Table Of ContentPROJECT APPRAISAL AND MACROECONOMIC POLICY
Project Appraisal and
Macroeconomic Policy
TSJALLE VAN DER BURG
Rotterdam School 01 Management,
Erasmus University, Rotterdam,
The Netherlands
Kluwer Academic Publishers
Dordrecht / Boston / London
Library of Congress Cataloging-in-Publication Data
Burg, Tja11e van der.
Project appraisal and macroeconomic poliCy / by TSjal1e van der
Burg.
p. cm.
Inc 1u des bl b 11 ograph i ca I references.
ISBN-13: 978-94-010-6503-0 (hardcover alk. paper)
1. Economic pol lcy--Econometric models. 2. Equilibrium
(Economics)--Mathematlcal models. I. Title.
HD87.B87 1996 95-40137
ISBN-13: 978-94-010-6503-0 e-ISBN-13: 978-94-009-0033-2
DOI: 10.1007/978-94-009-0033-2
Published by Kluwer Academic Publishers,
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Table of contents
Foreword 1X
Acknowledgements xi
1. Introduction
2. The macroeconomic effects of specific portfolios of projects 5
2.1. Introduction 5
2.2. The macroeconomic effects ofprojects which lead to savings on fuels
and other raw materials 5
2.2.1. The essence of the analysis 5
2.2.2. Counterbalancing effects related to an increase in spending 10
2.2.3. Effects on financial markets 11
2.2.4. Savings on non-imported fuels 14
2.2.5. The results of quantitative studies 16
2.2.6. The effects of a policy of saving on fuels and other raw materials
at the level ofthe European Union 20
2.2.7. Conclusions 23
2.3. The effects of some portfolios of projects on inflation 24
2.4. Conclusions 26
Appendix: A simple, quantitative analysis ofthe effects of a policy of
saving on fuels at the level ofthe European Union 26
Notes 29
3. Existing methods for the social appraisal ofprojects in situations of
unemployment 31
3.1. Introduction 31
3.2. Methods without a welfare-theoretical foundation 34
3.2.1. Primal methods based on an input-output model 34
3.2.2. Primal methods based on an econometric macro-model 36
3.2.3. A dual method based on an econometric macro-model 38
3.3. Methods with a welfare-theoretical foundation 40
3.3.1. Dual methods 40
3.3.2. Primal methods based on a theoretical model 48
3.3.3. A primal method based on an econometric macro-model 49
3.4. The consistency between project appraisal and macroeconomic analysis
and policy 51
v
vi Table 0/ contents
3.5. Implications for the development of an improved method 55
Notes 56
4. A method to calculate and evaluate the macroeconomic effects of
projects, including small projects 57
4.1. Introduction 57
4.2. ~The calculation of the effects of a project 58
4.2.1. Introduction 58
4.2.2. The effects of financing the expenditures 59
4.2.3. The effects ofthe expenditures excluding the effects offinancing
them 61
4.2.4. The effects ofthe output 64
4.2.5. Additional remarks 66
4.3. Potential eITors related to the estimates when large projects or port-
folios of projects are analysed 67
4.3.1. Introduction 67
4.3.2. EITors related to project-specific characteristics 67
4.3.3. EITors related to the estimate of the effects of a project that
leads to specific durable changes 68
4.3.4. EITors related to the estimates ofthe effects of other projects 69
4.3.5. Final remarks 72
4.4. Potential eITors related to the estimates when small projects are analysed 72
4.4.1. Introduction 72
4.4.2. The concept of risk-pooling 73
4.4.3. One ofthe problems related to the principle ofproportionality,
in the context of a hypothetical setting 75
4.4.4. The principle ofproportionality, considered from a more general
and realistic point ofview 78
4.4.5. The third step of the method 81
4.4.6. The justification ofthe method when it is used to analyse one
project, or a few projects only 81
4.4.7. A common misconception 85
4.5. The advantages ofthe method ofthis study as compared with the
conventional macroeconometric method 86
4.6. The evaluation ofthe effects 88
Appendix: The treatment of indirect taxes 92
List of symbols 93
Notes 95
5. The calculations done with the Freia model 97
5.1. Introduction 97
5.2. The Freia model 97
5.3. The base-run 102
5.4. The calculation ofthe H, and the V, 102
5.5. The extent to which the calculations fulfil the conditions of additivity 103
Table ofc ontents vii
5.6. Tbe differences between the effects ofincreases in government
investment and development aid in different years 107
5.7. The period to which the analysis refers 112
5.8. Comparison of the calculations made for this study with
calculations by the Central Planning Bureau 112
5.9. Evaluation ofthe errors 113
Notes 115
6. The macroeconomic effects ofwind energy in the Netherlands 117
6. 1. Introduction 117
6.2. Characteristics ofthe project from a microeconomic point ofview 118
6.2.1. Introduction 118
6.2.2. Costs and benefits from a private point ofview 119
6.2.3. Modifications needed for the calculation ofthe macroeconomic
effects 121
6.2.4. The private profitability ofthe project 122
6.2.5. InpuH:mtput analysis 122
6.3. The macroeconomic effects ofthe project 124
6.3.1. The macroeconomic effects 124
6.3.2. Evaluation ofthe effects 127
