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INVESTMENTS ON LARGE PUBLIC WORKS: THE CONTRIBUTION OF PUBLIC ECONOMIES
Gilberto Muraro*
Professor of Public Economics, University of Padua (Italy)

INTRODUCTION
For a public economist to speak at the international meeting of hydraulic engineers and scientists is not only a great honour but also a tough challenge. It’s clear indeed that it’s of no use to offer a textbook synthesis of economic analysis applied to projects. It doesn’t have any sense either to investigate deeply some specific technical issue, however intellectually stimulating it could be. It seems useful instead to answer to the curiosity of the engineer who, although knowing he could well elaborate the project by himself, considering the economic aspects too, is well aware that the success of the project is crucially dependent from something external which has to do with the social utility of that project; and he is asking himself how the verdict about the social utility is reached, thus determining the fate of the project.
I have therefore considered suitable to present the structure and the role of the economic analysis applied to the large works. This means trying to ascertain the critical points of the analysis, both technical and political, the criteria used to face them, the boundaries within which it can be applied and consequently the issues that economic analysis cannot tackle because of technical difficulties or problems belonging to the political area. My analysis applies generally to large public works, but I will try to find a few examples applied to hydraulic works.
The first paragraph deals with the relation between general rules and specific evaluations; the second paragraph analyses the criteria of social welfare, which is the reference point for the evaluation, and it shows the main differences between the financial analysis of the project and its analysis from the social utility point of view (the so called CBA - cost benefit analysis); the last paragraph is related to two political problems, precisely the referring community for which the social utility is evaluated and the issue of compensating those who are damaged by the project.

1. GENERAL NORMS AND SPECIFIC EVALUATIONS
As just said, our analysis deals with large works. The European Community defines the large project “as the sum of economically indivisible works which have a precise technical function and some well defined objectives, and have a total cost over 50 millions euro (art. 25 Reg. 1260/1999, Fondi Strutturali). Such a definition is however assumed here in less precise terms, considering as large a project that is costly and promises a remarkable impact on the markets or on the social and physical environment. It is therefore a conceptual reference more than a legislative one, which helps us to reply to the first question arising when we speak of a social analysis of a project: why a specific analysis?
Let’s imagine at the beginning a completely private investment: promoted, elaborated, financed, implemented, utilized by private firms. Why is it not enough to demonstrate that it respects all the pertinent rules, insofar as the place, the distances, the materials, the production processes, the emissions, and so on, are concerned? The reply is, indeed, that the rules are enough for the small works not for the large ones. The small works, when they respect the rules, are supposed to have no significant external impact. Only many small works together could create such impact. In this case the rational reply from public authority would imply to introduce some collective constraints, which assure that the sum of micro impacts will not reach a dangerous level. Examples: to define the borders of an industrial or a commercial or a residential zone; or to define the maximum amount allowed of air pollutant in a specific area (like in the case of the so called “bubble policy” used in certain countries for dealing with air pollution: for each main pollutant, a maximum amount is fixed, and it is totally or partially allocated among the existing firms active in the area; thus, a new firm will have to compete for the remaining “emission rights” available or it must acquire them from the existing firms, exactly in the same way used for land and workers). In this case, too, there are general rules to respect, with no need of specific evaluation and decision. Now that it is clear the concept of large work as the work that cannot be regulated only trough general norms, it must be added that the border between large and small projects is not uniform in time and space. It is not question of different sizes for different sectors, which is obvious, given, for instance, the different unit impact on the environment. It is for the same sector that there are remarkable differences.
There is normally a trade-off between the development of general legislation and the room assigned to specific evaluations; and a similar trade-off can be observed between collective constraints, like zoning, and the requirements imposed on a specific project.
This trade-off is observable from many points of view in the field of public works. The alternatives to be examined are normally more numerous when there is no territorial plan behind; the reliability of the economic forecasts is normally more debatable if there is lack of an appropriate macroeconomic framework, and this will generally imply a larger sensitivity analysis of the project for understanding the impact of various scenarios on the project’s results; and so on.
The rule of the European Community that puts the inferior limit of the large work at 50 millions euros must therefore be considered as a conventional definition, which tries to average among different traditions of the member countries and may well change in future.
Having said al that for big works at large, it must be added that the hydraulic works are in general more subjected to specific evaluation. The explanation is quite simple. Such works produce outputs which are not sold on the market and therefore require social evaluation at a minor scale too.
Considering the target of the hydraulic works, the following classification may be proposed:
a) works for protection against water;
b) work for improving the quality of waters;
c) works for exploiting water as an economic resource.

