Public Projects and Income Groups

Public Projects
And
Income Groups
Carlos Eduardo Guice, Sr.
University of London
Investment and Project Appraisal
Course Number: FME205
Assignment: TMA 2
Submitted On: September 28, 2006

Public Projects and Income Groups
FME205 Paper No. 2 Page. 2
TABLE OF CONTENTS
TABLE OF CONTENTS.................................................................................................................................................... 2
PUBLIC PROJECTS AND INCOME GROUPS ................................................................................................................ 3
1. AGGREGATE AND DISTRIBUTIONAL WELFARE CHANGES......................................................................................... 3
2. BEYOND UTILITY FUNCTIONS................................................................................................................................ 4
3. PROJECT-INDUCED WELFARE CHANGES............................................................................................................... 4
4. REDISTRIBUTION OBJECTIVES .............................................................................................................................. 5
5. CONCLUSION....................................................................................................................................................... 7
CASE STUDY - MOROCCO’S NATIONAL RURAL ROADS PROGRAM (NRRP-2) ....................................................... 8
1. BACKGROUND ..................................................................................................................................................... 8
2. PROGRAM OBJECTIVES........................................................................................................................................ 8
3. AFFECTS OF RURAL ROAD IMPROVEMENTS........................................................................................................... 9
4. IMPACT ON INCOME GROUPS.............................................................................................................................. 10
a. Impact on Transport User/Providers......................................................................................................... 10
b. Impact on Local Farmers ........................................................................................................................... 10
c. Impact on Rural Labor .............................................................................................................................. 11
5. CONCLUSION..................................................................................................................................................... 12
WORKS CONSULTED .............................................................................................................................................13

PUBLIC PROJECTS AND INCOME GROUPS
Investment decisions are critical to the development process. The evaluation, selection, and implementation of public
investment projects require a complex and multi-dimensional balance of vital factors affecting resource allocation often
in an environment of scarcity. One such vital factor is a project’s distributional affects. What are the channels and
mechanisms by which public projects distribute and allocate economic benefits? How are the benefits differentiated
among income classes? The following analysis considers these questions.
1. Aggregate and Distributional Welfare Changes
Public projects affect both the level of income and its distribution (Lyon, p. 444), which means that aggregate
and distributional welfare changes are co-determined. Public sector projects can affect social and group welfare by
increasing aggregate consumption, and distributing the associated costs and benefits. If we conceptualize aggregate
welfare as a function of society’s aggregate utility, we can write the following welfare function:
 
UWW  (1-a)
where the (W) variable denotes aggregate welfare, the (U) variable indicates utility, and the (a) superscript signifies
society as a whole. For analysis purposes, we will organize society into three broad income groups, and define society
as follows:
 HML ,, (1-b)
where the (L), (M), and (H) variables denote the income groups in our simple model.
We now expand equation (1-a) to differentiate the groups and bring to focus their respective utility functions:
),,( HML
UUUWW  (1-c)
where (UL), (UM), (UH), represent the utility functions for each group. Equation (1-c) now defines social welfare as a
function of their aggregate utility. We can now see that a change in the aggregate welfare function is the sum of the
constituent utility functions in society, represented in our model by the three groups. Equation (1-d) illustrates this
relationship.
H
U
M
U
L
U
UWUWUWW HML  (1-d)

Equation (1-d) demonstrates that various outcomes of public sector investment projects can produce a positive
aggregate welfare change and still breach the Pareto1 condition. A negative first, second, or third term in equation (1-
d) is consistent with a net increase in aggregate welfare, leaving at least one of the income groups worse off even
though society as a whole improves aggregate welfare as an outcome of the public investment.
2. Beyond Utility Functions
Since real benefits do not take the form of utility functions, we locate a proxy to facilitate our analysis. For
this we will consider consumption and measure utility in terms of goods and services consumed. Rewriting Squire’s
equation (Squire, 1989) for project-induced welfare changes, and differentiating for the broad income groups identified
above, we get:
H
iH
i
H
i
H
U
H
M
iM
i
M
i
M
U
M
L
iL
i
L
i
L
U
L
d
U
U
W
d
U
U
W
d
U
U
W
W
HML

