6.3.3. Sensitivity analysis with regard to the microeconomic characteristics 130
6.3.4. The dependency ofthe outcomes on macroeconomic factors 132
6.4. Conclusions 134
Notes 135
7. Converting the method into a dual method 137
7.1. General outline ofthe method 137
7.2. Shadow prices based on the Freia model 139
7.3. Conclusions 145
Notes 145
8. International aspects and the debate about import substitution 147
8.1. Effects on the world economy 147
8.2. Some comments on the debate about the effects of import substitution
on the domestic economy 150
Notes 152
9. Summary and conclusions 155
References 163
Index 167
Foreword
Environmental economics addresses the issues that arise on the boundaries between
economic systems and natural systems, such as pollution and natural resource de
pletion and degradation. Like any other branch of applied economics, it has drawn
its tools and techniques from the wide range already available in economics gener
ally, selecting, adapting and extending these to meet its own particular requirements
in its own particular context. Here, as elsewhere in economics, public policy analy
sis requires quantitative assessments of the economic impact of different policy
choices. Perhaps the most distinctive contribution of environmental economics has
been the development of techniques for the economic valuation of environmental
goods and services in the absence of markets for such goods and services, or in the
presence of markets that are at best imperfect or incomplete. Nevertheless policy
analysis still relies on one or another of three broad groups of methods used in eco
nomics generally. One is project appraisal, which at the micro level provides an
evaluation ofthe costs and benefits ofinvestment options to inform the choice among
them, while at the macro level policy analysis rests either on computable general
equilibrium (CGE) models or on economy-wide macroeconometric models.
All models are simplifications, designed to focus attention on the important fea
tures ofthe problem at hand, and neglecting other features that might for a different
problem assume greater importance. Project appraisal typically takes the macro en
vironment as given, and focuses on individual projects in a partial equilibrium
setting. In contrast, when aggregate macroeconometric models are used to assess the
consequences of an increase in public expenditure, no attention is typically paid to
the nature ofthe projects that might be funded by the incremental expenditure. CGE
models provide greater sectoral detail, having focused in early applications on trade
and public finance questions. With a foundation in Walrasian general equilibrium
theory, they are essentially comparative static models, in which policy exercises rest
on a comparison of a 'base' solution and a 'new policy' solution, each comprising a
set of relative prices that support flow equilibria in all product and factor markets.
The nature of the adjustment process that might lead from one equilibrium to an
other is not addressed. On the other hand, dynamic adjustment in disequilibrium
situations has been a focus of attention in macroeconometric models, and issues of
inflation. unemployment, and balance-of-payments disequilibrium are high on the agenda.
ix
x Foreword
Each approach in this stereotype form has obvious limitations, and the practical
methods have been adapted to overcome them. Project appraisal in a partial equilib
rium context, in which the markets for the project's inputs and outputs are ana
lyzed in isolation, gives misleading guidance if other markets are affected in
important ways. Shadow prices that take account of general equilibrium interactions
might then be generated by a CGE model. Such models in turn might require modi
fication or extension if their neoclassical assumptions are at variance with the be
havioural or institutional rigidities found in many economies. However, ad hoc
changes designed to increase the realism ofthe model may be difficult to interpret in
the received theoretical framework; on the other hand a theoretically pure model is
unlikely to yield reliable policy guidance in a situation where its assumptions are not
satisfied. There is always tension between theoretical purity and empirical accuracy,
and macroeconometric models have tended to emphasize the latter, having been
concerned to provide a good statistical description of the actual economy, market
imperfections, non-optimizing behaviour, and all. In-this case recent developments
are in the opposite direction to that of the CGE developments noted above, namely
towards a greater theoretical coherency, particularly in respect ofthe model's steady
state or long-run implications, as economic theories heavily based on equilibrium
concepts are more relevant to these than to the process of short-run adjustment.
Environmental policy studies typically require a longer horizon than the macro
economic policy analysis of everyday political debate, hence such modifications
make macroeconometric models more useful to the environmental economist.