For the first two types of works, it is clear that the central output - more safety, better quality - is a so called “public good”, that is a good which can be utilized by everybody at the same time, without the possibility to exclude who did not pay for it. In addition, an hydraulic work has often several targets, so that the work aiming as first target at the increase of some economic use of the water (an irrigation channel or a dam for hydroelectric energy, has a remarkable impact on the safety or quality question just mentioned. In conclusion, public goods are a pervasive output of hydraulic works.
Now, it is central to economic theory the notion that the production of a public good is not possible in the market or it is not possible at the most convenient size for the society. The reason is that the impossibility to exclude those who did not pay induces some people to play the role of the so called “free rider”, namely to hide their true preferences and to wait that the others pay and produce something which they will enjoy free of charge. But when many are “free riders”, it is impossible to collect the resources needed to produce or to buy the public good. In the best case, the minority will go on at its own expenses, however at a smaller scale. The result is in any case the loss of a potential improvement in social welfare.
Such a behavior in relation to public goods differs in time and in space, depending on the level of civic education in the community. When the Kant’s principle of “categorical imperative” (do everything as if your specific behavior would be a general law) is widely assimilated, the society can rely on a high level of civic loyalty, that is the citizens will generally reveal their true demand for public goods and their propensity to pay. The public goods can then arise out of a voluntary collective action , without need of State coercion. This would be in the true spirit of the subsidiarity principle which implies that the State intervenes only when the markets and the voluntary agreements cannot work; a principle that has become a relevant component of the European political culture since the Maastricht Treaty in the early Nineties, and it has formally be introduced in the recent reform of the Italian Constitution (see article 118, last comma). But, notwithstanding the general homage paid to the teaching of the great 18th century German philosopher Emmanuel Kant, it is granted that the phenomenon of free riders is relevant enough to justify a public responsibility in the production of many public goods.
Note at the end that the same relevance of public goods as output of the hydraulic works call for a systematic attention of public authorities to such works. It often happens, therefore, that a country elaborates general plans in this field (for example, in Italy, the plans for aqueducts and for depuration plants), so that a single project is subjected to a simplified analysis once it has been shown coherent to the plan. But more often, a project must be considered as standing alone and by itself socially convenient. How? Let’s see then the problems of the project evaluation.

2. THE ECONOMIC ANALYSIS OF THE LARGE INVESTMENTS
To evaluate ex ante an investment project means to reply to the following questions:
- which objectives to assume?
- which criteria are best suitable for assessing the effects of the investment?
- how to take into account the uncertainty?
- which trade-off between cost and reliability of the evaluation, that is which level of approximation to accept considering the cost of improving the knowledge and the evaluation?
- how to present the results of the analysis so that the decision maker can consciously decide?

It is well known that the economic literature has tried to reply to such questions by elaborating a wide set of criteria and techniques, the most known being the so called Cost Benefit Analysis (CBA), which is grown letting arise many variants like the costeffectiveness analysis, the cost- utility analysis, the multicriteria approach, and so on. It is not possible to face here the lively debate about the criteria and the parameters of the CBA from the choice of the social discount rate to the inclusion and the definition of an opportunity cost of public funds and to the use of the theory of real options in the evaluation of the public investments(1).
It is enough here to recall the general problems of how to shape the analysis. And such problems may be grouped into two items: the criteria of social welfare , and the relation between social-economic analysis and the financial analysis of the investment.

