CONTENTS

ACKNOWLEDGEMENTPREFACEABSTRACTINTRODUCTIONStandard Topics to Evaluate Architectural Projects.

THE SCOPE AND PURPOSE OF WELFARE ECONOMIESECONOMICS: SOLUTION FOR SURVIVALTHE NEED FOR ECONOMICSTHE MEANING OF ECONOMICSTHE APPLICATION OF ENGINEERING ECONOMICS

THE CONCEPT OF COST BENEFIT ANALYSISBy Ghulam Ishaq KhanCOST BENEFIT ANALYSIS IN PRIVATE SECTORBy Syed Irshad Hussain.LIMITATIONS OF COST-BENEFIT ANALYSISBy Dr. D. M. Qureshi.COST-BENEFIT ANALYSIS & ITS APPLICATION TO PAKISTANBy Sartaj Aziz.LimitationsProfitability MeasurementsSocial InfrastructureConcept of Shadow PricingAnalysis by the Private SectorRate of Interest of Private Sector LoansProject Balance-Sheet and Profit and Loss StatementsConventional Methods of Investment Appraisal.ESTIMATION OF COSTSEVALUATION OF BENEFITSPRELIMINARY COST ESTIMATING

LOW-COST HOUSING

SENSITIVITY ANALYSIS

Form and function of project reportDIFFERENT TYPES OF COSTS

EVALUATION OF INVESTMENT PROJECTSBy J. KoopmanThe benefit cost ratio.The Internal Rate of Return Formula (IRR)The Modified Rate of Return formula

CIVIL LIBERTIES AND THE PERFORMANCE OF GOVERNMENT PROJECTS

Standard topics to evaluate architectural projects.Project Appraisal Vocabulary

1) Name of the Project.2) Authorities responsible for sponsoring, execution andoptimum performance.3) Time required for completion.4) Plan provision: Case of time and money in delays.5) Relationship of the project with the objective sector.6) Capital cost of the project.7) Annual recurring expenditure after completion.8) Objective of the project.9) Location of the project.10) Earlier available facilities of same nature in target area.11) Case of return from the project.12) Dates of estimation preparation.13) Mode of payement /investment nature.14) Basis of cost estimates.15) Case of return from the project.16) Estimates of annual maintanence.

17) Estimates of unit cost like cost/sq-ft.18) Cash flow statements each for ten years.19) Phasing of physical workand project financial requirements.20) Forex expenditure.21) Payment to the department concerned from government.22) ikely other sources.23) Result of the project.24) Creation of job opportunities.25) Manpower: general / technical / foreign consultants.26) Physical and other facilities required for the project.27) Materials, supplies and equipment requirements.28) Case of imported material/ equipment. 29) Phasing of the work to be done.

PREFACE

There is a link between government efficacy and governance. Itdemonstrates a strong empirical link between civil liberties andthe performance of government projects. Even after controlling ofother determinants of performance, countries with strongest civilliberties have projects with an economic rate of return 8 - 22percentage higher than countries with the weakest civilliberties. The interrelationship among civil liberties, civilstrife, and project performance suggests tat the possiblemechanism of causation is from more civil liberties to increasedcitizen voice to better projects. By both participation andbetter governance can lead to greater efficacy in governmentaction.

The operation of economics is a vital and fundamental influenceupon social structure and the distribution of power in society.This influence stems from the essentially integrated nature ofeconomics and is shaped by the social value system which is botha cause and consequence of prevailing economic value. The conceptenables us to begin to discern the importance of economic poweras the key to the complex relationship between economy and

society. Most economists are prepared, even eager to makeprescriptions and recommendations about economic matters. It is asource of concern to many people that economists who are so eagerto prescribe policies often disagree among themselves. Positiveeconomics is an important element in welfare economics, becauseit describes what is feasible and predicts the observableimplications of particular policies. A good understanding ofwelfare economics is an important ingredient in the constructiveuse of economics.

Internet

Aims to promote research, discussion, scholarly interaction and publication on specific welfare states on the globe on the one hand and a critical evaluation on a comparative basis of the welfare states in a comprehensive framework on the other it seeksto focus on developments of welfare both in the developed and developing societies. An important dimension of such investigations is to see how far experiences in social policies formulations and performances on the ground can be relevant to the future growth of polity. Also, the objective is to undertake analysis of the welfare state phenomenon in both normative discourse with a view to evolve an appropriate methodology by examining the latest research modes, strategies and approaches aswell as interpretations. In the ultimate sense, to search for coherent, logical theory of the welfare state.

GLOBALIZATION AND

THE FUTURE OF WELFARE STATE

A Working Group at the Watson InstituteDietrich RueschemeyerDepartment of Sociology

Since last fall, a working group of Brown faculty and graduate students has met monthly at the Watson Institute for International Studies to examine the chances of systematic socialpolicies in an environment of increasing globalization and international competition. During the 1998-1999 academic year thegroup will continue to meet regularly to exhange views, discuss research plans, and review implications for new and established courses. Several members of the group are pursuing their own, broadly related research projects -- on left parties and social policies in eastern Europe and Russia, on the politics of social welfare in the Russian Federation, on social and economic adjustments in countries within the European Union, on welfare reform in the United States, and on the broad theme of citizenship and equality in welfare states.

After the fall of Communism, what is left are different kinds of capitalism. At the center of these differences are policies dealing with social and economic inequality -- social welfare policies. Is globalization leveling these differences by constraining national welfare state policies? This claim is subject to controversy. In one view, economic globalization creates huge advantages for the most mobile, but in particular for mobile capital in contrast to the far less mobile labor force. One might see the international hegemony of neo-liberal policy ideas as the intellectual epiphenomenon of such structuraland material developments, although the fact that these ideas have found institutional anchorage in institutions of national and international governance makes them perhaps a little more important than providing a mere ideational ornamentation for the "real" factors underlying the changed situation. In this first view, then, globalized international competition and the prevalence of neo-liberal policy ideas create strong obstacles tothe development of new welfare state policies, for instance in Latin America or East Asia; they create obstacles to a careful and conservative restructuring of the state socialist welfare systems of eastern Europe; and they result in strong pressures

for "building down" the existing welfare states of northwestern Europe.

That view is contested. There is first the argument that direct competition between low-wage poor countries and the advanced industrial economies with high wages (as well as the competition between the high-wage countries of northwestern Europe and the lower-wage countries of the US, the UK and others) is limited in many ways, most importantly by huge productivity differences between rich and poor countries. One may point out that Germany, which has constructed a generous welfare state and financed it with the highest level of wage-related welfare costs, also has aneconomy that is strongly export oriented and reaps huge export surpluses year after year. International competition is limited by many other factors, including the immobility of many economic activities that are tied to local consumption (from garbage collection through serving hamburgers to psychiatric treatment, as well as most of higher education).

There are in fact strong indications that greater exposure to theworld market is actually associated with more rather than less extensive social provisions offered by the state. This has been interpreted as a political response of societies highly exposed to the world market seeking to contain the resulting social and economic insecurity.

Prevailing public opinion in this country holds that the northwestern European welfare states are not only facing great difficulties (which they do) but that they are either cutting back their provisions dramatically or their economies are at the brink of crashing. In fact, the cutbacks have not been dramatic when viewed in relation to the continuing bulk of provisions. In fact, even in the United States, overall reductions in social expenditure have been quite modest.

One reason why this is so may be the staying power of existing welfare institutions and their support in different political constituencies. Complex institutional set-ups create strong mechanisms for their own self-reproduction. An example of a

different, but nevertheless relevant kind is the American liberalarts college system, which is unique in the world and perhaps of less obvious utility than a generous system of welfare provisions. In many countries, such institution-based political staying power is paralleled by the support of broad political constituencies. In turn, drastic cutbacks are much more likely where institutional anchoring and the political clout of consituencies are weak. More generally, political coalitions and long-term political developments make for dramatic differences inthe overall role of the state. The World Bank's Development Report of 1997 notes, for instance "...from a point of rough equivalence in 1960, the Swedish state grew to nearly twice the size of that in the United States by 1995, in terms of both spending as a share of income and public employment as a share ofpopulation" (p. 22).

The working group can build on past work at the Watson Institute.A conference under the leadership of Tom Biersteker focused on problems of financial globalization, a topic that recently has been brought to the attention of many. More recently, an international conference on the future of the German welfare state was organized by Marilyn Rueschemeyer for the Future of Germany project at the Watson Institute.

In the coming year, the group -- in contrast to individual research projects -- will most likely focus on interregional comparisons of the impact of globalization. The issues relating to international competition and the future of welfare states will look quite different in western Europe and in the formerly state socialist countries of eastern Europe and the former SovietUnion. Similarly, western Europe and North America will differ from each other in important ways, and so will North and South America. Finally, East Asia will face problems of yet a very different kind. Such interregional comparisons are understudies, yet hold great promise for a better understanding of the interrelations betwee globalization and national social policies.At the same time, this focus capitalizes on the opportunities forcross-departmental and cross-area specialty cooperation that are inherent in Brown's small size and are fostered by the Watson

Institute.

Dietrich Rueschemeyer is Asa Messer Professor and Professor of Sociology. At the Watson Institute, he directs the Research Program on Political Economy and Development.

When do welfare states develop? IWilensky found a strong relationship between welfare spending and level of economic development. The relationshipheld both over time within societies and among nations comparing cross-nationally. It seems that historically, as societies develop and industrialize, family, church, guild, community, and neighborhood no longer adequately perform support functions. Those functions are then taken over by the state.

Before you become nostalgic about the "good old days," realize that these institutions could perform some minor functions well, but they were not up to most tasks societiesface today. Ask yourself whether you want those institutionsto work well. Lionel, a graduate school friend from the Philippines, used to reminisce about his drinking buddies back home. He told us that he had great friends. "If I want to build a house, my friend the architect will design it, another friend will get the building materials, ..." Of course, when their turns came, you had to reciprocate. That's fair. This was all very nice but he also told us, youalways have to be there. You don't miss a night out. Anotherfriend from Vietnam told me how Vietnamese are always "talking, talking, talking." He told me they need to. That is how they get the information they need to survive. Wouldn't it be easier and less costly if formal institutionsworked well? Finally, do you really want to take care of your parents when they are old? It sounds romantic but some old people get a bit "cranky." No wonder there are so many reports of elder abuse and neglect in the Straits Times.