Exciting developments in quantitative methods occur on the interface between exist
ing methods, when complementary strengths overcome individual weaknesses. At the
rnacro level an input-output model might be incorporated into a macroeconometric model
to provide missing sectoral detail, or a macroeconometric model might be used to pro
vide the macroeconomic closure ofa CGE model. The interface between rnicroeconornics
and macroeconornics, with which this book is concerned, is a more difficult one. Al
though the use of a CGE model to generate shadow prices for use in project appraisal, as
mentioned above, provides an example, the author argues that the theoretical character
istics of the CGE approach are at variance with the practical airns of project appraisal.
Instead, he seeks to integrate project appraisal and rnacroeconornic policy analysis by
using macroeconometric models for the evaluation of small projects in a situation of
disequilibrium. The method is applied to a wind energy project, and it is estimated that
such projects and a number of sirnilar projects have positive macroeconornic effects. I
was honoured to serve as an external examiner of the dissertation on which this book is
based and, coming to this work from a background in rnacroeconometric modelling, I
found many challenging and provocative ideas. As a contribution to the discussion oft he
macroeconornic effects of environrnental policy and to the development of quantitative
methods more generally the book now deserves a wide readership.
Kenneth F. Wallis
ESRC Macroeconomic Modelling Bureau
University of Warwick
Acknowledgements
This book is a revised version ofmy dissertation, which I wrote when I was working
at the Faculty ofEconomics in Groningen. In writing the dissertation and the book I
have received aid and encouragement from a number of people. I would like to
express my thanks to the following people in particular:
Professor A. N entjes for his supervision, his many stimulating comments, and bis
patience in dealing with my intuition. Professor J .A. Kregel for bis useful comments
and his confidence in the project in its early stages, wbich made it possible to get
started. Professor J. Muysken and Professor K.F. Wallis for giving me some critical
and helpful comments in the last stage of the research.
Bemard ter Haar has done the calculations with the Freia-model, and wrote the
main part of the computer program for calculating the effects of the wind energy
project. I have been lucky in having an assistant with very high scientific standards.
I would further like to express my thanks to Diana Galjaard-Vlijenhoek and Theresa
Hekman-Huizinga for typing parts ofthe manuscript.
Without the good library ofthe Faculty ofEconornics in Groningen it would have
been rather difficult to do research, and I am grateful to Mr. H.A. Woensdregt and
his colleagues for their friendly way of helping me.
Finally, I would like to thank Caroline Cost Budde, Ellen Koen, and Maaike van
der Rijst for improving my English grammar.
xi
CHAPTER I
Introduction
It is curious how common sense, wriggling for an es
cape from absurd conclusiops, has been apt to reach a
preference for wholly 'wasteful' forms ofloan expendi
ture rather than for partly wasteful forms, which, be
cause they are not wholly wasteful, tend to be judged
on strict 'business principles'. (J.M. Keynes)
In the present western world there is a lack of consistency between proj ect appraisal
and macroeconomic policy. Project appraisal takes, of course, the specific charac
teristics of projects into account. In most cases, it is based on the assumption of fuH
employment. In a few cases, it takes account of the existence of unemployment.
However, as will be explained later in this study, in these cases it is nearly always
based on a partial analysis, or at least on an analysis which is not consistent with the
macroeconomic analyses used for decisions about macroeconomic policy.
Macroeconomic policy refers to policy decisions on aggregate variables (total
demand, the money stock, the exchange rate). In many cases it is based on an inte
gral analysis ofthe economy that takes account ofthe existence ofunemployment. A
restriction of such an analysis is that specific factors at a lower level of aggregation tend
to be neglected. F or instance, many studies about the rnacroeconomic effects ofKeynesian
policies concerning increases in government expenditures are based on the implicit as
sumption that there is only one type of government expenditure.
A number of economists have combined macroeconomic analysis with analyses
at a more disaggregated level in order to investigate the effects of specific portfolios
of government projects, or of other mesoeconomic policies. Some ofthese analyses
will be discussed in this study. At this point it can be said that despite these analyses
there is still a lack of integration between project appraisal and macroeconomic policy.
This study is concerned with situations ofunemployment. It is based on the idea
that, ifunemployment exists, fuH employment cannot always be (quickly) reached
by using conventional macroeconomic policies, or by supply-side policies aiming to
improve the free functioning ofmarkets, or by a combination ofboth.
Given this starting point, the lack of integration between project appraisal and
macroeconomic policy could lead to a non-optimal total policy. The selection of
individual public projects is generaHy not based on the criterion that they should
I
Description:Environmental economics addresses the issues that arise on the boundaries between economic systems and natural systems, such as pollution and natural resource de pletion and degradation. Like any other branch of applied economics, it has drawn its tools and techniques from the wide range already a