2.1 The concept of social welfare

Social welfare, even limited to the part that is affected by economic decisions, may receive different definitions. The common basis of the CBA and its variants is the adoption of a “democratic philosophy”, which can be summarized in two postulates:
1- social welfare is exclusively the result of the citizens’ welfare (against the organic theory of the state, advocated by the totalitarian philosophies of the 20th century and based on the “superior reasons” of the state);
2- each citizen is the best judge of his own welfare.

In human matters, one must always allow for exceptions. They are especially relevant insofar as the second postulate is considered. A good example is the poverty policy . It is intuitive that the receiver would be happier with money than with free services of equal value: with the money received he could buy the same combination of services, if wished, but he could switch to another combination if preferred. But the donors, or the State if it is a public policy, generally do not trust that the receiver is able to judge what is “really” beneficial to him, so that the preferred policy is based on essential services offered at low or zero price. Also for public works, especially when they have long run effects on the environment, one can find in the policy makers, democratically elected, a paternalistic attitude rather than a democratic one. But altogether, the democratic approach is the right reference also in the evaluation of a project.
The next step is how to elaborate the concept in order to have some practical guidance criterion. The most used criterion, at least in theory, is that one advocated by the Italian economist Vilfredo Pareto: one action is improving the social welfare if at least one individual is better off and nobody is worse off. The social optimum following Pareto (the so called “Pareto optimum”) is therefore a situation that cannot be improved, that is, it is no more possible to let one be better off without worsening the situation of somebody else. Of course, the real world is full of actions which brake a Pareto optimum and let somebody improve his own situation at the expenses of others. But the evaluation of such actions implies a comparison between individuals, i.e. it implies value judgments that are the domain of the policy maker not of the economist. Economic analysis can still help the decision by making clear and possibly measure the outcomes of the project with reference to the objective function chosen by the policy maker; but that is a different story.
Remaining on the domain of the Pareto criterion, a severe limit on its applicability arises out of the hypothesis, implied at least in the simplest version of the analysis, that the individual economic welfare depends only on his own consumption, with no regard to what happens to the others. But the issue of the distribution of goods among individuals cannot be dismissed so easily. First of all, because the value of goods and services arises out of a price system which in its tum depends on the initial distribution of the purchasing power; so that who does not accept the initial distribution of wealth can object also to the evaluation based on the depending price system. Second, because the individual utility functions are often interdependent in various ways. Solidarity toward those in need, envy, sense of justice, desire of equality: whatever the link, the result is that the outcome of a project is judged by the individual non only on the basis of his personal gain or loss but also on the base of the distribution of gains and losses. It is then intuitive that, assuming interdependent individual utility functions, one can have a negative vote by the winner and a positive vote by the loser, and that a project which implies a Pareto improvement may be rejected by the majority of the people concerned because the distribution of its results is considered unfair(2) (Eckstein, 1957). When such weaknesses of the Pareto criterion are added to the already mention inability to judge a project which creates both gains and losses, it is easily understandable the effort of the economic theory to elaborate criteria able to comply with a wider range of objective and subjective situations.
The solution mainly adopted is offered by the so called “potential compensation principle”, proposed by the 20th English Economists Nikolas Kaldor and John Hicks. It implies that a project is considered socially beneficial when it gives a net gain, in the sense that the winners would be able to compensate the losers and retain a surplus. Note however that what matters is that the compensation is possible, it does not need to be effective (if effective, there would be no losers, so that the project would pass the Pareto test)(3). The intuitive goal of the compensation criterion is to separate the allocative decision from the redistributive one. The result, insofar as the investment is concerned, is the maximization of total collective gain, technically the total consumption of the country. Given certain non controversial hypotheses about the macroeconomic variables, that we ignore here for sake of simplicity, it means that we try to maximize Gross Domestic Product, i.e. the value of all goods and services produced in one year within the country. Clearly, then, the compensation principle in evaluating the investments decisions is a component of the political philosophy which advocates the maximization of GDP as “the” criterion of all economic decisions. Needless to say that this is the most widespread attitude among economists, politicians, people at large, for whom GDP’s rate of growth is then the main reference point to judge countries and governments. In general terms, no objections. But one must be aware also of some weaknesses of that criterion, which appears evident when explained its basis. Namely, it is based on a technical hypothesis and on a political opinion.
The technical hypothesis is that the issue about the size of the GDP may be separated by the issue of its distribution because an unsatisfactory distribution may always be corrected through taxes and subsidies. The political opinion is that, given such a possibility, it is always convenient to maximize the economic result, because whatever social problem is better faced with more resources available.
We will come back to the theme of compensation. It is enough here to recall briefly two main objections to the technical hypothesis. First, in real world there are often technical obstacles to redistribute perfectly: it is enough to recall the information problems about who loses and who gains , and how much. Second, only the abstract form of lump sum taxes and subsidies have zero allocative impact. All the real instruments of redistribution alter the marginal existing equilibrium in the markets and create distortions which forbid to maximize the potential GDP. In our opinion the final word on this argument has been said forty years ago by Marglin (1967) with the following statement: “The pursuit of redistributive objectives may cause losses of potential total consumption both acting through fiscal and prices policies or through the inclusion of the redistributive aspects in the criteria for choosing public investments. It is debatable which approach reduces more the conflict between maximization of the economic cake and the optimal distribution of the cake.
When there is no clear social preference for one or the other instrument, common sense suggests to use both direct and indirect means”(4).
Concluding, the compensation principle is generally the right criterion to use because the distributive impact of the project is not relevant or there is no social preference about distribution. This is often the case for hydraulic public works which offer benefits (protection against flood, increased productivity of agriculture, additional electricity, environmental amenities, and so on) to the population at large. But when the redistributive impact is a real issue, the economic analysis should either incorporate the distributional weights chosen by society, if available, or indicate to the public debate the
distributive impact of the work.

