AGEC 608 Lecture 15-16, p. 1 AGEC 608: Lecture Objective: Discuss use of “plug in” values and construction of shadow prices in developing country context. Readings: –Boardman, Chapter Homework #4: class average: 89 Homework #5: Chapter 13, problem 3 Chapter 14, problem 3 Chapter 17, problem 1 due: April 24

AGEC 608 Lecture 15-16, p. 2 Plug-in values Estimation of shadow prices is costly and time- consuming. A practical approach in many CBAs is to use shadow prices that others have used. In other words, one “plugs-in” values from previous studies. Most useful in the cases of: value of life cost of injuries cost of crime value of time

AGEC 608 Lecture 15-16, p. 3 Value of life Two approaches to estimation: 1. Indirect (e.g. previously discussed hedonic method) 2. Direct (WTP or WTA via survey questions) Miller (review of 29 studies) 1. Wage premia for risky jobs 2. WTP for safety 3. Risk-avoidance behavior 4. CVM regarding safety and health Mean value of life = $3.02M (1999 US$)

AGEC 608 Lecture 15-16, p. 4 Cost of injuries See Table 15.1 Estimates usually include: medical + rehab costs lost wages administrative costs (sometimes) pain + suffering (e.g. WTP studies) Estimated values tend to depend on: 1. Region of body 2. Threat to life 3. Work vs. non-work

AGEC 608 Lecture 15-16, p. 5 Cost of crime Many projects aim to reduce crime. To estimate impact: 1. Estimate number of crimes reported 2. Estimate value of each crime avoided Net benefit = NPV (1 x 2) – Cost See Table 15.1 Some estimates include medical costs, lost wages, justice system costs Should stolen property count as a transfer?

AGEC 608 Lecture 15-16, p. 6 Value of time Most important concept for CBA is that of Value of Travel Time Savings (VTTS) 1. Nonwork travel time (commuting) typically valued at 40%-50% of after-tax wage rate per hour saved 2. Work travel time valued at 100% of pre-tax wage + benefits Note that some leisure time may have no cost, or even provide benefits!

AGEC 608 Lecture 15-16, p. 7 Transferring and adjusting plug-in values Issues to consider: 1. Income and socioeconomic factors higher values for higher incomes? 2. Physical characteristics population density, climate, topography, and current level of the good all may influence WTP and value (e.g. snow removal). 3. Temporal changes values could change over time, due to technology, population growth, etc.

AGEC 608 Lecture 15-16, p. 8 Example 40-mile stretch of rural road used by commuters and business travelers (50-50) to connect two major highways. Current speed limit is 55mph; estimated avg speed = 61mph What is the annual net benefit of raising the speed limit to 65mph? Assume: new avg speed would be 70mph 5,880 vehicles per day on road, 1.6 passengers 52 additional crashes/year, 0.1 new fatalities/year operating costs increase by $0.002 per vehicle mile average wage is $12.20/hour

AGEC 608 Lecture 15-16, p. 9 Example Vehicle miles on road per year = (5880)(365)(40) = 85.85M Vehicle hour savings = 85.85/61mph – 85.85/70 = 180,940 Total hour savings = (180,940)(1.6) = 289,510 hours Value of time ( ½ business, ½ commuters) = (.5)(12.20) + (.5)(12.20)(S) where S = value of commuters’ time Additional operating cost = ($0.002/mi)(85.85M) = $171,700 Injury costs (from Miller) = (52 accidents)(0.02)(V) Cost of fatal accidents = (0.1)(1.08)V

AGEC 608 Lecture 15-16, p. 10 NB (1,000 $) V=0.40 S= $2.0M $2.5M $3.0M-1,143-1, Results are very sensitive to assumed value of life!

AGEC 608 Lecture 15-16, p. 11 Shadow pricing in developing countries Rationale: Shadow pricing is often required in developing countries because: 1. markets tend to be more distorted than in developed countries 2. prices of imports and exports tend to be affected by taxes, subsidies, and quotas

AGEC 608 Lecture 15-16, p. 12 LMST Methodology Named after Little and Mirrlees (idea) and Squire and van der Tak (World Bank employees who applied the methods). Approach: divide all goods into two categories 1. Tradable (not just traded, but potentially traded) 2. Non-tradable (local labor, electricity, services, etc.) Use world prices for all tradable goods and local prices for all non-tradable goods. Shadow price of good = APR x market price, where APR is the accounting price ratio defined as: accounting price / market price

AGEC 608 Lecture 15-16, p. 13 Example 1: Import Value an import by: CIF price (Cost+Insurance+Freight) (also called the “border price”, i.e. landed cost) plus any transportation costs IGNORE tariffs Use official exchange rate to translate foreign currency into local currency.

AGEC 608 Lecture 15-16, p. 14 Example 2: Export Value an export by: FOB price (Free on Board) (cost of putting the good at the port) includes cost of production + export taxes + transport to port INCLUDE export taxes (foreigners have no standing) If some inputs would be exported in the absence of the project then shadow price should include foregone revenue as a cost.

AGEC 608 Lecture 15-16, p. 15 Example 3: Non-traded good Separate cost into its traded and non-trade components and then multiply each by its APR. tradable component APR = 1.0 domestic transfer APR = 0.0 non-traded APR = some weighted average Standard conversion factor (SCF): SCF = (M+X)/((M+T m -S m ) + (X-T x +S x )) Tariffs and export subsidies tend to inflate domestic prices while taxes on exports and import subsidies have the opposite effect.

AGEC 608 Lecture 15-16, p. 16 Shadow price of labor Different types of labor have different APRs If labor market works well, then wage is a good estimate If foreign workers are used, shadow cost depends on how much of their earnings are repatriated. If earnings are sent out, then they have an APR of 1. Unemployment is a complicating factor…

AGEC 608 Lecture 15-16, p. 17 Harris-Todaro model of migration Basic idea: urban wages > rural wages urban unemployment is often very high rural workers migrate to cities to find work Probability of urban employment upon migration = (L-U)/L = E/L Incentive to migrate as long as w U (E/L) > w R Migration stops when w U (E/L) = w R, but w U > w R If project is urban, shadow wage must be adjusted for the “induced” migration from the rural area.

AGEC 608 Lecture 15-16, p. 18 Additional issues 1.Discounting if govt can only fund a project by diverting resources (rather than raising taxes) then opportunity cost is forgone public investment (not private). 2.Social Accounting goal of public expenditures in LDCs sometimes goes beyond economic efficiency, and includes economic growth and redistribution. LMST approach may need to be modified. NPV reflects efficiency only.