  (2-a)
where the ( ) variable denotes goods and services consumed, the (i) variable represents goods and services, and the
(d xi) variable denotes the project’s effect on the consumption of goods and services by the various income groups2,
such that x = {L,M,H}. The project produces a change in the economic state which shapes the social welfare function
by means of real output and external3 effects on the consumption function of each group.
3. Project-Induced Welfare Changes4
These Project-induced welfare changes can result from income flows that allocate a project’s net economic
benefits or market price distortions that redistribute income.5. Additionally, project-induced welfare changes can result
1
Named after the Italian economist Wilfredo Pareto to whom is attributed its conception, the Pareto condition holds
when at least one person is made better off as a result of a change and no one is worse off.
2 For a discussion on these issues, see Squire (1989).
3 These indirect effects, which impact various income groups, arise from an environment conditioned by imperfect
markets, incomplete information, and institutional rigidities.
4
Here we distinguish project-induced welfare changes from the redistribution effects of government policies that use
public sector projects as a tool to direct benefits to preferential groups, or geographic regions. We will define these as
policy-induced welfare changes, and will discuss them further in Section 4. Admittedly this distinction is somewhat
arbitrary given that pricing distortions identified under project-induced changes can result from government policies.
However, the distinction works if the differentiating factor becomes those government policies that exist independent of
the project in contrast to those that require the project itself to accomplish its policy objectives.

from income enhancement opportunities created by public investments such as public education, or skill formation
(Infanger and Butcher, p.805).
To illustrate the allocative and redistributive affect of public project investments consider unskilled labor. If
the opportunity cost of unskilled labor is negligible due to chronic unemployment or underemployment in the labor
market then its economic value would, most likely, be less than the market rate for wages. As such, the market wage
rate does not reflect the opportunity cost of labor, resulting in a redistributive flow of income from the project to the
unskilled laborer. The price paid exceeds the value added. On the other hand, if the labor market experienced low
levels of unemployment or underemployment then the wage rate should more accurately reflect the true economic
value of unskilled labor. In this case, labor receives an undistorted allocation of the projects economic benefits.
Other factors that create pricing distortions and influence a project’s impact on income distribution are fiscal
and trade policies. Taxes and subsidies are transfer payments and as such distribute cost and benefits from and to
various social groups. Some enjoy the benefits while others bear the costs. Government charges, however, are not
always taxes; they can represent charges for goods and services, signaling a real resource flow. In this case,
government pricing policies will determine income distribution among project stakeholders. Trade policy tools such as
tariffs, duties, subsidies, taxes, and quantity restrictions can distort the price of a project inputs and outputs as well as
the price of foreign exchange, producing pricing distortions that influences the project’s distribution outcomes.
4. Redistribution Objectives
Market determined welfare distributions do not always satisfy social ethical norms. Sometimes, profit
maximization can expand the production possibility frontier at the expense of an equitable distribution of production
output. In short, the willingness (or ability) to pay does not necessarily produce good social outcomes. With this in
mind, welfare (or income distribution) weights can be used to assist in equity and efficiency evaluations of public sector
investment projects.
Making income the evaluative space for relative welfare implies a strong correlation between income
(consumption) and utility. Kula cites as support for this link the observed migration patterns from impoverished areas
to more economically prosperous regions (Kula, p. 102). Such observations seem to support the economic theory of
diminishing marginal utility. This theory states that an additional utility attached to an extra unit of a good diminishes as
5 Since market prices do not always signal the true scarcity value of inputs and outputs, the difference between
payments received and value added generate a redistributive loss and corresponding gain between social groups.

one consumes more and more of that good. Applying the notion to income, we assume that as incomes rise, the next
unit of income received diminishes in its utility value, which further implies that those with the ‘least income’ gain more
utility from an extra unit of income (consumption) than those with higher incomes.,
Thus, if income redistribution reflects public policy, project selection can serve as a tool to accomplish this
objective with the added benefit of easing the burden on fiscal policy to accomplish this objective. One methodology
for formulating Income (consumption) weights is as follows:
e
nc
c






 , where (5-a)
C = Average per-capita income,
Cn = Income of group n,
 = Welfare weight,
е = Elasticity of marginal utility of income
Utilizing the income weight derived in equation (5-a), we can formulate the following income weighted welfare
function (∆WD).
  