2.2 From the financial analysis to the cost-benefit analysis
Dismissing the distributive impact and the consequent need of value judgments about the right distribution, let’s consider, on a pure economic ground, why and how the analysis of social convenience- let’s call it with the general term of cost-benefit analysis - differs from the financial analysis (FA) of the project.
No need to say, the FA considers only the monetary profits and losses for the entrepreneur - an individual or a private firm or a public agency - responsible of the project: therefore only the items which originate a monetary flow for the entrepreneur are considered, and everything is valued at the market prices relevant for him.
The ACB then differs from AF in three main aspects: it adds some new items, it strikes some existing items, it modifies the value of some common items.

New items

The new items in the CBA concern the no-market impacts, i.e. production (or destruction) of public goods, and the production (or destruction) of the so called externalities. The public goods have been already mentioned as goods available to everybody at zero price: since they bring non money for the responsible of the project, they are ignored in the FA but are of course relevant for society and they are often central in the hydraulic field. The economic literature offers an impressive range of techniques to estimate the value of those goods, that can be grouped in three classes: interviews of the potential beneficiaries for the case in question or to the effective beneficiaries of similar services (trying to measure their propensity to pay to have the public goods); analysis of the alternative costs faced in the market for substitute services; impact on estate values affected by that kind of goods and services. The field of what can be reasonably evaluated through such techniques is really large, and it is a point of merit of the economic analysis to be able to offer a valid support to the public choices. But various phenomena - especially concerning long run effects on the environment - are still outside the analysis or, in the best hypothesis, are inscribed in large range of value with only the extremes known (no less than, no more than). In such cases an accurate description of the effects may be of help, but the final decision must be a discretionary one.
As for the externalities, they may be defined as the effects with no countervailing money flow: a dangerous effect that the author is, by law or by fact, not obliged to compensate for; or a positive effect, for which the author is not able, by law or by fact, to be paid for. Think to a polluting effect before the environmental legislation of the last decades; and think to the benefit given by a dam built for electricity production which incidentally reduces the probability of flood for the agricultural firms downstream. All said for public goods, as far as the role and the limits of CBA are concerned, clearly
applies to externalities too.