Welfare states develop because they are functional.

When do welfare states develop? II

Marshall asserted that welfare states are a natural extension of citizenship and a result of the political process of nation-building. He saw a natural progression among

· civil rights guaranteeing freedom of association, religion, expression

· political rights guaranteeing the right to vote and seek office, and

· social and economic rights guaranteeing social and economic security

Marshall saw a political struggle that was begun by the middle class to win rights "from above," wresting privilege from the hands of the aristocracy and/or colonial powers andcontinued by working people. Industrialization requires masses of people be brought together. These people may be ripped from earlier social situations with their informal protections against some risks. (Think back to Polanyi.) Demands for a welfare state is one way to win these protections back.

What about variations in welfare states?The strength and character of the "welfare state" varies from country to country.

· Countries with strong leftist parties manifest more highly developed welfare systems. The legitimacy of such parties and their accompanying organizations is tied to their welfare parties.

· Mass participation in political life leads to stronger welfare states. As just noted, the welfare state is tied to citizenship and citizen interests. Strong states develop stronger welfare states. The state is an organization with interests. Like all organizations, it tends to expand in order to increase its power and control.

Welfare states are a result of a political process.

When do welfare states develop? IIIWelfare states develop when there is a need and a political coalition. Industrial societies have certain similar functional requirements. (Remember Parsons and his discussion of the differentiated subsystems brought about bysocietal development. This brings about the need for specific institutional structures (often organizations) to integrate the society. Because welfare states are products of similar needs, they tend to converge on similar institutional structures.

Much of the apparatus of welfare states acts as an insurancemechanism spreading the costs of common risks. Welfare states may do more than that. They may enhance economic competitiveness. Accrding to Myrdal, “Welfare … actually lay[s] the basis for more steady and rapid economic growth.”Let's leave this point to discussion.

Welfare States Cutting Budget Deficits Canada and Sweden are known for their generous social welfare programs, purchased at the cost of high taxes and, more recently, mounting government debt and budget deficits. Both countries are fighting their way back from the budgetary brink by cutting government expenditures.The United States is in a better fiscal position than either Canada or Sweden. The U.S. has an estimated budget deficit for 1995 of $161 billion, or 2.3% of Gross Domestic Product (GDP), and a federal debt totaling 52% of GDP. In contrast:    Canada's national debt, which totaled less than 17% of GDP in 1975, began swelling after the 1981-82 recession until it now stands at 75% of GDP.    Sweden's public debt doubled in the early 1990s, unemployment tripled and the budget deficit increased tenfold to 10% of GDP in 1994, the worst among all industrialized nations.  In Canada, the liberal government elected in 1993 pledged to cut the budget deficit from 6% to 3% of GDP in three years. To do so:Discretionary spending will fall to 10% below the 1993 level and business subsidies are getting sliced by 60%.    The government'spayroll will decline by 15%, and some department budgets have been cut in half.    The current system of financing Canada's national health care system will be replaced by block grants to

the provinces, designed to shrink overall health spending from 10% of GDP to 8.5%.    By the time the full program is enacted, Canada's federal government, in terms of percentage of GDP, will be as small as it was in the 1950s.    Sweden is an even more extreme case, with a tax burden of 63% of GDP, compared to 31% for the U.S. Its standard of living, once the highest in Europe, has fallen behind France and Italy.    The Swedish government elected in 1994 is cutting spending on welfare, pensions, health insurance, unemployment, family assistance and child allowances. The budget deficit in Sweden will fall by 3.5% of GDP this year alone, with additional cuts of 4% of GDP over the next three years, for a total reduction of 7.5%.    Both countries have credible plans for reducing their deficits to zero over a much shorter period of time than the U.S. Congress is proposing.    Source: Rob Norton, "The Baddest Budget Cutters," Fortune, October 16, 1995.

THE CONCEPT OF COST BENEFIT ANALYSISBy Ghulam Ishaq Khan

Economic development is essentially a process in which currentsavings or present capital resources are invested for increasedfuture production. The need for the increased production, inalmost every sector of a developing economy, is often so greatthat the capital resources available to economy at any given timeare never adequate to satisfy all its investment requirements.Even when there is no paucity of capital as such there is alimited set by the annual budget to what Government can spend ina given period towards satisfying specific needs, and since thereare always more than one way of satisfying such needs there areinvariably more projects proposed by local interests or thefunctional agencies than for which funds can actually be madeavailable. Government must have certain criteria or standards bywhich to compare and evaluate the economic effect of investmentin individual sectors or projects.

The final decision may not be taken on economic considerations

alone; social and political considerations may make it necessaryfor the Government to keep some balance in expenditures amongfunctional fields and administrative regions regardless of theeconomic results of such expenditures. But cost benefit analysisfor projects evaluation and capital output ratios, as far asbroad allocations to sectors are concerned, are, nevertheless,now universally recognized as the most competent tools to employto arrive at decisions on these issue.

The use of cost benefit analysis for evaluation of individualprojects or the use of capital output ratios for purposes ofsector allocations, in their present sophisticated form is acomparatively recent development. Cost benefit ratios ofprojects, properly worked out, enable us, unlike the old “rate ofreturn” formula, not only to assess the economic worth ofindividual projects but also to determine which of the severalprojects designed to serve a given purpose would result in thelargest benefits for a given unit of cost and which of theseveral projects designed to serve different purposes wouldconfer the largest net benefits on the economy as a whole. Costbenefit analysis, as a technique, would also permit us to assignpriorities and to decide on the relative economic ranking ofprojects in the same field; to compare the economic worth ofprojects in different fields; and to determine what should be theoptimum size of projects of programmes.

It is not always easy to determine what constituents the totalbenefit of a project and what is its total cost. It is always anexasperating exercise to evaluate and compare the true cost andbenefits of projects. Benefits and cost accrue over time,sometime over several decades and not unoften in an unevenpattern. Price levels and interest charges are subject to change.The economic life of a project may be affected by changes indemand and technology. Benefits and costs are attributable to aproject only when they arise “with” and because of the projectbut would not arise “without” it and in its absence, eitherbecause of the passage of time or because of such otherunconnected reasons. The costs are usually divided into primarycosts and associated costs. Primary costs consist of the goods

and services which must be surrendered in order to construct andoperate a given project. These would include not only the moneyexpenditure incurred on a project but would also include themoney worth of the economic loss, if any, incurred by diversionof these resources. Interest during construction as well asadministrative expenses, engineering, supervision, cost of landand relocation of existing facilities affected form part ofprimary or direct costs.

Here again there are primary, secondary and intangible benefitsaccruing from a project. The primary benefits are the value ofthe immediate products or services of the project minus theassociated costs. The secondary benefits are the increasedincomes in secondary activities, such as, marketing. Theintangible benefits, which are hard to measure in monetary terms,include such items as contribution to National security,contribution to level of employment, removal of economicdisparity, recreation etc.

EVALUATION OF INVESTMENT PROJECTSBy J. Koopman

A Comparison of the “Benefit/Cost Ratio”and the “Internal Rte of Return”

Where public investment is concerned, the term “Cost” applies tothe real costs to the nation as a whole, as opposed to thebusiness man’s interpretation of actual money costs on a privatebasis. Thus in the public sector, a conscious effort must be madeto exclude such items as indirect tax, which have no bearing onthe real costs in the public sense. Again, it is advisable to use“shadow prices”, reflecting the opportunity cost, or free-marketcost of labour or capital.

THE BENEFIT/COST RATIO

This ratio compares the total benefits of an investment with thetotal cost. The income of the investment during each year of itspotential life time is treated as a profit for that year, while

expenditure is treated as a loss. The surplus (or less) for eachyear is discounted to the presented value at a prescribed rate.The discount rate should be realistic in that it truly reflectsthe market-rate.The benefit/cost ratio can be written as follows:

(1)    C:

)r1(S.........

)r1(S

)r1(S

r1S

nn

33

221

C is the capital invested. If the gestation period is more thanone year, interest during the construction period should beincluded. The interest during the construction period should becalculated according to the market-rate and not according to theloan, which might be granted at low cost.

S = V - O = net benefitsV = benefits in a certain yearO = Operating or recurring cost, or capital-cost in a

certain year.r = Interest rateS1 = Net benefits in the first year of operation.

Interest should not be considered as a part of operating cost.

Depreciation should not be considered as a part of the operatingcost either. The chosen discount rate is one of the majordeterminants of this ratio. Obviously, if the discount rate isaltered, the result will change accordingly and even the priorityrange between a number of projects may change. The discount ratecan affect the apparent desirability of certain types ofinvestments. There are, however, other ways to reach these goals.

The Internal Rate of Return Formula (IRR)

The formula of the internal rate of return, runs as follows:

(2)    C

)r1(S.........

)r1(S

)r1(S

r1S

nn

33

221

The same symbols are used as formula (1). The difference is, thatformula (1) is a ratio, but formula (2) is an equation. The rateof return is the value for r which solves the equation. Since all

“S’s” are known and “C” is known, it is the discount rate whichequals the discount benefits with the capital invested, which isin fact the internal rate of return. These are two importantdifferences between the benefit/cost ratio and the internal rateof return. In calculating the internal rate of return it isnecessary to regard depreciation as a part of the operating cost.

Both formulae have a disadvantage in common that the life-time ofthe project influences the result of the calculation. This willbecome very clear by applying these formulae. To overcome thisdifficult a modified formula will be discussed.