i i
i
n
i
n
iiD dcqdcqW )1(  (5-b)
where the subscript i represents output, the qi variable denotes output prices, dci denotes total consumption,
and dcn
i represents the project’s effect on group N consumption. We can distinguish N different income groups
impacted by the project: n=1,2,…..,N. For example, (n=1) can represent unskilled rural labor, or (n=2) can consist of
small agricultural producers.
By setting the first-term in equation (5-b) equivalent to the un-weighted, aggregate consumption benefit
produced by the project we get,
 
i
ii Cdcq , and
by setting the following term to be equivalent to income we get,
Ydcq
i
i
n
i 
We can now rewrite equation (5-b) as follows:
















e
n
nD YCW


1 , where (5-b)
∆WD is the weighted economic value of net project benefits, the C variable denotes un-weighted aggregate
consumption benefits, the Yn variable represents the income change to group n, the n variable denote the welfare
weight for group n, the η variable represents the value of a units of saving6, and the е variable denotes the elasticity of
marginal utility of income. Equation (5-b) captures both the aggregate consumption benefit produced by the public
sector project and its distributional impact on various income groups, corrected for relative welfare weights.
5. Conclusion
The outcomes of public sector investment projects confer gains and losses upon society and its constituent
members, groups, and income classes. The value added of public sector projects is distributed among society’s
members in very specific ways that are conditioned upon several factors such as project design, production inputs,
locality, institutions, and macro-economic conditions.
When public projects outputs are purchased society buys both the additional income generated and the
redistribution of that income (Lyons, p. 444). Lyons (1974) and Thurow7 (1971) argue that income distribution is a
public good. If so, it is an important factor in the investment appraisal process of public sector projects. A decision to
place a public project within the Pareto frontier addresses a need to balance equity and efficiency considerations in the
allocation of public resource. As, market outcomes often fall short of maximizing social welfare.
6 For the purposes of this analysis we will assume this variable equal to 1.
7
Thurow makes an interesting case for a ‘public good’ component of income distribution since it may be possible that
the distribution of income is an argument in the individual utility function (Thurow, 1971). This could be the result of
externalities associated with certain patterns of income distribution such as crime or political stability.

CASE STUDY - MOROCCO’S NATIONAL RURAL ROADS PROGRAM (NRRP-2)8
To place the above discussion within the context of a real world investment project, we will review the Moroccan
National Rural Roads Program (NRRP-2). The project is currently in the initial phases of construction. As a
consequence, empirical data that would facilitate an evaluation of the program objectives against operating results
does not, yet exist. Thus, the following discussion will examine the project’s likely distributional impact on the rural
economy and its stakeholders. These anticipated outcomes are formulated in view of the published results of another
major road program in Morocco: the Fourth Highway Project completed in Northern, Southern, and Central Morocco
between 1987 and 19919. This deficiency notwithstanding, the NRRP-2 was chosen to illustrate how public projects
can affect different income classes because it represents a clear example of the use of a public investment project to
implement income redistribution policies.
1. Background
The NRRP-2 Road Project represents phase-2 of a major highway investment program10 undertaken by
Morocco’s Directorate of Roads and Road Traffic (DCRC) of the Ministry of Public Works and Transport (MPWT).
Phase one was undertaken in 1995 to upgrade the national road inventory, adding eleven thousand kilometers of
newly constructed and improved rural roads. The estimated capital cost to complete NRRP-2 construction is MAD11
11,319 million with the construction period beginning in 2006, and continuing until 2015.
2. Program Objectives
The stated objective of this public project is to improve the social welfare of the rural population. Since over 70
percent of the country’s poor live in rural areas, the public investment reveals an implicit welfare weight in favor this
targeted group.
Moroccan urban dwellers have benefited substantially from the country’s economic growth in the past decade,
which is in sharp contrast to the rural population whose condition has significantly deteriorated since the 1990’s (Levy,
p.7). In response to this inequitable trend, the government launched the NRRP-2 project, which redefined the stated
8 This case study is taken from the World Bank Report prepared by Hernan Levy
9 These findings are published in the World Bank Impact Evaluation Report No. 15808
10 The First National Rural Roads Program (NRRP-1)
11 Moroccan dirham equivalent to €1,029, or $1,230

