George B. Baldwin
ALTHOUGH a diminishing number, there are people who believe that project evaluation is not a teachable subject. These people regard every project as unique—there are simply no generalizations to be taught. They also feel that all evaluations are critically dependent on judgment and experience, which cannot be found in classrooms and books. Since “nothing times nothing is nothing” these sceptics view courses in project evaluation as a waste of time. “Better to send the chaps out on the job….”
This view exaggerates a half-truth into the whole truth. If the same attitude had triumphed in medicine most of us would be dead. At the World Bank we see no conflict at all between a proper respect, on the one hand, for the individuality of separate projects and the need for good judgment and, on the other, the need to record and organize project experience and to give people tools and attitudes that will improve their judgments. It was in this spirit that the Economic Development Institute (EDI)—on April 1, 1963—began its first course in project evaluation. During the previous seven years of our existence the curriculum had been limited to general courses in economic development—the classical problems, the broad strategies for attacking them, and the major policy choices. Today, two thirds of the 150 foreign government officials who study at the EDI each year come for one of the five project evaluation courses which EDI now offers. Even the ten-year-old General Development Course has a section devoted to project appraisal. Although EDI was among the first to devise training programs for project analysis, many other institutions have since developed their own courses. Some of these have received help from EDI; many more have asked than we have been able to help. The aim here is to tell others what we do and how we do it.
Who Is an “Analyst”?
The Bank’s Charter puts the financing of “productive projects” at the center of its existence. When the World Bank evaluates a development project the finished analysis is the joint product of engineers, financial analysts, economists, lawyers, and area specialists. A finished appraisal report cannot be called the product of any one of these disciplines; it is a joint product requiring contributions from people with many different backgrounds and skills. In one sense all these people are “project analysts.” But in EDI we do not say that we “train project analysts”; there is no such profession. Instead, we prefer to say that we “teach project analysis.”
Obviously the EDI is not interested in educating people to become engineers, accountants, economists, lawyers, or the like. Such a job can be done only in universities or under long-term apprenticeship arrangements. However, we are interested in taking men who already have their basic professional training and giving them some new spectacles that will help them see investment proposals in a new way.
The main objective is to give them a general understanding of all the main elements involved in preparing, evaluating, and executing development projects. At the end of the course we expect graduates to be able to help design project studies or to participate in the over-all evaluations on which final decisions are heavily based. We are not necessarily training “decisionmakers”—that depends on a man’s position in the hierarchy. We are training men who can “ask the right questions” and smell wrong answers, and who can provide leadership in arriving at sensible judgments no matter where they may sit in the hierarchy. Since projects are the instrument through which the general process of capital formation and resource allocation takes place, the “envelope” problems of project appraisal are financial and economic. So the concepts and techniques of financial and economic analysis occupy the center of the stage. But we try not to let these actors run away with the show.
We are sometimes asked whether or not we are training technicians. We are not. A technician is an expert in a fairly narrow field who does not need to apply much judgment. But project analysis is a wide field, drawing on many disciplines, and it requires a great deal of judgment in addition to technical expertise. Consequently, although we introduce participants to many technical subjects (such as the rate of return, discounted cash flows, benefit/cost analysis, and the critical path method) we do not attempt to make them specialists in these topics. With the start we give him a man could move on to become a specialist if he wanted to; but our purpose stops far short of this. In exposing professional men to some of the techniques of project analysis they may not be familiar with, we want to make them broader, not more specialized. When participants have finished one of our project evaluation courses, they should be able, for example, to size up all the key elements in a project proposal so as to arrive at, explain, and defend a specific yes-or-no decision to whomever will make the final decision. Thus the role of the men we train contrasts with that of many of the professional people who will have been involved in preparing particular parts of an appraisal—for example, the financial analyst, who may be willing to say that a project is financially sound but has no idea whether or not it will be good for the economy, or the engineer, who may give his professional approval to the engineering aspects of the project but may very properly refuse to commit himself on its financial or economic aspects.
