PROJECT APPRAISAL AND MACROECONOMIC POLICY

Transcription

1 PROJECT APPRAISAL AND MACROECONOMIC POLICY

2 Project Appraisal and Macroeconomic Policy TSJALLE VAN DER BURG Rotterdam School 01 Management, Erasmus University, Rotterdam, The Netherlands Kluwer Academic Publishers Dordrecht / Boston / London

3 Library of Congress Cataloging-in-Publication Data Burg, Tja11e van der. Project appraisal and macroeconomic policy / by TSjal1e van der Burg. p. cm. Inc 1 udes bl b 11 ograph i ca I references. ISBN-13: (hardcover alk. paper) 1. Economic pol lcy--econometric models. 2. Equilibrium (Economics)--Mathematlcal models. I. Title. HD87.B ISBN-13: DOI: / e-isbn-13: Published by Kluwer Academic Publishers, P.O. Box 17, 3300 AA Dordrecht, The Netherlands. Kluwer Academic Publishers incorporates the publishing programmes of D. Reidel, Martinus Nijhoff, Dr W. Junk and MTP Press. Sold and distributed in the U.S.A. and Canada by Kluwer Academic Publisbers, 101 Philip Drive, Norwell, MA 02061, U.S.A. In all other countries, sold and distributed by Kluwer Academic Publishers Group, P.O. Box 322, 3300 AH Dordrecht, The Netherlands. Printed on acid-free paper All Rights Reserved 1996 Kluwer Academic Publishers Softcover reprint of the hardcover I st edition 1996 No part of the material protected by tbis copyright notice may be reproduced or utilized in any form or by any means, electronic or mecbanical, inc1uding photocopying, recording or by any information storage and retrieval system, witbout written permission from the copyright owner.

4 Table of contents Foreword Acknowledgements 1X xi 1. Introduction 2. The macroeconomic effects of specific portfolios of projects Introduction The macroeconomic effects ofprojects which lead to savings on fuels and other raw materials The essence of the analysis Counterbalancing effects related to an increase in spending Effects on financial markets Savings on non-imported fuels The results of quantitative studies The effects of a policy of saving on fuels and other raw materials at the level ofthe European Union Conclusions The effects of some portfolios of projects on inflation Conclusions 26 Appendix: A simple, quantitative analysis ofthe effects of a policy of saving on fuels at the level ofthe European Union 26 Notes Existing methods for the social appraisal ofprojects in situations of unemployment Introduction Methods without a welfare-theoretical foundation Primal methods based on an input-output model Primal methods based on an econometric macro-model A dual method based on an econometric macro-model Methods with a welfare-theoretical foundation Dual methods Primal methods based on a theoretical model A primal method based on an econometric macro-model The consistency between project appraisal and macroeconomic analysis and policy 51 v

5 vi Table 0/ contents 3.5. Implications for the development of an improved method 55 Notes A method to calculate and evaluate the macroeconomic effects of projects, including small projects Introduction ~The calculation of the effects of a project Introduction The effects of financing the expenditures The effects ofthe expenditures excluding the effects offinancing them The effects ofthe output Additional remarks Potential eitors related to the estimates when large projects or portfolios of projects are analysed Introduction EITors related to project-specific characteristics EITors related to the estimate of the effects of a project that leads to specific durable changes EITors related to the estimates ofthe effects of other projects Final remarks Potential eitors related to the estimates when small projects are analysed Introduction The concept of risk-pooling One ofthe problems related to the principle ofproportionality, in the context of a hypothetical setting The principle ofproportionality, considered from a more general and realistic point ofview The third step of the method The justification ofthe method when it is used to analyse one project, or a few projects only A common misconception The advantages ofthe method ofthis study as compared with the conventional macroeconometric method The evaluation ofthe effects 88 Appendix: The treatment of indirect taxes 92 List of symbols 93 Notes The calculations done with the Freia model Introduction The Freia model The base-run The calculation ofthe H, and the V, The extent to which the calculations fulfil the conditions of additivity 103

6 Table of contents vii 5.6. Tbe differences between the effects ofincreases in government investment and development aid in different years 5.7. The period to which the analysis refers 5.8. Comparison of the calculations made for this study with calculations by the Central Planning Bureau 5.9. Evaluation ofthe errors Notes The macroeconomic effects ofwind energy in the Netherlands Introduction Characteristics ofthe project from a microeconomic point ofview Introduction Costs and benefits from a private point ofview Modifications needed for the calculation ofthe macroeconomic effects The private profitability ofthe project InpuH:mtput analysis The macroeconomic effects ofthe project The macroeconomic effects Evaluation ofthe effects Sensitivity analysis with regard to the microeconomic characteristics The dependency ofthe outcomes on macroeconomic factors Conclusions 134 Notes Converting the method into a dual method General outline ofthe method Shadow prices based on the Freia model Conclusions 145 Notes International aspects and the debate about import substitution Effects on the world economy Some comments on the debate about the effects of import substitution on the domestic economy 150 Notes Summary and conclusions 155 References 163 Index 167

