Shadow-Prices for the Economic Appraisal of Public Sector Expenditures

Abstract

In a recent paper Glenn Jenkins (1980) alludes to the protracted debate which took place in the 1960s and early 1970s on the relative merits of the use of the shadow price (or shadow benefit/cost ratio) and the shadow discount rate in the evaluation of public projects. In the opening paragraphs of his paper Jenkins concludes (correctly) that 'most of the theoretical issues have been resolved' and the 'the areas of disagreement seem to have shifted to questions concerned with the empirical measurement of the variables.' In other words, it is generally recognized (see, for example, the paper by Sjaastad and Wisecarver, 1977) that the two approaches to shadow-pricing public projects (or expenditures) give the same result provided that the same assumptions about the appropriate reinvestment proportions and rates of return for public and private project benefits are used in applying each rule. Since Jenkins clearly subscribes to this generally held view, I interpret his description of the version of Marglin's (1963b) shadow-pricing criterion used in my paper (Campbell, 1975) as 'simplistic' and 'deficient' as a case of transferred epithet: what Jenkins really means is that my application of Marglin's criterion was simplistic and deficient in that I excluded the possibility of reinvestment of either public or private project benefits. Of course, the reinvestment proportions and rates of return for public and private project benefits will depend upon the nature of the public project and how it is financed. In the absence of any empirical information it is nonetheless possible to extend the kind of sensitivity analysis contained in my Table (1975:175). The results reported in that Table are based on the assumption that all public project benefits are consumed, that public project output is not subject to indirect taxes, and that there is no reinvestment of the throw-off from private sector projects. If instead we make the following assumptions: (i) the initial impact of the financing of a public project is to displace resources from the private production of consumption and investment goods in the proportions (1-b) and b; (ii) that private investment projects are perpetuities with a social return of r*; (iii) that a proportion b of the throw-off from private projects is continually reinvested at