In selecting participants for its project courses the EDI does not look for people in any particular discipline. It is probably more important that the candidate should have reached a certain level of maturity and experience, and possess certain qualities of mind (e.g., a healthy scepticism, a feeling for numbers, enough imagination to conceive of alternative ways of doing things) than that he come out of one discipline rather than another.
From what has been said it follows that it is difficult to teach project analysis to very young men, fresh from university, or to people whose interests and backgrounds are primarily theoretical. Such people do not have the exposure to the wide range of actual projects necessary to the development of a sound judgment in this field. Another aspect of the participant’s maturity that is important is political maturity—i.e., he must have had sufficient exposure to the realities of politics, administration, and business practices to understand the system of interests and pressures within which many projects are conceived, gestate, and are born. The first law of project analysis is that any project, anywhere in the world, can be made to look attractive by the use of suitable figures and good printing; that is why a healthy dose of scepticism is one of the chief assets of a good analyst. For these reasons the EDI ordinarily does not accept candidates under 30 years of age. But maturity alone is not enough to identify good candidates who can be recommended to the Bank-wide Admissions Committee that makes the final selections. EDI training—paid for entirely by the Bank—is expensive. The Bank bears this expense to assist general economic development in its member countries and its own operations in those countries. Consequently, EDI goes through a rather careful selection process looking for qualified individuals from important agencies.
Curriculum and Teaching Methods
Having decided to begin with what kind of “product” we want and what kind of “raw material” we need to start with, we come to the heart of the training program: the curriculum and the methods of teaching. The curriculum will obviously depend partly on whether one aims at producing a broad or a specialized analyst—i.e., a man competent to handle projects in many sectors or in only one or two. In EDI we began “broad” by offering a single project course that included material from many sectors. We have become increasingly specialized until we now offer three different courses every year—a course on infrastructure and social overhead, an industry course, and an agriculture course. Approximately the first third of each course is substantially the same, reflecting the fact that there is a certain amount of “core” material which we believe belongs in any project evaluation course regardless of sector. (See box.) Our use of core material for all project courses also implies that we do not rely exclusively on the case method of instruction. While we make generous use of case material 1 we also spend considerable time on general material which we feel cannot be imparted through cases. For example, for an analyst to deal with the financial and economic dimensions of a project he must have a reasonably good grounding in the fundamentals of accounting and in understanding the two main financial statements. For dealing with self-financing, revenue-producing projects in either the public or private sectors he must understand something of the principles underlying capital structure and the essentials of sound financial management. Our main emphasis as far as the income statement is concerned is to develop an understanding of the cash-flow concept and the main elements comprising it; this is essential for most calculations of the rate of return, and for arriving at judgments about a project’s ability to finance future expansion. The rate of return is, of course, one of the more important core subjects in every course. We stress the importance of working with time-valued money, go through the half dozen or so leading measures of the rate of return, show how rate-of-return analysis relates to other types of “cost-benefit” analysis, and how different measures of the “return” can give different rankings to projects. We give special attention to the technique of calculating and interpreting the internal rate of return—partly because the Bank uses this as the primary test of a project’s profitability.
One of the problems in teaching project analysis is that people who are not previously familiar with some of the standard techniques of rate-of-return analysis tend to become so fascinated by these techniques and so proud of their own ability to use them that they tend to give them more importance than they deserve. Tie experienced project analyst, already familiar with, various techniques normally employed, knows fiat the most important determinants of a project’s estimated profitability are the assumptions made and the values put into the calculations. When one appreciates this fact one realizes that the most useful analyzers of projects are not those who can dazzle their superiors with elegant techniques but those who can raise sensible questions about the validity and completeness of the data underlying the key calculations.
Core Topics: These Belong in All Courses Regardless of the Sector of the Economy
1. Definition and generalized model of a project. Internal and external inputs, conversion efficiencies, outputs. Value added, its distribution among suppliers of internal inputs, and its relation to national income.
2. Opportunity cost, with emphasis on the “cost” (waste) of unsuccessful projects.
3. Project identification and preparation; importance of technical and feasibility studies done with clear terms of reference; relation of project analysis to sectoral programing and macroeconomic planning.
