Cost-Benefit Analysis for Investment Decisions: Chapter 9 (The Shadow Price of Foreign Exchange and Non-Tradable Outlays)

The economic cost of capital, as measured in Chapter 8, deals with the intertemporal comparisons. It links the annual flows of benefits and costs over a project's life to its initial capital investment. In the present chapter we deal with another facet of the act of raising project funds from the country's capital market. This facet concerns the distortions that are affected not intertemporally but at the same moment that the funds are raised. Investment and consumption expenditures by others in the market are displaced by the very act of raising the project's funds in the capital market. As a consequence, the government loses tariff revenue plus value added and other indirect taxes. These losses must be counted in the economic evaluation of any project, in addition to those linked to the spending of project funds on tradable or non-tradable goods and services, and in addition to the intertemporal distortions captured by the economic opportunity cost of capital. The existence of these indirect taxes on domestic and trade transactions, the economic value of foreign exchange differs from the market exchange rate and there will be a tax externality associated with expenditures on nontradables. This chapter has provided an analytical framework and a practical approach to the measurement of the economic cost of foreign exchange and the shadow price of non-tradable outlays.