List of Abbreviations
5 Air traffic management
5.3 ATM as a source of hard currency
5.3.3 ATM project appraised with the world price numeraire
The illustration proceeds with the example of sections 5.1 and 5.2, taking as a starting point the situation depicted in Table 5.2. The project promoting ANSP ignores time savings to passengers and cost savings to airlines. This would reflect an extreme example of a project that has implications only for en route traffic within its airspace and where the country hosting the project appraises projects focusing only on benefits and costs to nationals. Since none of the en route traffic is national, the benefits and costs to this traffic segment does not count in the economic appraisal. In economic appraisal terms en route passengers would be referred to as having ‘no standing’ in the economic appraisal.
The exercise makes now the additional modification relative to Table 5.2 that the host country is subject to substantial trade distortions. These include
export subsidies, import tariffs, and other non-tariff barriers (NTB), such as quotas, licensing, lengthy administrative procedures, etc. Regarding the out-puts and inout-puts of the project at hand, we assume that revenues are not subject to any taxes or tariffs, but that some of the inputs to the project, including mostly imported ATC equipment and software, are subject to an import tariff of 25 per cent. Still, the fact that the domestic economy is subject to substantial trade distortions means that the project may have wider, indirect foreign exchange implications via the effects of the project on secondary markets. That is, the project may have implications for the generation and use of foreign exchange in the host economy that may not be reflected in the financial flows of the project converted at the official exchange rate (OER).
We assume no capital controls with a fully convertible currency and therefore the OER would also correspond to the market or prevailing ex-change rate. The local currency is referred to as LCU (local currency unit) and has a market exchange rate of EUR–LCU = 2, so that 1 euro buys 2 LCUs.
The analyst proceeds to estimate a standard conversion factor as specified in section 5.3.2. The host country exports X = EUR10bn and imports M = EUR5bn every year. On average, the country applies a tariff of 50 per cent to all imports – implying import tariff revenues Tm = EUR5bn and subsidises exports by 50 per cent, implying a subsidy bill of Sx = EUR2.5bn. It applies no subsidies to imports nor taxes exports, therefore Sm and Tx, respectively, are both 0. The SCF is therefore:
SCF M X
M T S X T S
= +
( + ) + ( + )
= 10 + 5
(10 + 5 0) + (5 0 + 2.5) = 0.6667
m m x x
The analyst knows that the local economy also uses many NTBs, but is unsure of the extent to which the wedge that on aggregate they create between domestic and border prices. The analyst therefore follows the ra-tionale set out in the Appendix A5.1 and performs a second check to see how the real effective exchange rate compares to what would be expected given the per capita GDP of the host economy. A shortcut to this is offered by the Big Mac index published by The Economist newspaper (see the Appendix A5.1).
The price of a Big Mac burger in the closest McDonald’s restaurant to the offices of the analyst is LCU10, or EUR5 at the OER. Yet, following The Economist newspaper, the income level (GDP per capita) of the country would suggest that the price of the Big Mac at the local restaurant should be EUR3.5, or LCU7 at the OER.
According to the logic explained in the appendix, the ratio of expected to actual Big Mac prices suggests a SCF of 7/10 = 0.7. This SCF = 0.7 value is very close to the SCF = 0.6667 estimate using tariffs and subsidies alone.
Moreover, the analyst knows that the SCF = 0.7 ratio has been quite stable over the last three or four years, suggesting that the real exchange rate is unlikely to be in the process of adjustment to any macro-economic shock. The analyst concludes that NTBs in aggregate do not contribute in net terms to differences in price levels between the domestic and border prices. Hence NTBs do not seem to account for any significant additional net rent or transfer relative to those accounted for by tariffs and trade subsidies. The analyst therefore decides to continue the calculations of project value with the SCF = 0.6667 as calculated with tariffs and subsidies only.
Table 5.3 displays the result of the appraisal. Columns a and b include the calculation process using the world price numeraire, expressed either in for-eign exchange EUR (column a) or in local currency LCU (column b).
Columns c and d display the calculation process using the domestic price numeraire, discussed in the next section.