Items eliminated
Second difference between the FA and the CBA: the elimination of some items. These are the taxes and subsidies concerning the inputs and outputs of the project, very relevant in the FA, but non pertinent to a calculus that aims to ascertain the “real” values of the goods and services exploited in the project (and therefore subtracted to alternative uses) or produced by the project: a cost must then be taken net of the tax which implies only a money transfer from the responsible of the project to the state, and a return must be taken net of the subsidy which is an opposite money transfer added to the real value assigned by society to that good through market price (Dosi 1992).

Different prices
Third difference, the prices used in the two types of analysis for some common items. The question may be grasped by thinking to the miracle of the competitive market, as explained first by Adam Smith in the Wealth of Nations (1776).
General competition in the input and output markets compels the producers to sell all goods at a price which covers exactly the cost of production in the most efficient firms, giving non more than a normal rate of profit to the producers, and compels them to pay to input suppliers, typically to workers, a price no inferior to the marginal productivity of that input, that is the contribution of that input at the margin to the increase in the value of production. When the markets are reasonably near the competitive model, then the market prices, used in any case in the FA, are good also for social calculus. But imagine that an input is sold by a monopolist. Then its market price is over its real value because affected by the additional sum imposed by the seller that exploits his market power: in other words, there is a kind of monopolist tax that must be taken away from the values of the input, in the same way that state taxes are ignored in CBA. The examples let understand the common feature of a large class of price corrections theoretically implied in CBA: when the markets concerned are by far away from the competitive model (monopoly, monopsony, oligopoly), then the CBA should try to estimate and use the “shadow prices” that would have arisen in those markets if they were truly competitive markets.
A second class of correction is instead necessary even in the hypothesis of a competitive market when the impact of the investment looks so large as the produce a significant change in the price concerned. Suppose an irrigation project which will enlarge the crop production to an extent large enough to produce a remarkable fall in its price. The benefit for consumers is not only the saving in expenses for the old quantity but also the welfare gain linked to the additional quantity bought thanks to the lower price: such a gain would be underestimated if valued through the lower final price, as the FA does, and it would be overestimated if valued at the higher initial price. The social truth lies somewhere in between.
Most important , the correction of the discount rate. Even in competitive markets it is assumed that the existing interest rate is over the premium that the present generations want, when deciding collectively trough a public agent, in order to renounce to consumption and to invest in favour of future generations. This means that in CBA one must use a social discount rate lower than the market interest rate. And this often a determinant parameter for investments, like many hydraulic works, that promise long run returns.
Needless to say, all those theoretical corrections of market prices are reduced to a small number in practice, because it wise to take into consideration only the cases of highly imperfect markets and relevant price changes. But also with this caveat, this kind of corrections, in the case of large projects, may produce a remarkable difference between the results of FA e CBA.