The Modified Rate of Return formula

In order to understand the influence of the life-time of theproject by applying formula (2) it is helpful to use the exampleof a capital invested in bonds, giving an annual interest of, say6%. This interest rate is the actual internal rate of return. Ifthe bond is $ 1,000 giving 6% interest, the annual income is $ 60(capital times interest rate = C.r). The total sum of thediscounted future annual flow of income, will only equal thecapital if the calculation tends to infinity, i.e.

(3)1000

)06.1(60.............

)06.1(60

06.160

n2

or more general:

(4)C

)r1(r.C....................

)r1(r.C

)r1(r.C

n2

nWhen formula (3) is calculated for n = 100, it appears that theright side of the formula covers 997.05 or 99.7% of the capital.For n = 50 the result is 945.71; for n = 40 the result is 902.77and for n = 20 the result is 688.20 or 68.8%.This means that the formula () cannot be applied for projectswith a short life-time. For a lifetime of 50 years, the error ofabout 5.4% (by a discount rate of 6%) can be accepted. But forprojects with a shorter life-expectancy the error would disturbthe outcome of the calculation too much.

Since the left side of formula (4) is the expression of thetheoretical return of capital over time, it is more accurate touse this expression instead of C. The modified formula for theinternal rate of return should therefore run as follows:

(5)n2n

n2

21)r1(r.C......

)r1(r.C

)r1(r.C

)r1(S.....

)r1(S

)r1(S

The left side of the equation (5) is similar to the left side ofequation (2).The formulae of the internal rate of return, seem verycomplicated, but by using a good compound interest table theformulae are easy to handle, which will be clear from thefollowing evaluation of a project, with a life-time of only 10years.

COST-BENEFIT ANALYSIS & ITS APPLICATION

TO PAKISTAN

By Sartaj Aziz

Conceptually cost benefit analysis or cost benefit ratio meansassessing the total costs involved in projects and their totalanticipated benefits to determine their relative priority.

Limitations

Firstly, that it is a device which facilitates the selection ofprojects from among given alternatives rather than generate goodprojects. If only poor projects have been conceived, only poorones can be selected, no matter how vigorous and exhaustive theanalysis made. Secondly, it cannot overcome weaknesses inestimates and technical detail, although it may indicate possibleareas where one can look for such weaknesses.

Profitability Measurements

The techniques of cost-benefit analysis developed so far includewhat the U.S. analysts call the “Payout period”, Maximum cashimpairment period”, “Profit to Investment Ratio” (or “CreditStatus”), “Ratio of Net Income to Investment” and the “DiscountedCash Flow Analysis”. These techniques as the name implies measurethe financial profitability of projects. Even where most of thesecosts and benefits are identifiable and measurable, theirsignificance and hence their relative weight for the society as awhole may be different from that for the individual or the firm.

Social Infrastructure

In the field of social overhead i.e., Education, Health and

Housing, the problem of the application of cost benefit ratiobecomes still greater and that is partly because of theconceptual difficulty. It is true that these costs can never bedetermined in a rigid framework but if there is a range of costit is possible to know whether a certain project is within thatrange or not. In some cases the costs may be higher because ofshorter construction season or higher cost of imported cement orbecause the place may not be quite accessible and so on, but bylooking for variations from the norm or the standard it can beensured that the project does not provide for buildings which aredisproportionately lavish in relation to the objectives.

Concept of Shadow Pricing

The concept of ‘shadow pricing’ or opportunity cost is offundamental importance to all the techniques of cost benefitanalysis. The basic premise of this concept is that real cost ofdifferent factors of production or key inputs such as capital,labour or foreign exchange is different from their apparent ormarket cost. Our projects tend to be more capital intensive andless labour intensive. There are certain very high productivitysector - sectors in which the use of capital increasesproductivity so much that substation by labour is neitherfeasible nor economical. In such cases the employment objectivecan be relegated, but there are many sectors of industry and alsoconstruction where there is infinite scope for substitutinglabour for capital. To exploit this scope, it is necessary tounderstand and use the concept of shadow pricing. The calculationof these prices is not easy, but it is better to use anadequately worked out shadow price rather than none at all.

In the industrial projects falling in the private sector,although the choice to select projects lies with the privateenterprise, the ultimate decision to embark on the scheme isdouble checked through the agencies of Economic Council andCentral Permissions Committee. These bodies have representativesfrom the top Government policy markers. The Planning Commissionis a high powered body headed by no less than the chief executiveof the country. It becomes obvious that the importance of the

crucial decision of selection of the projects and application offoreign and local financial resources for its build up is dulyrecognised.

The basic planning for the development of industries in privatesector lies with the Government - the Planning Commission, theEconomic Council, the Investment Promotion Bureau etc. Theyformulate and publish the Investment Schedules which govern thedevelopment in the private sector. They lay down fields ofoperation and the entrepreneurs function within the specifiedlimits. The Government also takes up projects outside theInvestment Schedule if these are timely and useful for theeconomic needs of the country economic development in thecountry. However, the people responsible for the wrong decisionwill not be quickly put into focus and brought to task.    It isnot unusual for the financiers to invest every rupee and employall their resources for the development of industrial ventures; amistake will bring them to the door of bankruptcy. With the highpersonal risk involved in the private sector a detailed analysisto carefully grasp the benefits and the risks involved becomesall the more important.

The decision of investment in fixed capital which will increasethe assets is much more complex as various factors like thelocation of the, date of commencement, source of raw materials,methods of financing have to be considered and the wrong decisioncan have dire consequences.

Analysis by the Private Sector

Every man in business starts from such basic concepts and as thesize of the project increases the mode of assessment becomes moreinvolved and sophisticated. In the case of large projects like atextile mill or a cement factory the mechanism is more,complicated. There, an entrepreneur has to find out the cost ofthe raw materials, machinery, labour charges, the administrativecharges and compare it with the benefits. In view of the factthat there has not been adequate competition that they will getprofit. In other words, in every project the cost of raw

materials, manufacturing charges and administration charges havebeen worked out and on the top of this a certain profit has beenadded. Because of lack of composition the price is dictated bythe producer.

Rate of Interest of Private Sector Loans

While the public sector is able to get cheaper loans from thecountry’s own resources or foreign agencies at a rate as low as1% interest, the private sector has to pay between 7 to 10%.There are instances where the world loaning agencies have givenloans for public utilities at a rate close to 1%, the same loanwhen obtained through International finance Corporation cost theprivate sector a rate of interest between 8 to 10%.

Project Balance-Sheet and Profit and Loss Statements

Once it has been decided to embark on a project, its projectedprofitability is fully looked into. This is done by drawing upprojected balance-sheets and also profit and loss statements.

Conventional Methods of Investment Appraisal

A progressive management applies logic to experience and theknown facts are used as a tool for making the investmentdecisions. Although the factors involved are complex and it isdifficult to forecast exactly the sales costs, technologicaldevelopment, obsolescence, the application of financialprinciples to whatever basic data is available highlights therisks involved and any latent pitfalls. It indicates the vistasopen by which the risks might be reduced to a minimum and theprofitability enhanced. The following three concepts are kept inview in analyzing the profitability of a project.

1. Rate of Return:    This is defined as ratio of profit to the invested capital.The profit can be taken as net of depreciation and afterpaying the taxes to the Government.

2. Pay Back:    This is one of the more popular methods. This is defined asthe number of years it takes for the investment to generateenough cash to recover the initial capital outlay in full.In order worlds how many years will it take to receive themoney which was put into the project.

3. Necessity-Postponability: By this method the attractiveness of a project is gauged onthe basis of how urgent the venture is. If the project is ofthe highest necessity keeping min view the market conditionsand availability of funds, it gets a higher rating. If theproject can be postponed without much loss over a long timeit gets a lower rating.

Summarizing, it can be said that the private sector has muchbigger risks involved when it launches on an industrial project.It is, therefore, important that the projected benefits arecarefully looked into and constantly reviewed. The profits haveto be generated at a higher pace compared to the public sector inorder to attract capital and make the project attractive to theinvestors. A mistake made in the private sector is much morecrucial and disastrous.

LIMITATIONS OF COST-BENEFIT ANALYSISBy Dr. D. M. Qureshi

There is a need to see whether the cost-benefit analysis isapplicable or not in developing countries like Pakistan and whatmodifications, if any, are necessary. There are a number of basicassumptions underlying the cost-benefit analysis and these haveto be constantly kept in mind while making use of the technique.The most important assumptions are, “full utilization of allresources, in the economy, the absence of production underdecreasing cost by indivisibility either in input or output and

the absence of external economies or dis-economies”. Theseconditions are not obtained perfectly even in advanced countries.Therefore, for practical purposes the system of perfectcompetition is accepted as a workable approximation of reality.But where deviations are too obvious, some adjustments arenecessary in the way of inclusion of certain indirect benefitsand of imputed returns. These adjustments, however, are not easyto make and introduce an element of subjectivity in the analysis.This is because even in the most advanced economies the inclusionor exclusion of indirect benefits have a large element ofarbitrariness.

In under-developed and developing economies, therefore, due tothe absence of basic infra-structure and lack of full developmentand presence of unutilized capacity in all or certain sectors ofthe economies the result of cost-benefit analysis may be quitemisleading. I benefit-cost analysis alone is taken as thecriterion for accepting or rejecting projects by the planners itwill be totally misleading.

Another limitation of cost benefit analysis is that both costsand benefits are subject to various errors associated withforecasting because time periods for estimating the costs andbenefits are different. The benefits have to be worked out onsome dates. These inevitable errors place a fairly large marginof error around cost-benefits ratio.

In view of inherent weakness of the cost-benefits analysis for asingle project, the general trend now is to use this techniquefor ranking or giving priorities to different project. If thelimitations of the cost-benefit analysis are understood properlyand it is used with care, the technique can help in choosingbeneficial projects.

The use of benefit-cost semantics makes at least only a modestcontribution to their solution.

The question arises as to what should be the basis of appraisalof investment projects in developing and under-developed

countries. The following suggestions are based on the discussionon Prof. Otto Eckstein’s Paper on “Regional Economic Planning -Technique Analysis”.