4. Estimating present and future size of the market (i.e., need for the project).
5. Cost estimating (both capital and operating costs).
6. Project Scheduling and the control of construction (with an introduction to the Critical Path Method).
7. Accounting as the process of “keeping score” on how, and how well, resources are used; how to read financial statements and a balance sheet; measurement of “cash flow” in both financial and economic terms.
8. Financial viability; capital structure; ability to meet recurring costs.
9. Organization and management of project entities to achieve reasonable efficiencies.
10. The difference between financial and economic accounting (i.e., private and social); use of market prices and “shadow” prices.
11. Time-valuation of money; relation between compound interest and the discount rate; use of financial tables.
12. The meaning of Benefits and Costs, and problems involved in their measurement and comparison (specific B/C comparisons, or investment criteria, differ somewhat among different courses). The choice of values for project calculations and the sensitivity of over-all results to changes in particular values.
13. A project’s effects on the balance of payments.
One of the most difficult concepts to teach effectively is the difference between private, or purely financial, accounting and economic or social accounting. Private accounting (or what might better be called “enterprise” accounting since it can apply to public enterprises as well as those in the private sector) is concerned with the recording of values experienced by the enterprise or project itself, using in the accounts the normal values of the marketplace. However, there is no necessary 1:1 relationship between the profitability of a project to itself and to the economy of which it is a part. Some projects (such as many schools, highways, public health, and irrigation projects) may be of much greater benefit to society than to the particular ministries which are responsible for them. Other projects may impose costs on society which do not show up in the accounts of the enterprise itself. Thus the economic analysis of a project involves the identification and measurement of benefits and costs to the economy as a whole and a recognition that these may not be the same as those recorded in the accounts of the enterprise undertaking the project.
A second source of discrepancy between private and social accounting is the treatment of transfer payments, such as taxes and subsidies. These values are taken at their face value in private accounting, since they obviously affect the profitability of the enterprise to its owners. However, the economic return is made with these values eliminated since they do not represent transactions in payment for goods or services, i.e., they are not used by the enterprise to exert a claim on the use of resources. They represent values created outside the project, somewhere else in the economy.
Still a third source of divergence between private and social accounts arises from the fact that the prices used by an enterprise in keeping its accounts may not represent true values so far as the economy is concerned. Thus we try to give an understanding of the concept of “shadow prices,” when it may be appropriate to use them, and how to make practical use of them. In general, however, we do not make a great deal of shadow prices since we do not feel that project analysts individually should use shadow prices in project calculations unless directed to do so by a central authority more experienced in handling this concept than project analysts need to be.
We have been noting sources of divergence between private and social accounting. It is perhaps even more important to emphasize the essential linkage between them, a linkage provided by the concept of value added. We do not spend more than one or two days reviewing the essential concepts and ways of measuring national income; but we do emphasize that the nation’s income today is nothing but the current performance of all past projects which are still in existence and that today’s investment projects will have much to do with the size of the national income in the future. The amount of value added generated by a project is the same thing as the amount of “national income” generated directly within the project. The concept of value added, combined with the capital invested in a project, allows one to understand the capital/output ratio—a concept we explain in only enough detail to make clear why we think it not very relevant for most project appraisals. A public project’s ICOR (Incremental Capital-Output Ratio) is often less relevant than its ICBR (Incremental Capital-Budget Ratio).
Another set of subjects on which we spend several sessions concerns the establishment of valid cost estimates for the project and a discussion of various techniques for scheduling and controlling project execution, and of different contracting arrangements, to assure that the cost and time values assumed in the project analysis will in fact be realized. Many a good project has been crippled by sloppy control over execution which has resulted from failure to pay proper attention to project scheduling and control.