7 Foreword Environmental economics addresses the issues that arise on the boundaries between economic systems and natural systems, such as pollution and natural resource depletion and degradation. Like any other branch of applied economics, it has drawn its tools and techniques from the wide range already available in economics generally, selecting, adapting and extending these to meet its own particular requirements in its own particular context. Here, as elsewhere in economics, public policy analysis requires quantitative assessments of the economic impact of different policy choices. Perhaps the most distinctive contribution of environmental economics has been the development of techniques for the economic valuation of environmental goods and services in the absence of markets for such goods and services, or in the presence of markets that are at best imperfect or incomplete. Nevertheless policy analysis still relies on one or another of three broad groups of methods used in economics generally. One is project appraisal, which at the micro level provides an evaluation ofthe costs and benefits ofinvestment options to inform the choice among them, while at the macro level policy analysis rests either on computable general equilibrium (CGE) models or on economy-wide macroeconometric models. All models are simplifications, designed to focus attention on the important features ofthe problem at hand, and neglecting other features that might for a different problem assume greater importance. Project appraisal typically takes the macro environment as given, and focuses on individual projects in a partial equilibrium setting. In contrast, when aggregate macroeconometric models are used to assess the consequences of an increase in public expenditure, no attention is typically paid to the nature ofthe projects that might be funded by the incremental expenditure. CGE models provide greater sectoral detail, having focused in early applications on trade and public finance questions. With a foundation in Walrasian general equilibrium theory, they are essentially comparative static models, in which policy exercises rest on a comparison of a 'base' solution and a 'new policy' solution, each comprising a set of relative prices that support flow equilibria in all product and factor markets. The nature of the adjustment process that might lead from one equilibrium to another is not addressed. On the other hand, dynamic adjustment in disequilibrium situations has been a focus of attention in macroeconometric models, and issues of inflation. unemployment, and balance-of-payments disequilibrium are high on the agenda. ix

8 x Foreword Each approach in this stereotype form has obvious limitations, and the practical methods have been adapted to overcome them. Project appraisal in a partial equilibrium context, in which the markets for the project's inputs and outputs are analyzed in isolation, gives misleading guidance if other markets are affected in important ways. Shadow prices that take account of general equilibrium interactions might then be generated by a CGE model. Such models in turn might require modification or extension if their neoclassical assumptions are at variance with the behavioural or institutional rigidities found in many economies. However, ad hoc changes designed to increase the realism ofthe model may be difficult to interpret in the received theoretical framework; on the other hand a theoretically pure model is unlikely to yield reliable policy guidance in a situation where its assumptions are not satisfied. There is always tension between theoretical purity and empirical accuracy, and macroeconometric models have tended to emphasize the latter, having been concerned to provide a good statistical description of the actual economy, market imperfections, non-optimizing behaviour, and all. In-this case recent developments are in the opposite direction to that of the CGE developments noted above, namely towards a greater theoretical coherency, particularly in respect ofthe model's steadystate or long-run implications, as economic theories heavily based on equilibrium concepts are more relevant to these than to the process of short-run adjustment. Environmental policy studies typically require a longer horizon than the macroeconomic policy analysis of everyday political debate, hence such modifications make macroeconometric models more useful to the environmental economist. Exciting developments in quantitative methods occur on the interface between existing methods, when complementary strengths overcome individual weaknesses. At the rnacro level an input-output model might be incorporated into a macroeconometric model to provide missing sectoral detail, or a macroeconometric model might be used to provide the macroeconomic closure of a CGE model. The interface between rnicroeconornics and macroeconornics, with which this book is concerned, is a more difficult one. Although the use of a CGE model to generate shadow prices for use in project appraisal, as mentioned above, provides an example, the author argues that the theoretical characteristics of the CGE approach are at variance with the practical airns of project appraisal. Instead, he seeks to integrate project appraisal and rnacroeconornic policy analysis by using macroeconometric models for the evaluation of small projects in a situation of disequilibrium. The method is applied to a wind energy project, and it is estimated that such projects and a number of sirnilar projects have positive macroeconornic effects. I was honoured to serve as an external examiner of the dissertation on which this book is based and, coming to this work from a background in rnacroeconometric modelling, I found many challenging and provocative ideas. As a contribution to the discussion of the macroeconornic effects of environrnental policy and to the development of quantitative methods more generally the book now deserves a wide readership. Kenneth F. Wallis ESRC Macroeconomic Modelling Bureau University of Warwick

9 Acknowledgements This book is a revised version ofmy dissertation, which I wrote when I was working at the Faculty ofeconomics in Groningen. In writing the dissertation and the book I have received aid and encouragement from a number of people. I would like to express my thanks to the following people in particular: Professor A. N entjes for his supervision, his many stimulating comments, and bis patience in dealing with my intuition. Professor J.A. Kregel for bis useful comments and his confidence in the project in its early stages, wbich made it possible to get started. Professor J. Muysken and Professor K.F. Wallis for giving me some critical and helpful comments in the last stage of the research. Bemard ter Haar has done the calculations with the Freia-model, and wrote the main part of the computer program for calculating the effects of the wind energy project. I have been lucky in having an assistant with very high scientific standards. I would further like to express my thanks to Diana Galjaard-Vlijenhoek and Theresa Hekman-Huizinga for typing parts ofthe manuscript. Without the good library ofthe Faculty ofeconornics in Groningen it would have been rather difficult to do research, and I am grateful to Mr. H.A. Woensdregt and his colleagues for their friendly way of helping me. Finally, I would like to thank Caroline Cost Budde, Ellen Koen, and Maaike van der Rijst for improving my English grammar. xi