2.3 Economic analysis and environmental impact assessment

No more is possible to say on this matter within the limits of this note, but a hint must be given to the environmental effects of a large project, which are often relevant for hydraulic works. In the first decades after the second world war, the environmental effects were perhaps the central topic of the CBA. The rapid economic growth in western countries let soon become visible many negative effects on the environment and let rapidly grow a sensibility for environmental protection. Some decades later the same evolution became visible in other countries subjected to rapid industrialization.
The environmental policy were at the beginning, and its development found two types of obstacles: the objective lack of knowledge about many phenomena and the better policy instruments to cope with the new problems; the hostility of the polluters affected, that worried about the increased cost induced by the environmental policy. This last obstacle was made more effective by international competition that increased after second world war, when the world started again to rely on free international trade. In this case, free trade, the hero of the impressive economic growth experienced by contemporary world, was the villain in the story of environmental protection: each country, indeed, wanted to wait for the others before adopting more severe policies, in the fear of loosing competitive advantages. Things went rapidly better when western countries decided, within the OECD, to move simultaneously toward environmental protection, adopting all the same principle, namely the polluter pays principle.
Since then, pollution control has become an important component of legislation and policy everywhere. Certain inputs and certain emissions are forbidden or strictly limited, and there a lot of standards and constraints regarding processes and products to respect.
On the other side, economic theory has developed the concept of “optimal residual pollution”, i.e. the level of pollution at which the increasing marginal cost of pollution abatement is considered equal to its decreasing marginal benefit; so that a further push of the abatement would decrease instead of increasing the social welfare, which of course depends on the environmental quality but also on the availability of goods and services.
In this new context the role of the environmental variables in the CBA is changed. As already said at the beginning of this note, speaking about the general relation between plan ad projects, the increasing framework of detailed rules has decreased the need of specific project analyses, in the sense that, till a certain size of the investment, the legislation simply requires the respect of the rules.
On the other side, for the large works which still require an ad hoc analysis, a new question arises, namely which relation to establish between the specific environmental analysis and the CBA. The question is generally been solved by the legislator himself, in most cases dictating a separate environmental impact evaluation. But it is interesting to examine the issue by itself, ignoring the official rules. It is then more convincing the solution of a comprehensive CBA, that includes also the environmental impacts. A unified evaluation promises to avoid the errors of omission or of double counting that are probable when the two evaluation processes are partial and autonomous (Muraro, 1982). At the same time it has been here stressed that technical difficulties in expressing every effect in money terms, especially dealing with the long term effects on environment, so that it is unavoidable to use for certain effects a unit measure different from money. In this case it is clear that CBA offers an evaluation of all events that are possible to evaluate in money and that the policy maker must receive two analyses, a CHA and an environmental impact analysis. It remains then strictly political the decision that must be made by comparing , in subjective terms, the net balance of monetary costs and benefits, on one side, and all the others effects, measured through specific indicators, on the other side. It is however a merit of the economic analysis to facilitate the policy decision by reducing as far as possible the elements to be compared.

3. SOME POLITICAL ISSUE IN THE ANALYSIS AND DECISION PROCESS
In addition to the technical questions till now examined, there at least two issues, prevailingly of a political nature, that deserve to be mentioned in order to understand the process of decision concerning the large works. Economic analysis assumes in these cases an ancillary role and it can only offer to the policy maker a contribution of information and knowledge. These issues concern the relevant community in evaluating the project, and the level and modes of the compensation to people damaged by the project.