As in Table 5.2, the calculation proceeds with two alternative assumptions.
First, that diverted traffic stays with the promoter ANSP, displayed in rows 1 to 15 in Table 5.3. Second, that diverted traffic would fly through an alter-native ANSP, requiring further adjustments, displayed in rows 16 to 19.
Following the world price numeraire involves pricing all tradable inputs and outputs at border prices, while applying standard conversion factor (SCF) to all non-tradable inputs and outputs. As mentioned in section 5.3.2, the application of the SCF is a shortcut.
The project output is measured by comparing incremental revenues with and without the project, included in rows 1 and 3, respectively, in Table 5.3.
These correspond to rows 3 and 6 in Table 5.2, respectively. The output of the project, air traffic management, is a tradable service. Indeed the current example assumes that all traffic flows benefiting from the project are en route flows, meaning that 100 per cent are exports. It is worth underlining though that the important element here is that the output is tradable rather than an actual export. If the en route flows consisted instead of domestic airlines, so that revenues were not an export, the treatment would be exactly the same as for foreign airlines. Also, no taxes or subsidies are applied to the output of the project; therefore the revenues require no further adjustment, whether expressed in EUR (column a) or in LCU (column b).
The increase in operating costs resulting from the project are included in row 5, corresponding to row 8 in Table 5.2. These operating costs consist mostly of labour and property-related costs, which are deemed non-tradable. The operating costs would then be applied the standard conversion factor SCF = 0.67, resulting in an economic cost of EUR2.6m (row 6).
For the capital investment cost, half of the items are tradable (row 8), namely the equipment and software, and the other half are non tradable (row 11), including civil works, installation, etc. For the share that is tradable, there is an import tariff of 25 per cent, half the rate of the average applied by the country across all imports. By removing the 25 per cent tariff we are left with
Table 5.3 Appraisal results of ATM project hosted by a country with barriers to trade
Price numeriare
World Domestic
(EURm) (LCUm) (EURm) (LCUm)
(a) (b = a
× OER)
(c) (d = c
× OER) DIVERTED TRAFFIC STAYS WITH THE SAME ANSP
(1) With project, incremental
revenues
95.2 190.4 95.2 190.4
(2) = (1) × SER With project, incremental
revenues, at SER
142.8 285.6
(3) Without project, incremental
revenues
95.8 191.5 95.8 191.5
(4) = (3) × SER Without project, incremental
revenues, at SER
143.6 287.3
Adjustments to project costs
(5) Increase in operating cost 3.8 7.7 3.8 7.7
(6) = (5) x SCF Increase in operating cost,
adjusted with SCF
2.6 5.1
(7) Investment cost 13.9 27.9 13.9 27.9
(8) = (7)/2 Tradable 7.0 13.9 7.0 13.9
(9) = (8)/(1 + 0.25) Tradable, at CIF prices 5.6 11.2 5.6 11.2
(10) = (9) × SER Tradable, at CIF prices,
at SER
8.4 16.7
(11) = (7)/2 Non-tradable 7.0 13.9 7.0 13.9
(12) = (11) × SCF Non-tradable, with SCF 4.6 9.3
(13a) = (9a) + (12a) Investment cost at economic
prices
10.2 20.5 15.3 30.7
(13c) = (10c) + (11c)
Net project flows
(14) = (1) – (3) – (5) – (7) Unadjusted financial flows -18.3 -36.7 -18.3 -36.7
(15a) = (1a) – (3a) – (6a) – (13a)
(Financial) flows at economic prices
-13.3 -26.7 -20.0 -40.0
(15c) = (2c) – (4c) – (5c) – (13c)
DIVERTED TRAFFIC FLIES THROUGH AN ALTERNATIVE ANSP
(16) Rev gain from traffic not
diverted
30.1 60.3 30.1 60.3
(17) = (16) × SER Rev gain from traffic not
diverted, at SER
45.2 90.4
(18) = (16) – (5) – (7) Unadjusted financial flows 12.4 24.7 12.4 24.7
(19a) = (16a) – (6a) – (13a) (Financial) flows at economic prices
17.4 34.7 26.0 52.1
(19c) = (17c) – (5c) – (13c)
the price of the equipment and software at border, CIF prices, amounting to an investment of EUR5.6 million (row 9). The non-tradable half of the in-vestment cost is adjusted by the SCF, just as was the case for operating costs in row 6, resulting in an investment in non-tradables at economic prices of EUR4.6m (row 12). To come up with the full investment cost at economic prices we add the tradable elements at border CIF prices and the non-tradable items adjusted by the SCF, resulting in a total capital investment cost at economic prices of EUR10.2m (cell 13a).
