Project Appraisal: UNIDO approach

The UNIDO approach recognizes that purely relying on market prices may not fully capture the
true value and impact of a project. Therefore, the approach incorporates various adjustments to
provide a more comprehensive assessment of the project's benefits and impacts.

1. Calculation of financial profitability of the project measure at market prices.

2. Obtaining the net benefit of the project at economic (shadow) prices

3. Adjustment for the impact of the project on Savings and investment

4. Adjustment for the impact of the project on Income distribution

5. Adjustment for Merit and Demerit Goods whose social values differ from their economic
values.

1. Arriving at the Financial Profitability of the Project Based on Market Prices:

This stage involves assessing the financial profitability of the project based on market
prices. It considers the expected revenues and costs of the project, taking into account
market conditions and pricing mechanisms. By analyzing the financial viability of the
project, UNIDO can determine whether it has the potential to generate positive returns
and achieve financial sustainability.

a. Revenue: calculate the expected revenue from the sales of goods or services produced by
the project. This involves estimating the quantity of goods or services that will be sold
and the price at which they will be sold in the market.

b. Costs: determine the costs associated with the production of goods or services. This
includes expenses such as labor, raw materials, machinery, utilities, and any other
operational costs.

c. Net profit: subtract the total costs from the revenue to obtain the net profit. If the net
profit is positive, the project is financially profitable; if negative, the project would result
in a financial loss

This analysis helps determine if the project has the potential to generate positive returns and
cover its costs.
 2. Using Shadow Prices for the Resources to Arrive at the Net Benefit of the Project at
Economic Prices:

Shadow prices are used in this stage to assign economic values to resources that either
lack market prices or whose market prices do not accurately reflect their true social value.
For example, natural resources, environmental services, or cultural heritage might be
undervalued or not accounted for in market transactions. By using shadow prices, the
approach captures the broader economic impact of the project and ensures a more
accurate assessment of its benefits at economic prices.

Shadow prices represent the true economic value of resources, which may differ from their
market prices due to externalities and unaccounted costs or benefits. The key steps are:

a. Identifying externalities: recognize externalities, which are the positive or negative

b. Assigning shadow prices: estimate the shadow prices for resources by incorporating the
externalities. Shadow prices reflect the additional cost or benefit of using a particular
resource, considering its social and environmental impacts.

c. Net benefit adjustment: adjust the net profit obtained in the first stage by incorporating
the shadow prices. This adjustment provides a more comprehensive picture of the
project's economic impact, considering the broader societal costs and benefits.

Sources of Shadow Prices

• Increase and decrease the total consumption in the economy

• Decrease import or increase imports

• Decrease or increase production in the economy

Concept of Tradability

Key issue in shadow pricing is whether the good is tradable or not.

o For a good that is tradable, the international price is the measure of its opportunity
cost to the country.

o The import (CIF) price is less or the export (FOB) price is more than the domestic
cost of production

A good/service is non-tradable; if
 o It imports (CIF) price is greater than its domestic cost of production and/or

o It exports (FOB) price is less than its domestic cost of production

General Principles of Shadow pricing Treatment of Taxes

When shadow prices are being calculated, taxes usually pose difficulties. General guidelines of
UNIDO taxes are:

o If the project augments domestic production, taxes should be excluded

o if the project consumes existing fixed supply of non-traded inputs, tax should be
included

o For fully traded goods, tax should be ignored

3. Adjustment of the Net Benefit for the Project's Impact on Saving and Investment:

The purpose of this stage is to

• Determine the amount of income gained or lost because of the project by different
income groups (such as business, government, workers, customers etc.)

➢ Evaluate the net impact of these gains and losses on savings

➢ Measure the adjustment factor for savings and thus the adjusted values for savings
impact

➢ Adjust the impact on savings to the net present value calculated in stage two

This adjustment considers the project's impact on saving and investment within the
economy. It assesses how the project contributes to capital formation, stimulates
investment, and promotes long-term economic growth. By evaluating the project's
potential to generate savings and attract additional investment, the approach provides a
more comprehensive understanding of its economic benefits beyond immediate financial
profitability.

Impact on Distribution:

▪ Measure of gain or loss: difference between price paid and value of received
Impact on Saving:

▪ Given the income distribution what would be effect on saving?

▪ What is the value of such saving?

4. Adjustment for the Net Benefit for the Project's Impact on Income Distribution:

This stage analyzes how the project affects different income groups and strives to ensure
that it contributes to equitable income distribution. This adjustment helps assess the
project's potential to reduce poverty, address social inequalities, and promote inclusive
growth. By considering the project's impact on income distribution, UNIDO aims to
support projects that generate benefits for the broader population.

Income Redistribution Impact

• Redistribution of income in favour of economically weaker sections

5. Adjustment of the Net Benefit for the Goods Produced Whose Social Values Differ
from Their Economic Values:

If there is no difference between the economic value of inputs and outputs and the social value of
those, the UNIDO approach for project evaluation ends at stage four

In practical, there are some goods (merit goods), social value of which exceed the economic
value (such as creation of employment etc.) and also there are some goods (demerit goods),
social value of which is less than their economic value (e.g., cigarette, alcohol, high -grade
cosmetics etc.)

Certain goods produced by the project may have social values that differ from their economic
values. Social values refer to non-market benefits or costs associated with goods that are not
captured in market prices. By considering both economic and social values, the UNIDO
approach aims to capture the full range of benefits that the project delivers to society.. For
example:

A. Positive social values: some goods may have positive social impacts, such as
environmental conservation, cultural preservation, or public health improvements.

B. Negative social values: conversely, some goods may have negative social impacts, such
as pollution, health hazards, or depletion of natural resources.

C. Adjustment for social values: adjust the net benefit obtained in the previous stage to
 incorporate the social values associated with the goods produced by the project. This step
provides a more holistic evaluation of the project's societal impact beyond purely
economic considerations.

In summary, the stages (UNIDO approach) are a comprehensive method used to evaluate the
economic viability and overall impact of a development project. It considers financial
profitability, shadow prices, savings and investment effects, income distribution, and the social
values of goods produced. By analyzing these aspects, policymakers and stakeholders can make
more informed decisions regarding project planning and implementation.