3.1. Which community’s welfare?

As for the first issue, it is traditional in the CBA to assume, in an implicit or in explicit way, that the community to be considered in the evaluation of the social impact of the project is the national community. In abstract terms, one imagines a national decision maker who evaluates and decides. If there are various levels of government - federation, states, regions, provinces, counties - one imagines that the central power imposes to local decision makers a set of criteria and parameters which let arise at the end the social impact of the project at the national level. The main reference for such an approach in history is the Green Book issued by the Federal Government in USA in 1936. As it is well known, the “New Deal” introduced by President F.D. Roosevelt in order to fight depression gave a large role to public investments, especially, as matter of fact, in the hydraulic sector (think to the huge works for producing hydroelectricity in the Tennesse valley).The federal government declared itself ready to finance whatever public project proposed by a public body if socially convenient, where such result should be backed by an analysis calculating all the benefits and costs of the proposed investment to “whomsoever they could accrue”. By the way, this is , how CBA, whose theoretical grounds have been built in 1842 by the French engineer and economist Jules Dupuit, became an official tool of public decision making in contemporary society. Fifty years after the Green Book, Italy adopted the same policy and the same set of rules for the Investment and Employment Fund (FIO - Fondo Investimenti e Occupazione).
This approach to analysis is clearly inspired by the positive concept of national solidarity, which appears especially strong when the nation faces some dramatic problem, like the depression in the Thirties or the vast destructive impact of a hurricane like Katarina. In a global economic world one can even wish that the national dimension will be put aside in favour of an international one or at least by an enlarged one (for the states belonging to European Community, this one could be the reference society).
But in real world and in normal times, the presence of a multilevel governmental structure creates hard obstacles to a nationwide evaluation. Each decision maker feels indeed that it is his duty to maximize the welfare of the community he is responsible for, might it be featured by living in one specific territory or belonging to one specific sector of activity.
Consider for example the local governments. Empirical analysis has collected sure proofs that the unwritten rules of the political game compels the local policy maker to think exclusively to the welfare of his restricted community: this means in practice to ignore, or even to hide, the costs and to underline the benefits falling outside, in order to improve the probability of getting the approval of the project and the financial help at the national level. It must be recalled that several scholars not only consider unavoidable such a behaviour, they even recommend it because positive also for national welfare. The underlying theory considers the society organized, even on the political arena, on the logic of the countervailing powers. It is therefore good that each policy maker concentrates himself on his own constituency, letting that the competition among institutions leads to a reasonable equilibrium at the national level.
Aside from the ethical aspects of the question, it is clear that the dominance in real world of a local approach in the institutions is troublesome for the analyst. The local principal will often suggests, and even more than suggest, that the analyst should judge favourably the projects that are positive at local level, even if negative at the national one; or to judge negatively the projects with a negative local impact even if they look positive for the national welfare. Aside from these extreme attitudes, there is always the danger of altering the evaluation process, stressing the god or negative local impacts.
Even when these external pressure are not present, the analyst is always in the dilemma about the right reference community for his work. The reply is necessarily subjective. My personal opinion, is that CBA must remain in its national tradition and therefore it must try to show all the relevant effects, independent from the boundaries of the local or professional constituencies.
However, that does not forbid to perform a two level analysis, namely offering a local evaluation and a national one.
Such a double evaluation may prove useful in the political game among institutions: it can offer an objective basis for the compensations that are normally required to solve the conflicts when there are relevant impacts outside the relevant constituency; in addition, it helps to understand the limits of the project and its rank among other possible local projects.
A specific consideration for the case of a local project that can rely on a constrained central subsidy. It is well known from the general theory of public economics that a constrained subsidy gives to the local community a benefit not greater than an unconstrained subsidy of the same level. How to put such a case in the general framework of the CBA? It is possible that a such a constrained subsidy, while giving a net positive result for the beneficiary, leads to the approval of a project that is negative at the national level. In such a case, assumed the subsidy as a constraint, the analyst should at least try to find out the best way to use it, i.e. to shape in the best way the subsidized investment. By the way, it happened too that a correct analysis succeeded to demonstrate to the local policy maker, eager to obtain the constrained subsidy, that the project was negative also from the local point of view when due account was taken of the overall impact of that project within the local community.
Having said all that in general terms, it important to note that large works, especially the hydraulic ones, most often involve diffused interests that call for a central intervention or subsidy and therefore for a nationwide evaluation. But the warning remains valid because the menace of local pressures is always present.

