Chapter 11: Distributional Weighting in CBA

Question 1

What do we need to acknowledge and account for when accounting for income distribution?

Answer 1

Government’s income distribution objectives

Project’s distributional impacts

Question 2

Atemoral Distribution

Answer 2

How income (and income changes) is distributed among individuals or groups at present (within present generation)

Question 3

Intertemporal Distribution

Answer 3

How income (and income changes) is distributed over time (between present and future generations) among individuals or households

Question 4

How do we measure inequality?

Answer 4

The Lorenz Curve:
- Cumulative % income vs. Cumulative % of population
- If income was equally distributed, the Lorenz curve would lie on the diagonal
- The flatter the L-curve, the less the degree of inequality
The Gini Coefficient
- The shaded area between equality and the Lorenz Curve
- The smaller the Gini Coefficient, the less the degree of inequality

Question 5

Changing income distribution: How can the government affect distribution?

Answer 5

The government can affect distribution between sectors and regions through the sectoral and regional spread of public investment projects

Question 6

Changing income distribution: How can the type of investment affect distribution?

Answer 6

The type of investment undertaken can influence the distrubiton of income among various categories of income-earners

• An investment that uses more labour than capital creates more employment and possibly a larger share of income for the wage-earner vs. profit-earner
• Different types of investment will have different implications for employment (and income) of different kinds of labour

Question 7

What will the final choice of investment depend on?

Answer 7

The final choice will depend on the relative importance attached to the economic efficiency objective vs. the income distribution objective

Question 8

Distributional weighting: What would happen if the government didn’t attach distributional weights? What would this imply?

Answer 8

If the government didn’t attach distributional weights to the net benefits for different groups, projects would be selected purely on the basis of their aggregate referent group net benefits
This would imply:
- Government does not regard project selection as an important means of distributing income; or
- Government does not care about income distribution

Question 9

Deriving Distributional Weights: Algebriac Expression

Answer 9

The appropriate income distribution weight can be expressed as follows:

di = (Ybar/Yi)^n

di = distributional weight for income group i
Ybar = average level of income for economy
Yi = average level of income for group i
n = elasticity of marginal utility with respect to income - represented as a ratio of the % fall in marginal utility on the % rise in income

Question 10

Distributional weights used are determined by two factors:

Answer 10

1. The relative income/consumption level of the project beneficiaries;
2. The value-judgement that is made about the utility or satisfaction that is gained by project beneficiaries of different income levels (n)

Question 11

To apply distributional weights, we would need to know the following about the project…

Answer 11

1. Identification of the project’s gainers and losers
2. Classification of the project’s gainers and losers - i.e. to which income category they belong
3. Quantification of gains and losses - i..e by how much do the net incomes of the gainers and losers increase or decrease?
   - Relevant project-level information about 1 and 3 already exist, for this is, in effect, what is contained in the referent group analysis

Question 12

How does identifying distributional weights help?

Answer 12

Through CBA we can make ourselves and the relevant policy-makers more ware of the consequences of decisions concerning project selection by identifying the possible distributional implications

Question 13

Intertemporal Distribution: the decision we make today regarding how much is spent vs saved…

Answer 13

Is a decision about how consumption should be distributed among those living today and those living in the future - the more that we consume today, the less than is left for future generations

Question 14

If the social time preference rate < market rate

Answer 14

The present value of the additional benefit that could be generated by an extra dollar of savings is > the additional benefit that could be generated by an extra dollar of consumption

Question 15

Shadow-Pricing for Inter-temporal Distribution

Answer 15

The social discount rate makes no allowance for the different effects of projects on savings and reinvestment of project net benefits
It then becomes important to establish what part of referent group net benefits are saved and what is consumed, with a view to attaching a premium on that part saved
Once we introduce a premium (shadow price) on savings, we need to make an additional adjustment to the original estimates of referent group net benefits

Question 16

If distribution objectives are to be accommodated by a system of atemporal and inter-temporal weights…

Answer 16

It will be necessary to disaggregate net benefit for each referent group gainer or loser into its consumption and savings components, and then weight:

• the consumption component by the atemporal distribution weight; and
• the savings component by the inter-temporal distribution weight (or savings premium)