objectives of NRRP-1. The main focus shifted from physical output concerns such as road inventory, agricultural
potential and economic efficiency to increasing the percentage of rural population served, formalizing local government
participation, and accelerating construction completion.
The policy expectation is that the NRRP-2 investment project will improve the social welfare of the rural population
and eventually allow the rural communities to enjoy a more expanded participation in the country’s overall economic
growth.
3. Affects of Rural Road Improvements
A first cut analysis of the distributional impact of the NRRP-2 project would consist of quantifying the economic
benefits12 accruing to the implementing agency and road user groups. And a more comprehensive review would
consider the links between the investment cost of improving the rural roads and the expanded socio-economic
opportunities created for the rural poor. This requires a complex and multi-dimensional analysis.
However, we can make a general observation on how transport projects operate to influence development
(Fromm, 1965):
a. Transport is an input in the production process that permits people and commodities to move
between and within production and consumption centers;
b. Transport improvements can shift production possibility functions by altering factor cost and
reducing inventory levels;
c. Transport improvements can increasing factor mobility, transferring resources where they can
be most productively employed;
d. Transport improvements can increase individual welfare by providing better accessibility to a
wider range of facilities and public goods.
It is anticipated that NRRP-2 project will have a similar influence on the economic development of Morocco’s rural
economy.
12 Benefits could be assessed utilizing a consumer surplus approach measuring road user cost savings such as vehicle
operating costs, travel time costs, accident costs, and road maintenance cost associated with the new investment.

4. Impact on Income Groups
Narrowing our concerns to the project’s impact on specific income groups, we will focus our analysis on the
following three: transport user/providers, small agricultural producers, and rural (landless) laborers.
a. Impact on Transport User/Providers
A major beneficiary of the NRRP-2 will be the road users. Benefits accruing to this group were identified
by The World Bank study as follows:
 Reduced operating vehicle cost;
 Lower prices for freight and passenger services;
 Increased transport services;
 Increased ownership of motor vehicles.
These benefits provide an enabling condition to bring about the growth and development of private
sector transport provisions, increasing the supply of road passenger and commercial freight services.
This should boost the aggregate consumption of transport services.
Based, solely on road user cost savings the World Bank projected an economic rate of return on
the NRRP-2 project of 19% and a global Net Present Value (NPV) of US$ 373 million, with cost savings
benefits accruing to approximately 2.8 million Moroccans (World Bank, pp. 72).
b. Impact on Local Farmers
Another important group to consider is the local farmer. Under the right conditions, another benefit of
the NRRP-2 project should be an increase in farm incomes, resulting from expanded agricultural
activity. Since 70 percent of the country’s poor reside in rural communities, this should advance the
government’s policy on poverty alleviation.
Benefits anticipated to accrue to the local farmers begins with a more extensive use of commercial
transport services in lieu of less efficient means of transport such as non-motorized options. This should
reduce the cost of bringing agricultural products to market and extend the distance to break-even
locations, and lead to a more intensive cultivation and increased production of cash crops. Moreover,
the reduced transports cost could cause a reduction in production costs as a result of lower input prices.

When travel time is saved, more labor is available for production which is tantamount to an increase in
the labor supply, which also increases production.
The NRRP-2 mandate to increase all-weather road accessibility will provide the local farmers
greater market access which should stimulate agricultural production, improve prices, and increase the
use of modern technology and inputs. The World Bank study cited the following positive impacts of
Morocco’s previous road projects on local rural farmers13:
a. An overall increase in agricultural production, productivity, and the monetary values of the
output;
b. Land use shifts from low-value cereals and grains to higher-value perishable crops
transformed the production mix.
In addition, favorable shifts in livestock production, improved technology, and increased use of
extension services were noted as favorable impact of past road investment projects.
c. Impact on Rural Labor
Finally, we will consider the potential impact on rural labor. The NRRP-2 project can open up alternative
non-farm employment opportunities, leading to higher income levels and more diverse sources of
income. Greater road accessibility will reduce the cost of job seeking, contributing to a more efficient
labor market. The NRRP-2 project can stimulate the non-farm economy, creating more shops and
stores in the rural village and a higher demand for non-farm services.
An immediate impact on the incomes of rural labor could result from employments associated
with the construction of the road, especially when labor-based methods are consciously incorporated
into the program. This short-term work could provide an infusion of cash to rural households that could
be a significant source of non-farm income as well as contribute to the skill formation in the construction
trade. With respect to long-term prospects, maintenance requirements for the new roads can jobs;
again, provided that labor-based maintenance methods are employed.
In addition, NRRP-2 can provide access to opportunities outside the rural villages, which
allows small producer households the opportunity to diversify family income through both agricultural
wage-labor opportunities in other rural areas, or non-agricultural employment in urban areas.
13 Rural Roads and Poverty Alleviation in Morocco 2004

