Ways To Maximise Social Welfare

Arun GC

It is believed that the Egyptians of 3,000 B.C. have a systematic taxation system. However, Vedic texts of more than 5,000 B.C. have also clearly mentioned the concept of taxes and roles as well as the responsibilities of the citizens and the government. Nonetheless, we are still debating the efficiency of government expenditure from those revenues. 

Several Schools

In economics, there are several schools of thought. The orthodox school of economics started by Adam Smith harshly resists the role of the government in the market. They believe in the long run, the market will be in equilibrium ensuring neither an excess supply nor excess demand. Further, they are firmly convinced that the intervention of the government will lead to a net loss of social welfare - especially in terms of deadweight loss. 

However, when the great depression of the 1980s did not show any sign of self-correction as the orthodox school believes, a new school emerged as a Keynesian School with the pivotal role of the government in the market.

Nowadays, a consensus can be observed among several schools of thought that a role of the government is deemed necessary - especially to correct a market failure, for provisioning of public goods, for social security schemes, the national defence, and to stabilising the economy in general. Whatever the rationale behind it, in the contemporary world, we can observe an active role of the government in the economy in all countries - whether it is a capitalist or a socialist. 

It is well known to us that the government collects taxes and spends them. Taxes are the major source of government revenue. But the central question is where to collect and where to spend. 

As a basic proposition of economics - we know that we have limited resources and unlimited wants. Therefore, there is a need for rationalization and economization of resources. As rational humans, we assume that every individual accepts these fundamental economic principles. However, what about the government? Are they economizing the available resources? Are they spending the collected revenue where maximum social benefit could be generated?

A very simple answer to the aforementioned questions would be ‘we do not know’. How do we know if we have not compared and analyzed at all? To allocate scarce government resources to maximize social welfare, we can perform a simple yet powerful economic analysis which is known as the cost-benefit analysis (CBA).

It is a simple economic tool that helps the decision-makers to choose among several competing project alternatives by monetizing everything. It simply accounts for all potential benefits and costs of the projects in the monetary term with an appropriate level of discounting. Discounting means normalizing the further value of money to equalize its value in today's worth - present value. Then a difference is taken between the benefit stream and the cost stream. 

If we get a positive result, it is acceptable otherwise not. Further, if there is more than one project, we choose the project having the highest net present value. Indeed, all big private investments carry out this analysis. Besides private investments, most developed countries are also practising this analysis for their policy, program and project the government. 

The CBA is believed to have originated in France in the seventeenth century as a decision criterion for public constructions. Since then France has extensively used this technique. This technique was adopted in the USA in the early nineteenth century and mainstreamed through The Flood Control Act, 1936. It was further formalized and popularized by the Clinton and the Bush administrations. 

The current Biden administration has also prioritized it. Similarly, Australia has also suggested the standard method for performing the CBA through the Department of Prime Minister and Cabinet. Likewise, the United Kingdom, Canada, New Zealand, and many other countries have suggested their standards. 

CBA in Nepal

As mentioned before, private investments are doing CBA not only in Nepal but rather throughout the world. Likewise, various non-governmental organizations are also carrying out the CBA as an economic analysis in their interventions. But at the governmental level, we cannot see any such guidelines and strict practices. 

Most of the programs and projects are developed based on political choices. More interestingly, the annual budget program seems a collection of political demands without considering any economic analysis which has been recently documented by the Policy Research Institute of Nepal.

It is already discussed that if we do not consider economic analysis - like CBA, we might be misallocating our scarce resources. It means we will not achieve economic development with the available resources to their potential. Further, we have observed several conflicts at the community level and at the national level regarding project selection which could be resolved through the systematic CBA implementation.

 If we do not perform CBA before the adoption of any policy or any program, it might have a negative net present value. It means we are 

wasting our resources by choosing the wrong alternative. 

It does not mean that we have not done any CBA at all in the government projects. All the loans and most of the grants need it. For instance, projects funded by the World Bank, Asian Development Bank and other funding and donor agencies have this condition as an obligation. More interestingly, recently the most debated and finally endorsed by the parliament of Nepal, the Millennium Challenge Corporation (MCC) also requires CBA in its project. MCA Nepal has calculated the net present value of the transmission line project to be around USD One billion 84 million with a benefit-cost ratio of 1.197. 

Now the government of Nepal should promptly develop the CBA guideline for the regular program planning and should be mandated for utilization of the government resources anywhere. Developing its guideline does not mean the establishment of an entirely new theory for CBA, rather it means we need to prescribe certain important issues. 

Toughest Task

For instance, choosing a discount rate is one of the toughest tasks in this analysis. Slightly changing the discount rate can entirely change the decision of acceptance or rejection of the project. Therefore, the US government has suggested a seven per cent and three per cent discount rate for their use and it periodically updates. Another important issue to be considered is the valuation method. Because every resource and every cost does not have a market price.

Likewise, it should be prescribed what kind of indirect costs and benefits should be considered. Without consistency on those key elements, the result may vary drastically. The CBA along with the benefit-cost ratio and internal rate of return will help us better utilse our scarce resources and guide us toward higher-level of economic development and net social welfare.

(The writer pursues  MPhil-PhD  in Economics at Tribhuvan University.)