Needless to say, one of the core subject areas that is most important yet most difficult to handle adequately is the organization and management of project entities. The question of organization is somewhat easier to treat than management. As is well known, the World Bank has a strong preference for organizing revenue-producing projects—even government projects—as autonomous commercial enterprises with their own self-contained accounts and an autonomous management insulated so far as possible from politics and from the rules and regulations which often hamper departmentally run projects. The Bank also believes that the political problems of an appropriate rate structure are more manageable for governments if revenue-producing projects are run within the depoliticized framework of a semiautonomous, self-financing activity.
The daily routine of our courses at the Economic Development Institute involves lectures and discussions five mornings a week, with special sessions about two afternoons a week to cover requested topics or to review work problems. The latter are very valuable (they are the nearest we come to any formal written work—we have no tests, examinations, papers, or individual assessments). The daily reading load comes to roughly 20-25 double-spaced, mimeographed pages, usually a 3-5 page outline prepared by the speaker of the day plus about 20 pages of readings, such as a case study or article. The selection of suitable readings, and the preparation of concise, clear outlines is a time-consuming but vital responsibility of the staff. In every course we conduct one or two “syndicates”; these consist of exercises in which teams are assigned specific roles for analyzing and reporting on a case, usually actual but sometimes hypothetical. A syndicate extends over 3-4 days, culminating in an oral “confrontation” supported by written papers of 3-6 pages. The routine of every course is also broken by field trips, usually two, of approximately a week each.
If I were asked to summarize the beliefs on which teaching at the EDI is based, I would offer seven generalizations about projects and project appraisal that ought to be reflected in any course designed to teach project analysis:
1. Projects can be judged in isolation and often are, but they should not be. This negative truth applies in two senses. The first is the need to fit (large) projects into some kind of general development strategy for the sector of which they are a part. In this sense, sector planning and, at least a rough-and-ready “systems analysis” (bringing alternative sets of related projects into sharper focus) both precede project analysis. Second, any good project analysis involves comparisons, which requires looking beyond the boundaries of the project under study. It always pays to see if there is anything better that might be done with the money—or whether anything better might be turned up if people put their minds to it. Every bad project is a monument to a missed opportunity.
2. An understanding of accounting is central to project analysis. This must begin with an understanding of conventional enterprise accounting; but it must not end there. Analysts must realize that accounting is simply a way of keeping score in the game of consuming and producing economic values. The rules by which the score is kept (e.g., the treatment of depreciation, market vs. shadow prices, the treatment of taxes, the valuation of assets) will affect the outcome of the game, changing a project’s profitability or ranking. An analyst who is too respectful of the conventions used by professional accountants will not be flexible enough in his thinking to examine a project effectively (accountants must respect conventions in order to perform their function). An experienced analyst will understand the assumptions underlying accounting and will be able to rearrange conventional accounts to show things he wants to know, but accountants may not.
3. The attractiveness of projects usually varies with the vantage point from which they are being viewed. The three main vantage points are those of (1) the owners, (2) lenders of capital, and (3) government planners. These last have the widest viewpoint in the sense that they must set the policies and regulations that determine which projects will be accepted, which rejected. It is therefore important that people involved in project analysis understand how to manipulate project accounts (largely by including or excluding certain market values, but sometimes by changing the values themselves) in order to move from the vantage point of individual entrepreneurs or bankers to the vantage point of someone responsible for the over-all deployment of investment to the country’s best advantage. Projects may. also need testing in the other direction, i.e., to make sure that projects which look attractive from a national point of view contain sufficient private incentives so that the required behavior will actually occur.
4. The measurement of financial and economic surpluses is the heart of any project analysis. It is the key to most kinds of cost-benefit and rate-of-return analysis. By “surplus” we mean that portion of the total value produced by a project which is left over after paying for all current inputs. This residual, the cash-flow generated by a project, is not the same thing as “profits” nor does it necessarily represent “savings.” However, the cashflow of a project does represent potential savings. It is a measure of a project’s ability to generate funds for additional investment in the economy if those receiving the cash-flow choose to use it for investment purposes.