1. The investment projects should not be appraised individuallybut as a “combination” or a “programme” of project.

2. The benefits should be measured as an addition to thenational product induced by the investment “programme”. Thevalue of scarce factors can be used as negative benefits.This analysis for a single year would be of limited use.

3. The benefits should also include indirect effects madepossible by the existence of unused capacity.

4. In most under-developed countries, accurate information onmarket prices is difficult to obtain. In such cases, ‘shadowprices’ should be used. Also wages of un-skilled labour areusually higher than the opportunity costs of labour.

5. The costs should include the value of all scarce factorsused in a “programme”. The scarce factors should be valuedat ‘accounting’ prices.

6. The effect of projects on other aims of economic policy suchas the employment, the balance of payment, the regionalincome distribution etc., should also be worked outproperly.

The measurement of indirect benefits is a very difficult exerciseand this coupled with errors of forecasting calls for utmost carein the application of the technique.

ECONOMICS: SOLUTION FOR SURVIVAL

Our conclusion, many years and many clients, is that when thereis the “carrot” treatment about future work, one should rememberthat the “stick” is always in the background and that it is bestto let the later jobs take care of themselves. We have beenexcessively exposed to developers in the worst sense, but we have

come to find that nothing improves the character of a client morethan having his own money invested in our work via the initialretainer before we do anything except talk to him about ourqualifications.

These qualifications are the same as those required of anyprofessional who is a specialist in any field or of any architectwho is a specialist in a certain direction, such as educationalbuildings, hospital work or shopping centers. In many cases, theprofessional knows more about his client’s business than theclient does. It does signify that the architect must know all ofthe things which cause his client to arrive at his decisions:why, how and how much and what kind of return is expected for adollar of expenditure in any of many categories of capitalexpense, maintenance, operations, social services, resale andreturn to investors, including tax shelter situations.

Economics means an understanding of all of the factors by whichthe client can determi8ne whether his project is feasible. It isan understanding of the relative value of the land and of theconstruction, together with the cost of financing theconstruction during the interim stage as well as the amountsnecessary to satisfy the debt service, operation, maintenance andadministration so that a profit will be returned to the investor.

The human organism seeks to conserve energy by minimizing therequired motion. In walking, we seek the simplest path along thelines of least resistance through doors, slopes etc., from apoint to goal. The shortcut is a universal item of human-being.And yet architects often frustrate this biological need toconserve energy by creating circuitous paths, oddly placedacross, changes in levels and the like. What clues are there inpsychological and emotional responses which will indicate thechoice of route?

PRELIMINARY COST ESTIMATING

The size, quality and complexity of a project must be consideredin preliminary cost estimating. These elements are reflected in athree-pronged, crosschecking system in which square footage andarea of enclosure methods, joined by a percentage analysis, givesthe architect a simple but effective tool early in the game.

Projecting a cost estimate in the early stages of a job is oftenlike throwing darts at a “cost board”. The efforts on the apartof many architects to make an intelligent approach to proper costestimating are further complicated by a multitude of pitfalls.The point is that the architect must develop methods by whichcost estimates can be easily and efficiently made in the earlystages of the program and the project cost budget checked beforethe job gets too far along.

Early cost estimates are too often carried through to become thefinal, fixed budget.What are we going to do to increase our expertise in projectingcosts and reducing the gamble? First and foremost, a schematicestimate of construction cost must be made simple, direct andeasy for everyone to arrive at - even the designer who claimsimmunity to the dirty word “cost”. The designer with the projectmanager should evaluate and be made aware of the costs and theconditions under which these costs are valid.

The accuracy of all good systems relies upon two factors:(1) a good data or historical base.(2) a consistent method of procedure that is always the same andwill average out other irregularities.

A cost Analysis Summary Sheet, is typically in    many officesattempts a breakdown of the total budget. The keystone in settingthe limitations of the program is the target; at the same time,the program can be the control point at a logical budget. Theprogram includes all of the requirements, the most importance ofwhich is the size of whole and all the parts thereof. Next inimportance is the construction, followed by complexity, based

upon the sophistication of the spaces.

In summary, preliminary cost estimating should consider size,quality and complexity; these factors can be reasonably reflectedby intelligent use of the three methods of estimating which havebeen described here. Do not compare apple with oranges. Thesystem won’t work by using the wrong data base. One which haveaccumulated a good file of historical cost data and good updatinginformation can usually make good cost protections.

THE SCOPE AND PURPOSE OF WELFAREECONOMIES

Welfare economics is the framework within which the normativesignificance of economic events is evaluated. In order to makestatements about the consequences for economic welfare of anevent we must go beyond the study of positive economics, which isconcerned with the effects of an event on objectively measurableeconomic variables such as price and quality. This is, thewelfare economist wishes to determine the desirability of aparticular policy.

Welfare economics can be viewed as an investigation of methods ofobtaining a social ordering over alternative possible states ofthe world. A social ordering permits one to compare all states ofthe world and rank each one as ‘better than’, ‘worse than’, or‘equality as good as’ every other. We are interested in rankingdifferent allocations of resources, where this is used in itsbroadest sense to refer to the combinations of commoditiesproduced and consumed by each decision-maker in the economy andthe combinations of factors used in the production of eachcommodity. This convention ought to be construed as meaning notthat non-economic characteristics are irrelevant in rankingsocial states.

The ranking of social states is inevitably a normative procedure;

that is, it involves making value judgment. For each set of valuejudgments adopted, a different social ordering result. The use ofwelfare economics for policy purposes is, we would argue based onthis premise. Much of the welfare economic analysis underlyingpolicy prescriptions is based on a certain set of value judgmentswhich are widely accepted among economists, including ourselves.

A good deal of welfare economics is based on the concept ofeconomic efficiency. This concept is used to order social stateson the basis of some minimal value judgments. Two main valuejudgments are involved. The first is that the social orderingought to be based on individual orderings of alternative socialstates, that is, on individual preferences. This assumption iscalled individualism. There are obviously a number of problemswith it, the main one being that some individuals may be judgmentincompetent to formulate their own preferences, for examplebecause of insanity or youth.

The second widely accepted value judgment is the Paretoprinciple, which says, in its strongest form, that if state A isranked higher than state B for one person, and all other personsrank A at least as high as B, then A should be ranked higher thanB in the social ordering.

In order to make use of these two ethical principles, it isnecessary to have a theory of how an individual’s level ofwelfare or utility is determined by the state of the world. Thenormative analysis of economic efficiency proceeds with onlyindividualism and the Pareto principle as value judgments. Thereis an important relationship between resources allocationsgenerated by the market economy and those ranked highly by thePareto criterion. This relationship is summarized in what arereferred to as the two basic theorems of welfare economics. Theexistence of market failure implies that there are someopportunities for mutual gains that are not being exploited. Suchsituations are described as “inefficient”.

The study of welfare economics is useful in identifying suchinefficiencies and in recommending and evaluating ‘corrective’

policies. Even in the absence of market failure, the fact thatcompetitive economies are Pareto optimal is of limited use. Oneattempt to deal with this incompleteness is to extend the Paretoprinciple by means of a hypothetical compensation test. Somestates, such as the Pareto optimal ones, cannot be ranked by thecompensation test.For these reasons, a complete study of welfare economics attemptsto go beyond the concepts of economic efficiency based on thePareto principle. This involves devising some means of weightingthe utilities of different households, and this, in turn,requires that stronger value judgments be made. The valuejudgments can be codified into a social welfare function (SWF) orordering.

The choice of an SWF is constrained by the ethical assumptions tobe incorporated and the information about individual utilitiesassumed to be available. The least restrictive informationalassumptions are that the individual utilities are only ordinallymeasurable and non comparable among households. The types ofsocial welfare functions available under such assumptions areextremely limited and violate some reasonable equity assumptions.

Despite this rather arbitrary procedure, the use of an SWF is animportant element in modern welfare economics. With such adevice, the framework of welfare economics is complete and wellstructured in principle. In applying welfare economics, weimmediately face a conundrum. Much of the theory of welfareeconomics was designed to produce an ordering or ranking ofsocial states, either at the individual level or for society as awhole.

In applied welfare economics we are often asking for somethingmuch more; we would like to have a measure of welfare whichenables us to measure the welfare change in going from oneallocation to another. Welfare change measures for an individualinvolve obtaining an estimate of the change in value of the moneymetric resulting from either a change in the bundle ofcommodities consumed by the individual or, because the commoditybundle chosen by the individual depends upon prices and income,

from a change in the prices and income facing the individual.Applied welfare economics must confront the problems of measuringwelfare change in a many consumer economy in a manner which isconsistent with some underlying social ordering or social welfarefunction. The culmination of this effort lies in the field ofcost-benefit analysis or project evaluation.

Cost / Benefit Analysis

The application of the tools of the measurement of welfare changeto a particular sort of problem is important evaluation ofinvestment projects. Equity or redistributive considerations thatwould arise if one used a social welfare function are ignored.The need for cost-benefit analysis arises when privateprofitability does not rank projects according to the socialordering: This might be for several reasons. Princes of inputsand outputs may not reflect their true marginal costs or benefitsif the inputs are purchased or the outputs are sold on distortedmarkets. The social values of inputs and outputs purchased andsold may not capture all the costs and benefits of a project.Finally, the discount rate used to determine privateprofitability may differ from the social discount rate if thereare capital market distortions of one sort or another.

Cost-benefit analysis is an attempt to arrive at a measure ofwelfare change which incorporates all these items missed by theprivate profitability criterion. The procedure is as follows. Thecosts and benefits within each period are summed. In the case ofinputs and outputs of the project, shadow prices are determinedwhich account for distortions on the markets themselves or forthe fact that the items are non marketed. The non marketed itemsmay include time saved risk taking, health improvements. Oneinvolves the shadow pricing of labour when there are distortionsin labour markets. Another is the evaluation of tradablecommodities when tariffs are levied on international trade. Thethird is the cost of financing public projects through debt or

taxes when distortions exist in capital markets. In addition,there is an analysis of the evaluation of some non-marketed costsand benefits, especially the cost of risk-taking.

