abstract

Florio M. (2006) Cost–benefit analysis and the European Union Cohesion Fund: on the social cost of capital and labour, Regional Studies 40, 211–224. Cost–benefit analysis is a formal regulatory requirement for the evaluation of Cohesion Fund projects. It requires the calculation of shadow prices. Observed prices in less-developed European Union regions do not reflect the social opportunity cost of labour and capital because of market failures and policy constraints. The paper discusses simple rules for the calculation of financial and economic discount rates, and of shadow wages, i.e. the opportunity costs of capital and labour, in the context of the appraisal of infrastructure projects part-financed under the Cohesion Fund. It is argued that for the 2007–13 programming period, the European Commission should adopt a unique financial discount rate of 3.5% in real terms, social discount rates of 5.5% for the Convergence regions and 3.5% for Competitiveness regions, and a region-specific shadow wage rate.

Cost–benefit analysis  Social discount rate  Shadow wage  Cohesion Fund

Florio M. (2006) L'analyse coÛt-bénéfice et le Fonds de cohésion de l'UE: à propos du coÛ t social du capital et du travail, Regional Studies 40, 211–224. L'analyse coÛt-bénéfice est une obligation légale préalable à l'évaluation des projets assistés par le Fonds de cohésion. Elle nécessite le calcul des prix virtuels. Les prix observés dans les zones de l'UE en voie de développement ne reflètent le coÛ t d'opportunité social, ni du travail, ni du capital, à cause de la distorsion du marché et des contraintes de politique. Cet article cherche à discuter des règles simples visant le calcul des taux d'escompte financiers et économiques, et des salaires virtuels; autrement dit les coÛ ts d'opportunité du capital et du travail, dans le cadre de l'évaluation des projets d'équipement financés en partie sous l'égide du Fonds de cohésion. On affirme que, pour la période de programmation 2007–13, la Commission européenne devrait adopter un taux d'escompte financier unique de 3,5% en termes réels, des taux d'escompte sociaux de 5,5% pour les régions de convergence et de 3,5% pour les régions de l'Objectif ‘compétitivité’, et un taux des salaires virtuels propre à chaque zone.

Analyse coÛt-bénéfice  Taux d'escompte social  Salaire virtuel  Fonds de cohésion

Florio M. (2006) Kosten-Nutzenanalyse und der Kohäsionsfond der EU: Bemerkungen zu den Sozialkosten von Kapital und Arbeit, Regional Studies 40, 211–224. Kosten-Nutzenanalyse ist ein formales behö rdliches Erfordernis für die Evaluierung von Kohäsionsfondprojekten. Es bedarf der Berechnung von ‘Schattenpreisen’. In weniger entwickelten EU Regionen beobachtete Preise spiegeln nicht die sozialen Opportunitätskosten von Arbeit und Kapital wider aufgrund von Marktversagen und Policybedingten Einsdränkungen. Dieser Aufsatz bespricht einfache Regeln für die Berechnung finanzieller und wirtschaftlicher Diskontsätze und für Schattenlöhne, d.h. die Opportunitätskosten von Kapital und Arbeit im Zusammenhang mit der Einschätzung von Infrastrukturprojekten, die vom Kohäsionsfond teilfinanziert werden. Es wird der Standpunkt vertreten, dass die Europäische Kommission für die Programmperiode 2007–2013 einen einmaligen Finanzdiskontsatz von effektiv 3,5% einführen sollte, einen sozialen Diskontsatz von 5,5% für “Konvergenz” Regionen und 3,5% für “Wettbewerbs” Regionen sowie einen bestimmten regionenspezifisch zugeschnittenen Schattenlohnsatz.

Kosten-Nutzenanalyse  sozialer Diskontsatz  Schattenlohn  Kohäsionsfond

Florio M. (2006) Análisis coste-beneficio y el Fondo de Cohesión de la UE: sobre el coste social de capital y trabajo, Regional Studies 40, 211–224. Los análisis de costes y beneficios son un requisito formal y reglamentario para llevar a cabo la evaluación de los proyectos del Fondo de Cohesión. Requieren el cálculo de los ‘precios sombra’. En los precios de las regiones de la UE menos desarrolladas no queda reflejado el coste de oportunidad social de trabajo y capital debido a fallos de mercado y restricciones polí– ticas. Aquí se exponen reglas simples para el cálculo de las tasas de descuento, según un valor financiero y económico, y los ‘salarios sombra’, es decir, los costes de oportunidad de capital y trabajo, en el ámbito de una valoración de proyectos de infraestructura financiado en parte por el Fondo de Cohesión. Se sostiene que para el periodo de programación 2007–2013, la Comisión Europea debería adoptar una tasa exclusiva de descuento financiero del 3,5% en términos reales, tasas de descuento social del 5,5% para las regiones de Convergencia, un 3,5% para las regiones de Competitividad y una tasa específica de salario sombra para cada región.