5. The timing of financial and economic values is a matter of great importance. It is often difficult for people to understand that the same economic or financial values, occurring at different times, do not have anything like the same weight in our decisions. For example, who cares very much if a project will pay off handsomely 100 years from now? Everyone understands compound interest; indeed, we insist on it. Yet many people who take it for granted that present values should grow larger as time passes have great difficulty seeing that future values should grow smaller when looked at in the present. Mathematically, compound interest and discounting are reciprocals. So part of the teaching of project analysis is to get rid of the double standard in economic arithmetic whereby we use compound interest when we run the film forward but ignore discounting when we run it in reverse to draw the future back to its present worth. Hence the need to emphasize the logic and mechanics of discounting.
6. The acceptability of projects cannot be ranked exclusively by estimates of their rate of return on capital, however defined, or by any single benefit-cost calculation. The well-trained analyst must understand that different kinds of benefit-cost calculations can reveal different aspects of a project and that no one of them necessarily deserves to be elevated into a controlling measure. This does not mean that all investment ratios are equally valid and useful—far from it. But it is important for analysts to learn that the search for a single, general-purpose investment test is a false one. They must learn to live with multiple criteria and with considerations of risk and uncertainty (which are just beginning to find systematic expression in a few project calculations).
7. Finally, one of the most important attributes of people engaged in project analysis is a proper attitude toward numbers. The proper attitude can best be stated as a paradox: project analysts must understand both the importance and the unimportance of numbers. No one is entitled to believe the latter unless he believes the first. Numbers are important because without them nobody can construct project accounts or estimates, and without accounts and estimates it is impossible to say “this looks like a good project but that one looks bad.” However, the calculations on which such judgments rest depend on the quality of the data underlying them. Unfortunately, in the teaching of project analysis far more time has to be spent on what calculations to make and how to make them than on testing the quality of the data used. The experienced analyst knows how arbitrary and fragile are many of the values that get fed into the calculations. He knows he should not believe them too unqualifiedly, that he should lean on numbers hard partly to see if they will break. He knows he must play with alterations in the important numbers to see what projects look like under pessimistic as well as optimistic assumptions—i.e., he must develop a “feel” for sensitivity analysis. So the effective analyst will live with the tension created by his obligation to produce the best numbers he can and his knowledge of their frequently poor quality, no matter how conscientious the project preparation. He knows, too, that when all is said and done, project decisions will sometimes be made, quite properly, on the basis of nonmeasurable factors that numbers cannot reach.
Development Finance Companies: Aspects of Policy and Operation
edited by William Diamond
Private development finance companies perform financial, technical, and entrepreneurial services that are crucial to economic development. Combining profit-making with a development orientation, these companies provide medium and long-term risk capital to local private enterprises and mobilize domestic and foreign savings for investment purposes. By mid-1968, the World Bank and its affiliates, the International Finance Corporation (IFC) and the International Development Association (IDA), had provided finance amounting to $687 million to 27 development finance companies in the low income countries.
Edited by William Diamond, Director of the Development Finance Companies Department, this collection of essays deals with certain aspects of the operations of development finance companies: their role in promoting enterprise; their financial policies; their promotion of broader ownership of private securities; their relationship to government; their relations with the managements of the enterprises they promote, sponsor, or finance. These subjects were discussed at a conference of development finance companies sponsored by the World Bank Group in October 1965, which was attended by top-ranking executives of 18 such institutions.
Contributors to the volume are full or part-time members of the Bank Group staff, all experienced in the work of development finance companies. E. T. Kuiper has been chief executive officer of several development finance companies and represents IFC on the boards of directors of such companies in Greece, Morocco, and Tunisia. P.M. Mathew is Deputy Director of the Development Finance Companies Department. Douglas Gustafson is a member of the same Department.
The 128-page paperback book costs $3.00 and may be ordered from: The Johns Hopkins Press, Baltimore, Maryland 21218, U.S.A.
An analytical casebook of World Bank-financed projects was published by the Johns Hopkins Press in 1967. Its title is Economic Development Projects and Their Appraisal: Cases and Principles from the Experience of the World Bank, by John A. King, Jr. (530 pp., $15.00).