In addition to the evaluation of inputs and outputs themselves,indirect effects in each period must be evaluated. These indirecteffects may include externalities emitted elsewhere in theeconomy. The evaluation of externalities is problematic since nomarket price exists from which social values can be deduced. Theother sort of indirect effect is the change in net benefitsresulting from changes in resource allocation on distortedmarkets elsewhere. Thus, if price exceeds marginal cost elsewherein the economy, the marginal social benefit will exceed themarginal social cost if output is increased.

Finally, the benefits and costs within each period must beaggregated into a single measure of welfare change. This is doneby converting all current benefits and costs into an equivalentvalue in terms of present period consumption: that is, byaggregating the present value of all benefits and costs. Theappropriate discount rate for determining the present value isthe rate at which society would just be willing to substitutepresent for future consumption at the margin - the socialdiscount rate.

CIVIL LIBERTIES AND

THE PERFORMANCE OF GOVERNMENT PROJECTSGovernment, like religion, is a broad topic that inspires strongbeliefs and is difficult to measure reliably. We mean bygovernance? As “the manner in which power is exercised in themanagement of a country’s economic and social resources fordevelopment”, which does not easily lend itself toquantification. We hope to shed some empirical light on one

dimension of governance by demonstrating a positive link betweena country’s civil liberties and the performance of thegovernment’s investment project.

Governance involves actions of publicly vested authorities. Welabel three interrelated dimensions of government action as what,how, and how well. What public decisions are taken - includingthe enactment of laws, policies, and regulations - affects theallocation of public expenditures and investments and determinesincentives for all other actors. How public decisions andauthority are exercised depends on underlying social structures,political structures, and official and unofficial institutions.How well public decisions and authority are exercised determinesthe efficiency of government in accomplishing its objectives.

Economic and social outcomes so depend on governance - for goodand for ill - that the what, how, and how well of governmentaction underlie the richest social science traditions. Studiesexamines the effects of directly measurable government actions ongrowth, such as levels and patterns of public investmentexpenditures.There should be analysis the effects of underlying socialstructures, political structures, and institutions that determinehow governments exercise public decisions and authority. Much ofthis work focuses on the effects of civil and politicalliberties. There is association between higher levels of incomeand higher levels of civil liberties and of popular politicalparticipation. Current research, although deeply divided, tendsto find no causal link at all between democracy and growth.

The what and how of government action are, of course, criticallylinked. Policies and actions matter, and underlying conditionspartially determine the choice of good or bad policies.Democratic arrangements may lead to greater public investments ininfrastructure, greater and investments in human capital, moreopen trade policies and better provision of a secure legal systemand property rights. The other argument is that more democraticarrangements may have negative effects on government policies and

actions when vested interests lobby for preferential treatmentand against efficiency enhancing reforms.

A recent set of papers uses private service ratings for foreigninvestors to analyze government efficiency. Mauro (1995) examinesthe impacts of various measures of institutional quality andsuggests that corruption is associated with lower economicgrowth, primarily by reducing investment. Knack and Keefer (1995)find significant negative effects of the overall quality ofgovernment on economic outcomes. Chong and Calderon (1996)explore the connection between these same institutional qualityindexes and economic inequality.

Citizen preferences are not linked to revenue for governmentservices, because taxation is ultimately coercive. Accordingly,other channels induce government performance, includingaccountability, openness, transparency, predictability, and therule of law. Markets create managerial discipline and induceefficiency through the exercise of choice, government areprincipally disciplined through the exercise of voice. Very fewempirical studies have documented the link between citizen voice- facilitated by openness - and accountability and performance.They postulate that a free flow of    information pressures (evennondemocratic) governments into public action. Literature on theinvolvement of potential beneficiaries in government financedinvestment projects also suggests the importance of citizenvoice. Overall, citizen voice is an important determinant ofgovernment accountability and efficiency but do not identify theunderlying social and political conditions conducive to citizenvoice.

We hypothesize that basic civil liberties - such as the freedomof individual expression, a pluralistic and free media, theability of groups to organize, and freedom of dissent andcriticism - facilitate greater citizen voice and hence moreeffective government action.

PROJECT PERFORMANCE AS AN INDICTOR OF GOVERNMENT

EFFICACY

Mistaken beliefs may cause government to pursue policies that areinefficient, or even counterproductive, relative to its ultimateobjectives. For instance, many governments have actively anddeliberately discouraged many types of foreign investment. Nearlyall data concerning government actions concern public resourcesspent on inputs, not comparable outcomes. Governments do notspend money equally effectively. We use the economic rte ofreturn (ERR) as an indictor of outcomes.

Determinants of Project Perfomance

The Data

The ERR is the discounted stream of project costs and benefitsover the life of the project, evaluated at economic (as opposedto financial) prices and calculated. The quality of cost benefitanalysis overall.

Government Efficacy

The rates of return on government investment projects areasonably proxy for government efficacy? To find the answer, weaddress two issues. First we    evaluate the reliability andrepresentativeness of the sample.    We investigate the potentialrelationship between ERRS and civil liberties that is specific tofinance projects. Thus the first reason for potential bias isthat this choice may involve cream skimming, in which governmentsseek financing for projects with very high expected ERRS.

The lack of strong correlance between the ERR and other possiblemeasures argues against interpretation of ERRs as an indicator ofgovernment efficacy. For instance, rank countries by variouscharacteristics that indicate their attractiveness for foreigninvestment. These various measures are not significantlycorrelated with the ERRS in our data set. In part the lack of

correlation might occur because these private sector ratings areflawed indicators of government effectiveness. The time varyingvariables, such as the black market premium, must be matched tothe period relevant to project performance.

We include a set of sectoral dummy variables because the sectorsdiffer substantially in their ability and in their techniques forassessing the ERR. We include a set of time varying countrycharacteristics that potentially determine returns. We use theeconomywide capital labor ratio because a higher capital laborratio lowers the potential return on capital. Our estimatesconfirm this relation: a unit increase in the natural log of thecapital labor ratio reduces the ERR by between 1 and 1.6percentage point. We consider the black market premium to be anomnibus indicator of distorted policies because it is associatedwith over valued exchange rtes, trade distortions, andmacroeconomic instability, all of which have a strong negativeimpact on ERRS. Even accounting for the black market premium,projects do better in countries with a larger fiscal surplus. Weexpected that gross domestic product (GDP) growth would also havea large impact on returns, ;but the effect is modest. Theinclusion of the regional controls does have a significant impacton the estimates of other variables.

CIVIL LIBERTIES AND PROJECT PERFORMANCE

The checklist includes media free of censorship, open publicdiscussion, freedom of assembly and demonstration, freedom ofpolitical organization, non discriminatory rule of law inpolitically relevant cases, freedom from unjustified politicalterror, free trade unions and peasant organizations, freebusiness and cooperative, free professional and other privateorganizations, free religious institutions, personal socialrights, socioeconomic rights, freedom from gross socio-economicinequality, and freedom from gross government indifference orcorruption. The Humana index includes such items as the right ofpeaceful assembly, freedom of opinion and expression, the right

and opportunity to take part in the conduct of public affairs,the right to freedom of opinion and expression, and the right toform trade unions.

Each of the measures of civil liberties shows a statisticallysignificant and empirically large association with the return toproject. Each of the civil liberties indexes and otherdeterminants of project performance differs in scale. Theseeffects of civil liberties on project returns are empiricallylarge compared with those of macroeconomic policy.

CIVIL LIBERTIES, CIVIL STRIFE, AND PROJECT PERFORMANCE

An interesting interrelationship among civil liberties, civilstrife, and project performance suggests that the possiblemechanism of causation is from more civil liberties to increasedcitizen voice to better projects. After controlling forpopulation, higher indicators of some types of civil strife, suchas an increased number of riots, protest demonstrations, andstrikes, are strongly positively correlated with projectperformance. The civil unrest variables (riots, protestdemonstrations, and strikes) come as the number of incidents percountry per year. This means that countries with largerpopulations have a greater absolute number of incidents.

The greater civil tension is associated with better projectsmight appear puzzling. Typically, analysts associates all formsof political and social instability with worse investmentclimate. The base this reasoning on associating civil strife withrisks to private projects and with political instability. Somedegree of civil tension reflects a citizen’s ability to agitateand influence government’s behavior without negativerepercussions, a mechanism that plausibility leads to greateraccountability and hence better choice and implementation ofprojects.

The extent of a country’s civil liberties has a substantialimpact on the successful implementation of government investment

projects. This impact of civil liberties is as empirically largeas the more celebrated impact of economic distortions on projectreturns.

THE NEED FOR ECONOMICS

Society operates on political and managerial decisions made,directly or indirectly, on the advice of engineers andeconomists. In fact, with the complexities of modern society,many other disciplines are involved: ecology, geology, planning,and social science, to name but a few, and it behoves eachprofession to be able to speak the language of others. More thanthat, because of the breadth of the engineer’s training inapplied science, he often finds himself as the coordinator ofother disciplines: it should be simpler for him to grasp thebasic principles of economics than for the economist to graspthose of engineering.

Moreover the engineer cannot work in an economic vacuum. Evenforgetting the old dictum that an engineer can do for one dollarwhat anyone else can do for two. It is patently obvious that nodesign can be valid unless it is the most economic design ofseveral alteratives. There is a world of difference between thecheapest and the most economic engineering solution.

Shakespeare’s Caesar said ‘The fault, dear Brutus, lies not inour stars, but in ourselves, that we are underlings’. Theengineer who has no understanding of the laws of economics islikely to remain as underling.

THE MEANING OF ECONOMICS

Economics is the study of how men choose to use scarce or limitedproductive resources (land, labour, capital goods such asmachinery, and technical knowledge) to produce variouscommodities and to distribute them to various members of societyfor their consumption.