5. Conclusion
The NRRP-2 is an example of a public project being utilized to implement a government’s income
redistribution policy. The benefits are intended to accrue primarily to the rural population as a means to correct the
economic inequities between the urban and rural sectors, arising over the past decade. The benefits are expected to
occur as a result of reduced transport cost, increased quality and frequency of transport services, higher farm incomes,
and increased access to and higher quality of social services.

Works Consulted
Asian Development Bank, (2002) Impact of Rural Roads on Poverty Reduction: A Case Study-Based
Analysis (Operations Evaluation Department , IE-68), Manila, Philippines
Balassa, B. (1974). Estimating the Shadow Price of Foreign Exchange in Project Appraisal. Oxford
Economic Papers, New Series, Vol. 26, No.2 147-168
Butcher, W., Infanger, C. (1974). Individual Income Redistribution and Publicly Provided Irrigation: The
Columbia Basin Project. The American Journal of Agricultural Economics, Vol. 56, No.4 805-811
Clark, C. (1973). The Marginal Utility of Income. Oxford Economic Papers, New Series, Vol. 25, No.2
145-159
Fromm, G. 1965, Transport Investment and Economic Development, Washington D.C.: The Brookings
Institute
Garn, H., McGuire M. (1969). The Integration of Equity and Efficiency Criteria in Public Selection. The
Economic Journal, Vol. 79, No.316 882-893
Kelsey, D. (1988). Policies to Achieve a Better Distribution of Income: Or is a Dollar a Dollar? Oxford
Economic Papers, New Series, Vol. 40, No.3 557-583
Kula, E. (2002), Regional Welfare Weights in Investment Appraisal – the Case of India. The Journal of
Regional Analysis & Policy, Vol. 32, No.1 pp. 99-114.
Lyon, K. (1974). The Valuation of Income Redistribution Impacts. The American Journal of Agricultural
Economics, Vol. 56, No.2 444-447
Neenan, W. (1971). Distribution and Efficiency in Benefit-Cost Analysis. The Canadian Journal of
Economics, Vol. 4, No.2 216-224
Pursell, G., Tower, E. (1987). On Shadow Pricing Labour and Foreign Exchange. Oxford Economic
Papers, New Series, Vol. 39, No.2 318-332
Squire, Lyn (1989). Project Evaluation in Theory and Practice. The Handbook of Development
Economics, Vol. 2 1091-1137
The World Bank, (1996) Morocco – Socioeconomic Influence of Rural Roads: Fourth Highway Project
(Impact Evaluation Report No. 15808), Washington, D.C.
The World Bank, (2004) Rural Roads and Poverty Alleviation in Morocco, Washington, D.C.
The World Bank, (2006) Project Appraisal Document on a Proposed Loan in the Amount of Euro 50
Million to the Caisse Pour Le Financement Routier with the Guarantee of the Kingdom of Morocco for
a Second Rural Roads Project (Report No. 35118-MA), Washington, D.C.
Thurow, L. (1971). The Income Distribution as a Pure Public Good. The Quarterly Journal of Economics,
Vol. 85, No.2 327-336
Weckstein, R. (1972). Shadow Prices and Project Evaluation in Less-Developed Countries. Economic
Development and Cultural Change, Vol. 20, No.3 474-494

Public Projects and Income Groups

Recommended

Recommended

More Related Content

Similar to Public Projects and Income Groups

Similar to Public Projects and Income Groups (20)

Recently uploaded

Recently uploaded (20)

Public Projects and Income Groups