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Multi-government cost-benefit analysis: shadow prices and incentives

Listed author(s):
  • Massimo FLORIO


Europe needs a huge investment effort for (broadly defined) infrastructure in the next decade. A combination of EU grants, loans by the EIB and the EBRD, and their leverage effect on private capital is going to mobilise a huge amount of savings. Planners should establish priorities and criteria. Microeconomic social accounting, i. e. cost-benefit analysis, despite its limitations, is needed as a support to investment planning and evaluation. The key message of modern CBA theory is that shadow prices are not proxies of perfect markets outcome, but are planning signals that solve a (policy–constrained) social planner’s problem. Planners must compute shadow prices, evaluators should use them for project appraisal, and the two functions should not be confused. In principle this distinction applies at each planning level, but a consensus decision-set should emerge from this process, using a bottom-up approach. In a multi-government setting there are, however, information asymmetries that need to be addressed, and we have to turn to incentive theory. The paper proposes to move away from the current low-powered incentive EU co-financing mechanism, essentially an investment cost part-reimbursement scheme, towards a more incentive-based system. Financial and economic analysis, ex ante and ex post, should be linked to an economic performance bonus for more socially deserving projects. Examples are given of such mechanisms. Planners, managers and evaluators should be given appropriate incentives to use CBA as a cooperative learning game

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Paper provided by Department of Economics, Management and Quantitative Methods at Università degli Studi di Milano in its series Departmental Working Papers with number 2006-37.

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Date of creation: 22 Nov 2006
Handle: RePEc:mil:wpdepa:2006-37
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  1. Massimo Florio, 2005. "A ``European Consensus'' on the Growth Agenda? A Discussion of the Sapir Report," Transition Studies Review, Springer;Central Eastern European University Network (CEEUN), vol. 12(3), pages 411-431, December.
  2. Dreze, Jean & Stern, Nicholas, 1990. "Policy reform, shadow prices, and market prices," Journal of Public Economics, Elsevier, vol. 42(1), pages 1-45, June.
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