Engineering economics may then be defined as the study of howengineers choose to optimize their designs and constructionmethods to produce designs or objects which will optimize theirefficiency and hence the satisfaction of their clients.

There are also many subdivisions: of money, and of social or welfareeconomics; and these are dealt with more briefly although theyhave many applications, particularly in civil engineering.

Some knowledge of all these divisions of economics is necessarybefore the engineer can fully grasp the principles of projectappraisal and cost benefit analysis without which littleengineering work can be justified.

THE APPLICATION OF ENGINEERING ECONOMICS

They need an understanding of macro economics, i.e., fiscal andeconomic controls, the national product, welfare economics,taxation, and of balance of payments problems. All need athorough understanding of project cost analysis. It is necessaryto stress to engineers, that economics is a social science. Sincethe mathematics of economics is a quantification and projectionof observed data. As solutions in engineering are seldom accurateto within 1%, it is postulated that those in economics may not beaccurate tho within 10% certainly where cost benefit analysis,which deals with the future, is involved; and this aspect isstressed throughout the work. Solutions to many problems may bereached by differential analysis.

LOW-COST HOUSING

The government was planning to construct low cost housing schemesfor those from the lower strata of the society. These schemeswould provide shelter to the needy at affordable rates and easyinstallments. Such schemes would prove to be a better alternativeto the slum dwellings and katchi abadis which provided a raw dealto their inhabitants since they were unplanned.

Given the way the population of the country is exploding, theneed for immediate efforts for solving the housing problem of themasses cannot be under played. The figures speak for themselves:two thirds of the population lives in rural areas but with therapid trend of moving to urban areas, it mis estimated that bythe year 2005, 40 percent people will be living in the cities;there are some 20 million houses in the country of which only 21percent are made with bricks; the population of our cities isincreasing by 3.5 percent. However, the one that really puts adamper on the success of all such schemes is the disclosure thatthe average monthly income of 80 percent of the families is lessthan Rs.7,000. Given such a dismal scenario with the paltry sumbarely enabling them to make ends meet, the low and middle incomegroups can only nurture hopes of ever possessing a home of theirown.

It is necessary to look at the situation to tackle thiscumbersome task. The last Mera Ghar Housing Scheme, launched withmuch fanfare in four major cities, by the Pakistan HousingAuthority has failed to make any noteworthy headway. Except forIslamabad, it has failed to generate any positive response withonly a small proportion of the flats having been plucked up. Itis the high cost of the units that has been responsible for thispoor response.

ESTIMATION OF COSTS

The first problem is to estimate total costs for a given quantumof output to be produced during a given period of time by theproject to be constructed. As is well known, the capital costwill include;(a) the cost of land inclusive of all expenditures required forthe development of land on which the project will be constructed.(b) the cost of buildings, furnitures and fixtures.(c)    the cost of equipment and machinery including the initialstocks of spares and auxiliary equipment, cost of transportation,taxes and duties, and insurance charges paid.(d) expenditures incurred in advance for preparation of theproject. (e) remunerations paid to engineering consultants andcontractors.(f) capitalization of interest, if any, to be paid on capitalborrowed during the period of construction.

The operating cost will include all expenditures on (a) labour and raw materials.(b) fuel and power used.(c) supervision and administration.(d) commissions, insurances, taxes, and dues paid andadvertisements made.(e) interest on working capital borrowed.(f) maintenance of machinery and equipment.(g) replacement of plant.

Sometimes (f) and (g) are not included in the operating cost andthese are added separately as maintenance and replacement coststo the total cost for a given quantum of output.

The annual capital cost simply means the sum paid for theamortization of capital per annum. This represents the totalcapital divided by the number of years. Replacement costs referto the sum to be put aside from the current earnings of theproject for replacing it after the expiry of its normal life.

EVALUATION OF BENEFITSGross benefits of a project depend upon the willingness of thebeneficiaries to pay for its output. In evaluating the benefits,the first problem is how to quantify the beneficiaries’willingness to pay. In a competitive economy, the willingness ofthe beneficiaries to pay is reflected in the market prices ofoutputs. The annual gross benefits, thus, will represent thetotal value at the market prices of the output produced in a year(i.e., total quantity of output produced multiplied into the unitprice).

SENSITIVITY ANALYSISIn a perfectly competitive economy the proper prices for costbenefit analysis are in general the market prices of the resourceinvolved. But in this economy and in the economies of many under-developed countries where there is an over-valued domesticcurrency, where there is a large supply of excess labour, timeand so on, the market prices do not reflect the costs elsewherein the time economy.

There is something called sensitivity analysis which is beingtalked about a great deal in operations research circles in theUnited States and in England these days. What sensitivityanalysis means is this. When we analyse a problem of any sort wehave always a set of prices that we regard as given from thepoint of view of a project, the price of labour, the interestrate, the price of foreign exchange, the price of cement. Certaintechnical data whose values are not completely sure fall into thesame category. The question that sensitivity analysis asks is“How much difference does it make if we are wrong?” In otherwords, “How sensitive are our results to a change inassumptions!”.

What is the real cost of unskilled labour to the economy? We

should try several interest rates and if we find that the projectis terribly sensitive to the assumptions that we make about theinterest rate, then it means that we will have to pay a lot ofattention to ,picking the proper rate for discounting the costsand returns. On the other hand the project may turn out to berather insensitive to the rate of interest we assume fordiscounting. It may change the relative magnitudes of costs andbenefits comparatively little if we assume eight per cent ratherthan four per cent.

If the project’s worth is sensitive to the cost of capital, thenthis sensitivity further suggests that we ought to try to designa less capital using solution to the problem, since the costs ofbeing    wrong could be substantial. We do not know exactly whatthese prices (“shadow prices”) should be in order to reflectopportunity costs.How sensitivity analysis can improve cost-benefit analysissubstantially? Prof. Jan Tinbergen did some work on cost-benefitanalysis for a road project in the Netherlands in which heapplied sensitivity analysis. He took two different prices forforeign exchange and three for labour. He discovered that theproject was almost completely insensitive to assumptions aboutdifferent costs of foreign exchange and of labour. Since    thebenefit cost ratio was high, this additional informationincreased his confidence in the project: if he assumed that hewas wrong about labour and foreign exchange costs by reasonableamounts, the projects still remained clearly profitable.

FORM AND FUNCTIONS OF A

PROJECT REPORTThere are five elements of costs:

Amortization on capital including interest.

Wages and pay rolls.Results - including elements of quasi-rent.Profit.Inter-industry purchases.

The classification given above costs across classifications likecapital costs and operating costs, and including all theelements. There is a tendency to be selective in matter of costsfor evaluating projects. Strictly speaking there is no objectionto such a procedure. Any cost element will have a positivecorrelation with the benefit criterion, only the picture may beinadequate. For our purpose, for evaluating projects we have totake into account every element including the inter industrypurchases, which back up the benefit criterion as it appears in aparticular state of the system. The first form element enumeratedearlier will be accepted without such difficulty.

Given the information on costs we develop point estimates forsot, corresponding to the benefit criterion for each state of thesystem. The information from which point estimates of costs couldbe evolved, was analysed and presented in a short note earlierfor projects in the industries sector.

The relevant points are:I.Capital required for the project.

1. Fixed capital 2. Working capital.

II.Operating costs (90% capacity). 1. Raw materials directly used 2. Servicing materials like jute bags for example and

other supplies.

III.Labour and manpower a) Direct Labour i.e., labour requirements which vary

directly with         operating capacity.b) Indirect labour. i.e., administrative and technical

overheads.

IV.Miscellaneous and Contingencies Analysis of Physical inputsand coefficients per ton of output e.g. 4 Basic material ·5 Chemicals ·6 Water ·7 Power ·8 Fuel ·9 Manpower

a) Direct Skilled · Semi-skilled · Unskilled ·

b) Indirect ·7 Managers and Supervisors ·8 Technicians and Scientists ·9 Office Staff ·10 OthersAnalysis of Economic Coefficient for one, two and threeshifts at 90% capacity (in rupees per ton of output). ·11 Direct labour ·12 Direct materials ·13 Water ·14 Power ·15 Fuel ·16 Indirect labour and overheads ·17 Depreciation on fixed capital ·18 Interest on fixed capital.

If the information called for is carefully reviewed it will befound that there should be no difficulty in evaluating thepoint/state estimates for the contribution of a project in termsof the selected benefit criterion.

ECONOMIC LIFE OF INVESTMENT

Economic life of an investment can be expressed in severaldifferent ways. Physical life, for example, does not often defineeconomic life. Consider the industry which manufactured buggywhips and faced with the disappearance of buggys, lost itsmarket. Project market life would then be the determining factor

in economic life. Or viewed from the aspect of technology, wecould cite many examples wherein the same product continues to bemanufactured, but by more advanced machinery or process. Thetechnological life of the original manufacturing or process plantwould have come to an end, and the outmoded machinery would havelittle or no value.

Economic life is always the shortest of the above. It is neversubject to exact estimation, but we can do no better than to makeas accurate approximation as possible.

Project Appraisal Vocabulary

WANTSThere is also, for each person and for all of us together, aplain impossibility of getting so much of every one of thesekinds, all at once, that we could not possibly find any enjoymentin having any more: we can not have everything to the point ofcomplete satiation. To each person by himself this impossibilitypresents itself as a lack of money.

‘Very well, then it will be no use giving you any dinner, youwill only get hungry again’. Most of our wants, and nearly all ofthose which refer to the necessaries of physical health orcomfort, are not ‘once for all’ wants, but need to be gratifiedhour by hour or moment by moment. Scarcity prevails whenever wecannot satiate all our wants. An ordinary want cannot besatisfied once for all. The extra contentment or satisfaction orutility due to an extra unit flow of consumption of some good isthe marginal utility of that good to the person concerned.

RESOURCES

A flow of fresh supplies into the shop is needed to match theflow that the customers carry away, and these fresh supplies mustbe produced by the never-ending collaboration of the forces ofnature, the hands and brains of people, and the stores, tools,machines and constructed facilities which the people have made inthe past and kept for use in the present.