3.3. Potential and effective compensation

We said already that ACB is generally inspired by the compensation principle. The winners from the investment must be able to compensate the losers. But it is a separate question whether to do it or not: to become effective, the compensation must be both technically possible and politically acceptable.
In abstract and obvious terms, compensation will not become effective when it is not possible to identify the beneficiaries of the investment or to compel them to compensate the victims; or when it is not possible to identify or to pay the victims. On the contrary, it is generally possible when costs and benefits are concentrated.
In practice, the effective compensation is not implemented when the subjects involved are very numerous and/or the individual benefits and costs are rather small so that one must fear that they are smaller than the procedural costs of the compensation process. This is often the case in public projects. But the possibility of real compensation is enlarged, even when individuals are many and impacts are low, if they are concentrated from the point of view of the territory or sector or economic category. A reasonable solution could then be based on a collective compensation though payments or services given to local governments, associations, and so on.
When technically possible, must the compensation be implemented? Of course, it is the policy maker who has the duty and the power to reply. The analyst may help the policy maker to decide by informing him on the subjects involved, the entity of individual benefits and losses and the possible ways to implement the compensation.
This opens the question of the best ways to implement the total or partial compensation. The preferred way should be the most socially convenient one, taking into account both the direct cost of compensation and its indirect costs. These last include of course the administrative costs - the cost of bargaining and the cost of defining and manage the chosen actions- but the economic impact of the compensation performed. From this point of view one must recall that, aside from lump sum transfers, the changes in taxes or tariffs necessary to finance the compensations and the compensating subsidies themselves can change the marginal equilibrium in various markets and imply an efficiency cost for the economic system. The rule is that a CBA of the compensation project is necessary, in the form of minimizing the cost for each level of compensation pursued.
A final question concerns the possibility that the total cost of the compensation, taking into account both its direct and indirect components, is higher than the damage suffered by the victims of the project; and nevertheless the policy maker decide to go on with the compensation. Is there something wrong in this decision? Not necessarily. If compensation is considered necessary to have the project implemented, it is rational to do it insofar as the project promises a net social gain, although reduced by the compensation cost.
Such a statement has an interesting consequence. Precisely, it justifies a change in the original project (for instance, a barrier against noise) which has a cost higher than the damage avoided but inferior to the foreseen cost of the compensation ex post, with the obvious constraint of letting a net social gain (of course , here one speaks of remedies more costly than the damages avoided, because in the contrary case - a remedy less costly then the damage - it should be introduced in the original project as a contribution to social welfare).
But is it wise to assume an “unavoidable” compensation , thus justifying - through an ex ante change in the project or an ex post payment to damaged people - a cost higher than the damage itself? The reply should obviously be negative within the hypothesis of a decision maker with unrestricted power, like the benevolent dictator assumed a reference actor in many economic analyses. But the reply becomes positive in the real framework of a very reactive society in which many projects of sure general utility are blocked by the noisy and sometime violent opposition of local communities or small pressure groups that are afraid of the danger they could suffer. The slogan of NIMBY has become very popular in many countries to explain such situations. From this point of view it seems appropriate to consider here also the participation, that is public debate as an official step of the decision process, notwithstanding it does not have anything to do with the procedures of economic analysis in a strict sense. It can indeed be an useful instrument for a better evaluation of the impact from the project, for the improvement of its design, for a more reliable forecast of the residual damages and for an optimal plan of compensating actions. No need to say, as every instrument, also a public participation process may be used in a perverse way and it can confer to restricted social groups a veto right on public works of high general interest. It is therefore necessary to make a wise use of the instrument, in order to create a surplus between the social benefits and costs of the participation. One cannot say more on this topic, while it is the policy maker that has the right and duty to decide. Let’s conclude with the wish that he takes the right decision.


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* Dpt. of Economic Sciences, Via del Santo 33, I 35123 Padova (Italy). E mail: Questo indirizzo email è protetto dagli spambots. È necessario abilitare JavaScript per vederlo..
The present paper has made extensive use of concepts elaborated in the paper Dosi-Muraro-Pancheri (2005), where a more technical analysis and many quotations can be found. The author remains of course the only responsible for what is said here. The paper has been presented at 32nd Congress of IAHR - Venice 2nd July 2007.
(1) in the vast literature on CBA, see Layard e Glaister (1994), Commissione Europea (2003), Pennini e Scandizzo (2003).
(2) On this hypothesis has been built by Hochman e Rodgers (1969) the theory of “Pareto optimal redistribution”.
(3) It is not relevant here to recall the theoretical debate, started by Scitovky (1942) about the possible inconsistencies of the criterion, since they all refer to rather extreme cases.
(4) Quotation pag. 17 of the Italian edition (1971).

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