Análisis de costes y beneficios  Tasa de descuento social  Salario sombra  Fondo de cohesión

Acknowledgements

The author gratefully acknowledges the extremely useful comments received from three anonymous referees and the journal editors. Helpful comments were also offered also by Silvia Vignetti as well as by participants in different seminars at the Department of Economics, Business and Statistics, University of Milan, and at the DG Regio, European Commission, Brussels. The usual disclaimer applies.

Notes

1. The Commission carried out a broad ex-post evaluation of 200 projects co-financed under the Cohesion Fund over 10 years, 1993–2002. This exercise, which was executed by independent evaluators, has revealed some frequent problems in the application of the CBA standard methodologies. The study was performed for the four countries and considered strategic planning procedures, achievements, efficiency, effectiveness, impact, management, implementation and Community added value. For a subsample, the economic rates of returns were calculated and compared with the ex-ante returns.

2. It is restated in the latest Annual Report of the Cohesion Fund, which says that the European Commission urges project promoters to use CBA techniques, ‘not only with the view to improve the projects’ chances of success but also to increase its socio-economic impact on regional development' (European Commission, 2005, p. 59).

3. For the current programming period (2000–06), the available data show that the transport sector accounts for around 54% of total Cohesion Fund commitments and the environment for 46%. The priorities remain railways in the case of transport, and the supply of drinking water and the treatment of wastewater and solid waste for the environment.

4. These are Regulations 1264/1999 and 1164/94.

5. As part of its updating of the CBA Guide for the cost–benefit analysis of major projects, during 2001, the Commission carried out substantial internal work to make the ex-ante financial analysis more consistent of the various project types. This included consideration of the discounting rate used, the arrangements for applying the polluter-pays principle to water-management projects, taking account of historic costs before the submission of a project to the Commission in calculating financial profitability, and the accounting for financial costs (European Commission, 2005).

6. Florio and Vignetti (2005) discuss some of the other issues that cannot be dealt with here, particularly those under (c).

7. For details on financial discounting in project analysis, see the CBA Guide (European Commission, 2002), or introductory texts such as Potts (2002) or Campbell and Brown (2003).

8. This is the Pre-Accession Instrument, similar in its mechanism to the CF, and reserved for future members (European Commission, 2005).

9. For example, the US Treasury (1992) estimated that the average pre-tax return to private investors in real terms is 7%; for the European context, see Saerbeck (1990).

10. For the many variants, see Stiglitz (1994).

11. For example, a water-distribution project of a municipal enterprise that sells at tariffs below costs will lead to a financial loss, but it may be beneficial to the society if the benefits to users are greater than the financial costs.

12. The evidence considered in Florio and Vignetti (2002, 2003, 2005) includes large samples of projects (Cohesion Fund, ISPA and ERDF) of different vintages: 200 projects over 1989–93, another 200 over 1994–99 and 300 for the CF ex-post evaluation. More qualitative evidence was collected by the author at the Capacity Building Seminar for the New Member States, DG Regional Policy, Brussels, Belgium, 18/19 May 2004, and at previous seminars with EC officials in Brussels on 13 July 2001, 6–7 November 2001, 24–25 November 2004 and again in 2004 during the meetings of the Steering Committee of the ex-post evaluation of a sample of projects co-financed by the Cohesion Fund (1993–2002).

13. This discount rate is supposed to decline further in the distant future (after 30 years), probably because of the adoption of a quasi-hyperbolic discounting approach.

14. In principle, this seems advisable, but the expected growth rates of these regions are lower than in the CF countries.

15. Florio and Vignetti (2005) show how it would be possible to link the FDR and SDR in the co-financing mechanism under the CF in order to achieve a better incentive structure.

16. The justification is offered in the CBA Guide (European Commission, 2002, Annex B, pp. 103–105).

17. For example, with t = 0.30 and u = 0.20, the conversion factor, SWR/FWR = 0.56.