These resources are scarce. Between the scarcity of resources and thescarcity of goods ready for consumers to enjoy, there is acurious reciprocal relation. A thing is not scarce unless twoconditions are fulfilled: the thing must be wanted and it must bein some degree hard to get. Now resources are not wanted fortheir own sakes: they are only wanted for the sake of what can beproduced by their means. Resources are, if you like, a sort ofunripe consumers’ goods. Nobody wants unripe strawberries.Productive resources themselves are, in strictness, unlimited intheir variety, for no two people, no two fields, no two buildingsites are exactly alike. Resources which are widely different intechnical character can in various degrees act as substitutes forone another.

Land comprises all the untouched and primal dispositions of nature. Labour meanspeople of any and every kind, with all their various bodily and mental powers and skills.Capital means all other ‘real’ resources.

SCARCITY

MERE fewness is not the same thing as economic scarcity. Nothingis sought after which is not desired, nothing is sought afterwhich presents itself super-abundantly without our making anyeffort to find, collect or fashion it. The early economists werestruck by the astounding contrast between the cheapness of suchabsolute necessities of bare physical existence as air and water,and the dearness of such fripperies as diamonds or ostrichfeathers.

Exchange-value is proportional to cost. The relevant cost is the

marginal cost. This marginal cost will be different when thetotal output is different. We need also to know the demand, howbadly people want more of the farmer’s wheat. For scarcity ofanything to prevail, two conditions must be fulfilled: ;theremust be some obstacle to procuring unlimited quantities of thisthing, and there must also be some desire to have more of it thancan be got without effort.

BUDGDETS

A budget is just a shopping list in which care has been taken tokeep the total money cost, of all the items within all allottedexpenditure. Plainly if we go on transferring shilling aftershilling from butter to tea, the stage will eventually be reachedwhen we shall be condemning ourselves to eat some of our breaddry, and it will be the tea that is more than sufficient for allour felt needs. No one needs to be told, of, course, that this isthe principle that should guide the composition of a householdbudget: everyone follows this plan by intuition or by instinct.

The law of demand simply says that in almost all practicallyimportant cases, lower prices will be associated with largerquantities bought per time unit and vice versa, provided that allthe other governing and influential circumstances, except theprice of the good in question, remain unchanged. We shall not beable to afford so much tea, we shall buy more coffee instead; theprice of a substitute for tea will tend to rise when tea becomesdearer. These propositions can be turned round and used as adefinition of what we mean by saying that some pairs of goods aremutual substitutes and some are mutual complements.

PRICES

Word price formal meaning is simply that of a ratio, the ratio ofwhat you give to what you receive in exchange. What you give andwhat you receive must of course be expressed in some units, andthese units are quite arbitrary. Price is the radar of economics.It is convenient to reduce all prices to terms of money, and it

ism indeed this convenience which is one of the two greatservices that money renders and which makes the notion of moneyone of the great discoveries of, inventions that have madecivilized life possible.

Price gives ampler shares to those who would be willing to paymost for given quantities of the good. Suppose that particularpainting is being sold by auction. Here, in regard to thequantity available, we have an extreme case. There is anothermethod of making demand and supply equal, and that is byrationing. Rationing is arbitrary, and hands out prescribedquantities of each good to each person regardless of his tastes.Another term for goods which can in some degree take each other’splace is competitive goods.

Prices are like boats on a smooth lake: not a movement of asingle boat, however slight, but starts a ripple which willsooner or later affect every other boat. Resources are made to goas far as they can towards satisfying people’s needs. Price whichbalances demand and supply we can call the equilibrium price.

PRODUCTION

Production means every kind of operation or process which helpsto bring things to the condition, place or time where they arewanted. It thus includes the winning of raw produce from natureby farming, fishing and mining; the treatment, fashioning andconstruction of materials by manufacture; and the transport,storage and retailing of products which are finished. What isproduced, then, is really always economic value. To produce, inthe economist’s meaning of the world, is to take some pre-existing things and render them more valuable.

There is the economic level, the question of economic efficiency.We assume that, whatever set of quantities of physical resourcesare used, they will be used with the highest technicalefficiency. There is the question what kinds of things toproduce, and in what quantities. How to produce depends on what

we decide to produce, and what to produce depends in return onhow various things can be produced. Parallel to the principle ofdiminishing marginal utility there is the principle ofdiminishing marginal productivity.

The rule for the householder is to make marginal utilitiesproportional to price. The rule for the producer, the businessmanor head of a firm, is to make marginal productivitiesproportional to prices. No method of production can attain thehighest possible economic efficiency if it does not attain, for agiven combination of quantities of factors of production.

SPECIALISATION

The foundation stone of economics describes the advantages ofspecialization or ‘division of labour’. Sometimes the distinctionis made between specialization by product and specialization byprocess. The coin and the bank note are valueless in themselves:they are mere tokens or counters, manufactured from the cheapestmaterials that are sufficiently durable and difficult to imitate.What is the total effect of specialization and exchange? Money’spurpose is to provide such a scale and such a system ofaccounting.

FIRMS

Firm, buys and brings together the factors and seeks to sell theresulting goods for more than the factors have cost it. In doingthis it serves the general interest as well as its own. Thefirm’s essential function is to take decisions. It must decidewhat commodity to produce; what quantities of factors to use,according to what technique, in making this commodity; and howmuch of this commodity to put on the market in each unit of time.The firm must obey in order to produce at the lowest possibleexpense any stated output of any particular product. The firmwill take the market price of its product as a datum, so we canplausibly suppose that the firm will ignore any possible rise.The obstacles which price interposes against wasteful use of

resources are not, in a free and competitive economy, the resultof arbitrary dictation. Mechanism, which serves the generalinterest, is driven by the private interest of firms which seekto maximize their own net revenue.

There are usually certain expenses which a firm cannot avoid ifit is to remain in business at all, but which are constant intotal amount regardless of whether the output is large or small.These overhead expenses are rightly considered as part of thecost of whatever output, greater than zero, is chosen, for only azero output would avoid them. The firm maximizing its net revenueif it produces that output at which marginal cost equals price.It will be possible for the firm to stay in business providedtotal cost is not greater than total revenue.

MARKETS

Perfect competition is a state of affairs where a large number offirms are selling to a large number of buyers a commodity everyspecimen of which is exactly the same in all respect as everyother. No matter which firm supplies it; and where all pricesasked, offered or accepted are at once known to all sellers andall buyers.The notion of equilibrium is that of a state of affairs arrivedat when a great number of individuals each seeking his owninterest give away to each other what they can best spare inexchange for what they most desire.

Perfect factor mobility, and perfect ‘freedom of entry’ of newfirms into an industry, perfect competition assumes, the pursuitby each actual or potential firm of maximum profit will lead to auniversal leveling down of profit to that point where only thenecessary minimum reward is being earned. When elasticity ofdemand for the firm’s output is infinite, the firm is selling itsproduct in a perfectly competitive market.

EQUILIBRIUM

There is a logic of how to make the best of things, of how toattain the position of greatest comfort and contentment in spiteof our human circumstances of scarcity, of not having as much ofthings as we could use. Economics is the subject which studiesthis logic. This total adjustment which plainly has some right tobe called the optimum position of the economy as a whole, iscalled general equilibrium. Amongst the governing conditions,up9on whose constancy the maintenance of a given equilibriumposition depends, we have listed ‘resources’.

Everyone is a consumer, most of us are also suppliers ofproductive services, a few of us are organizers of production andmanagers of firms. The conditions whose simultaneous fulfillmentwould constitute general equilibrium can be considered in threegroups corresponding to these three types of agent. In perfectlycompetitive equilibrium of the firm, marginal cost equals price,there will be no incentive for the firm to change its output. Inreflecting on this idea of a general equilibrium, we out toremind ourselves that to prove the ‘existence’    of a set of‘sizes’ or levels of all the economic quantities, which would beself-consistent and have no inherent tendency to change.

INCOME

These money streams going into their pockets and their bankaccounts together make up, of course, their aggregate income.Income amongst those who provide the productive services whichgenerate that income is simply a reflection of the generalpricing process and of the fact that each person is able andwilling, in given circumstances, to furnish a certain quantity ofa certain kind of service. When an unskilled labourer finds thatan hour’s work of the kind he can do adds half a crown to thevalue of the hourly output of a firm.

BARGAINING

There will be some level below which any price for the productwould at best buy things which I value less than I value the

painting for its own sake. This will be the very lowest price Ishall in any circumstances accept, an absolute minimum. And therewill be some level above which any price would buy for you thingswhich you would rather have than the painting. This will be thevery highest price which you will in any circumstances given, anabsolute maximum. If it becomes apparent that my lowest price ishigher than your highest price, there is an end of the matter. Nodeal can be done. But suppose my lowest price is lower than yourhighest price. Then there contract zone, a range of possibleprices affording room for bargaining.

RENT

To mankind as a whole, ‘land’ is by definition a pure gift. It isprovided and maintained by nature free of all cost, and whethermen would be willing to pay much or little for the use of any ofthe great variety of factors of production comprised in it, thequantity available of each such factor will remain unchanged.Why, then, should it be necessary for anyone to pay anything forthe sue of ‘land’?

This excess of market value of output over cost of output canonly be secured provided the firm has access to land. The ownersof the land can therefore hold the firms to ransom: they candemand a part or the whole of the surplus. This payment to theland owners is rent. For the farmer’s purposes some types of landwill be better than others. When all of the    best land is inuse any further increase of output of its product will cause therent of this best land to rise, and ultimately, instead ofsecurity a share of this best land for his won use by paying thishigh rent.

The two essential characteristics of rent are:

Rent is a payment not necessary to maintain this factor ofproduction in existence.

Rent can be exacted because the existing quantity of thisfactor of production does not increase in response to theoffer of higher pay per unit employed.

PROFIT

Earlier it was perfectly easy to see profit as a natural andessential element of the competitive mechanism by which a freeenterprise economy allocated resources according to tastes so asto maximize satisfaction. Profit steered resources where theywere wanted. And it also rewarded those who luck had placed themin this favourable position. So profit was the reward of a factorof production, or of a bundle of factors collected under the nameof enterprise.

The chief analytical defect of this conception of profit is itsfailure to distinguish between what is expected or hopefullyimagined, and what is realized in recorded fact. Past profit isknown, a recorded fact; expected profit is a creation ;of themind, in essence no more than a conjecture. When we go on to askwhat it is in the nature or character of a real economy, whichgives scope and possibility for profit expectations and for theoccurrence of recorded profit,, the main answer cannot be indoubt.

SAVING

When all the people in a self-contained economic system, takentogether, use up by eating, wearing, burning and so on, a smallermoney value of goods in some particular month than the moneyvalue of the transformations of things into more useful forms orplaces, that are effected in that month, the difference betweenthese two money values measures the net amount by which theeconomy’s total store of wealth has been increased in that month.It was plausibly suggested by John Maynard Keynes that there isat least one broad ‘qualitative’ rule: the more income you have,the more you save. He did not say, as so many people have wronglysupposed, that the more income you have, the larger theproportion of it you save. A balanced budget, in the sense of our assumptions, is notnecessarily ‘neutral’ in the matter of how much the economysaves. Aggregate saving is the excess of the total value of what

is produced in a given time interval over the total value of whatis consumed in that interval. Thus the larger the economy’sincome, the larger the value of goods which, in any timeinterval, must be bought by someone other than consumers. In amodern economy an important proportion of the economy’s aggregateincome will not be left at the free disposal of the individualsbut will be taken from them in taxation by the government andspent by the government on their behalf.

EQUIPPING

WHO, in a self-contained economy, buys the goods that areproduced but not sold to consumers? Who, that is to say, otherthan the government? For it may well be that even after thegovernment’s economic activities are allowed for, there is stilla big gap between aggregate disposable income and the aggregatespending-flow on consumption. Part of the answer might be thatmerchants and manufacturers sometimes pile up extra goods intheir warehouses or storerooms, perhaps because they expect to beable in the near future to sell larger quantities.We can easily see, too, that a quite large change in theinterest-rate from, say, five per cent per annum to four per centper annum will make a relatively small proportionate change inthe total discounting rate.

OUTPUT

The output of a commodity is the number of physical units of itproduced in a unit of time. This description of the mechanism,whereby we can suppose the output and the price of any given typeof investment-goods to be determined, is exactly analogous tothat of the determination of the output and price of anyconsumer’s good. We cannot simply say, then, that the marginalefficiency of capital is a decreasing function of the output ofinvestment-goods in general.

DEMAND

Aggregate income of all income-earners is simply the total valueper time-unit of goods and services produced. Aggregateconsumption-spending is simply the total value per time-unit ofgoods and services consumed. The difference between income andconsumption-spending, and the difference between production andconsumption each measured in value, are two names for the samething and are inevitably equal.

We mean by ‘intended effective demand’ the total of all theamounts which income-receivers as such intend to spend in theimpending interval on consumption and of all the amounts whichbusinessmen as such intend to spend during that interval on netinvestment. Employment depends on output, that output depends oneffective demand, and that effective demand is made up, in aself-contained, government less economy, of the two components,consumption-expenditures by all income-receivers and notinvestment expenditure by businessmen as such.

EMPLOYMENT

Let us suppose that for many successive quarters ex ante netinvestment has been equal to ex ante saving and that output as awhole has remained constant. Let us also suppose, however, thatthis output is a much smaller one than the economy could produceif all its means of production were fully employed. We shallassume that there are large numbers of people who would be gladto take employment at the current money wage-rates for their kindof work, and that it would be possible to employ them by workingthe existing equipment more intensively or drawing some idleequipment into production.

LIQUIDITYThe nature of the advantages conferred by possession of a stockof ready money, advantages usually collected under the name ofliquidity; to show how the market value of these advantages, andtherefore of those which must be sacrificed to gain them, ismeasured by a rate of interest. The ‘liquidity’ conferred bypossession of a stock of money consists, however, in other things

besides the guarantee it offers against loss through a fall inthe prices of promises of future specified payments.

SECURITIESWe said that the interest-rate cannot be at rest even for theshortest time unless holders (both potential and actual) offixed-interest securities are divided into two camps withopposite views about the interest-rate’s next movement. Wheneverthere is a consensus of opinion, that is, whenever the bulk ofthose concerned with the market are all in one or other camp, therate will move until it has transferred sufficient former Bullsinto the Bear camp to equalize the quantity of money.

BANKSMoney is created by the banking system. Banks pay no interest onthe money which their customers lend to them on ‘currentaccount’, that is, on condition that the customer may withdrawhis money without notice. It is a great convenience to anindividual, and indispensable to a firm, to have a bank account,for the money deposited with a bank is as safe.The underlying simplicity of the banking mechanism, which canlook superficially so complicated, appears most vividly if weinvent a model of it such as to exhibit only the essentials. Tomake unlimited loans, which would be the same thing as creatingunlimited quantities of money, would of course have disastroussocial consequences, soon reducing the currency to a mockerywhich everyone would ignore, and driving people to use insteadcommodities useful in themselves, such as cigarettes, reels ofcotton, bales of cloth, etc.

LIVING COSTSImagine a river-gorge with its sides sloping gently from thefloor at first and getting steeper and steeper as they rise incliffs towards the lip of the gorge. When the floods come down,the river can spread sideways over the flat floor and gentlelower slopes of its gorge, but as the volume of water which flowsdown per minutes gets greater and greater its depth also must

increase, and because of the steepening sides, this increase ofdepth must proceed by increasing steps as the width of the riverincreases by equal steps.But as the increase of volume proceeds, the water must rise upthe steepening sides of its channel, the further increase ofoutput will encounter shortages and ‘bottlenecks’ and the need todraw in inferior resources which, nevertheless, will require ashigh a money wage as the more efficient resources already inemployment. Thus prices will rise, and this rise will more andmore outpace the growth in the flow of ‘real’. The stock of moneyhas been compared to the cable of a balloon. If the balloon is tobe able to rise, the cable must be let out; but merely lettingout the cable will not of itself make the balloon ascend.

CAPITAL

The word ‘capital’ has been the center of so much confusedthinking and writing that it might be better for us to avoid it.Finance, of a ‘capital’ is natural and inevitable, for are not‘finance’ and ‘capital’ very intimately related ideas?

To earlier economists it appeared possible without distortion ofessentials to treat labour as    a homogeneous factor ofproduction, and to treat land as another such factor. But whatwas to be done with that immensely various collection ofinstrumental goods, comprising stacks or bins of materials, toolsof every kind, machines, buildings and constructions, all of themevidently associated with the productive process but yet notseeming to possess that active power to forward this processwhich belongs both to men and to nature?

TAXES

Out of the total yearly quantities of food, clothes, electricityand so on, which are produced by the economy certain portions areto be made available to the State Servants, these preciseportions must be forgone by the farmers, tailors and engineers,and other such non-State Servants, who actually produce them. The

farmers, tailors and engineers must therefore be prevented fromspending on food, clothes, electricity and so on, the whole ofwhat they earn in producing these things. That particular part oftheir gross earnings has to be taken away from them by taxation.

Taxes fall into two great classes. There are those which exactfrom the individual a certain fraction of his income or of hisfortune; and there are those which exact from him a certainfraction of his outlay on particular goods and services. Taxes ofthe former kind are called direct taxes, and of the latter,indirect taxes or commodity taxes. There is, perhaps, a morereasonable hope of getting meaningful results from such tracingfor direct than for indirect taxes.

EXPENDITURES

When the government provides justice, order and defence it is, ofcourse, not an enterprise trading in the market with willingbuyers, but an authority exercising powers. So far as theindividual is concerned, compulsory and inescapable. We cannot becontent to isolate for study the process of gathering governmentrevenue, but must consider it together with that of makinggovernment expenditure. The government can borrow from thecitizens as well as taxing them. Now-a-days it is recognized thatall aspects of the gathering and the spending of governmentrevenue, and of the government’s borrowing and its use ofborrowed funds, need to be studied together as a whole. ‘Publicfinance’ is the name of this whole subject.

DEFICITS

The government, when it wishes, can overspend or underspend itsrevenue, it can allow the expenditure it makes within someinterval to exceed or to fall short of what it receives, fromtaxation and from profitable trading taken together, in thatinterval. For the twelve-month period ending on some fixed yearlydate. If, in a ‘financial year’, the government’s expenditure hasexceeded its revenue, it is said to have a deficit; in the

opposite case, a surplus.

An ‘Unbalanced Budget’, an excess of expenditure over revenue, isthe only means by which the government can augment the total flowof effective demand.

DEBTS

It is sometimes proper and desirable for the government to spendmore in a given period than it receives in that period by way oftaxation and profitable trading; in other words, to have Budgetdeficit. These deficits build up a debt to banks or to citizensand non-bank firms. In order to borrow, the government must payinterest, and these payments transfer income from taxpayers ingeneral to those particular citizens or firms who have lent moneyto the government. How far can the government go in increasingits debt to its own citizens?

On the other hand, the government may owe money to its owncitizens. When we regard all these citizens as together forming anation, the internal national debt merely means that the nationowes money to itself. A large internal national debt is like thescar of an old wound:

PLANNING

‘Planning’ can mean widely different things. When it means thedetailed prescription of the outputs and prices of all goods andthe arbitrary fixing of the rtes of pay of all factors ofproduction, the purpose to be served is evidently something quitedifferent from that of giving the utmost scope to the individualfree human personality. Planning in this sense adds, as it were,an extra dimension to the frame of law and order within whichpeople are free to choose their own work, their own consumptionand their own risks. Planning in one sense is like a palisadebuilt to enclose more of the desert for men’s use; planning inthe other sense is like a fence built to confine them to tillground they have not chosen and do not own.