Note the difference with the investment cost at financial prices of EUR13.9m (cell 7a). This means that what may appear as an investment cost of EUR13.9m, actually involves a cost to the domestic economy of EUR10.2m after accounting for import tariffs to tradable inputs and, critically, to non-tradable inputs. Such non-tradable inputs either use themselves tradables in their construction or manufacturing or have an opportunity cost in terms of alternative uses as inputs for tradables.
To estimate the economic value of the project we follow the same procedure as for the financial value but operating with the adjusted (or
‘shadow’) prices, where applicable. So the value of the project in eco-nomic prices would be the difference in incremental revenues (row 1 minus row 3), minus both adjusted (or, in CBA terms, shadow-priced) operating (row 6) and investment costs (cell 13a, or cell 13b if the cal-culation proceeds in LCU).
Note the difference in the economic value of the project of –EUR13.3m (cell 15a) at economic prices, compared to the –EUR18.3m (cell 14a) at fi-nancial prices. The figures expressed in local currency are –LCU26.7 (cell 15b) and –LCU36.7 (cell14b), respectively.
The analysis reveals that the financial value loss of EUR18.3m from the project, masks a smaller loss to the economy of EUR13.3m. The reason for this difference is twofold. Firstly, some of the tradable inputs include a tariff, hence the adjustment of removing the tariff from row 8 to row 9.
This is equivalent to a standard adjustment in economic appraisals of removing taxes from input costs. If we were to calculate the gains and losses to the economy from the project by simply looking at the financial business plan of the project, this adjustment would be a fairly obvious one to make. What would be less apparent is the second reason for the dif-ference in the size of the loss, namely, an adjustment also needs to be made to estimate the foreign exchange opportunity cost of non-tradable inputs, for both for operating costs (row 5, adjusted in row 6) and in-vestment cost (row 11, adjusted in row 12). Those inputs, while non- tradable, come at the expense of tradables.
Let us dwell somewhat more on the intuition behind the result. An intuitive take on the adjustment to non-tradable inputs could be made in two ways, taking operating costs as an example. Firstly, we know that the SCF measures the extent of the average distortion to foreign trade in the economy. We could assume that the non-tradable inputs of the project
are themselves made of components that are representative of the average use of foreign exchange in the economy. Then the actual amount of tariffs we expect to be embedded in the price of the non-tradable input is measured by the SCF. In the perhaps less readily intuitive case of the salaries of air traffic controllers, such items could include, for example, training abroad that is taxed domestically (to, say, protect domestic trai-ners), or a policy of including in the compensation package an imported company car, subject to a tariff.
Secondly, in a freely trading, undistorted market economy, inputs of non- tradables worth EUR3.8m should be exchangeable in the domestic market for EUR3.8m of tradable inputs. If we were then to exchange the tradable inputs at the border, they would generate, at the prevailing exchange rate, EUR2.6m of foreign exchange. Therefore consuming EUR3.8m of non-tradable inputs comes at the expense of generating EUR2.6m of foreign exchange. But when there are trade distortions, as in the current example, consisting in this case of tariffs in the price of inputs, whether directly because they are tradable, or indirectly when they are not tradable, the actual consumption of foreign ex-change is not as high as suggested by market prices. The EUR13.3m loss measures the value of the project if all inputs and outputs were free of dis-tortions, at world (border) prices. This can be expressed in either foreign exchange (column a) or in local currency (column b), by simply converting at the market exchange rate.
Assuming alternatively that there is a competing ANSP, in rows 16 to 19, the project becomes profitable, as was seen in Table 5.2. When al-lowing for trade barriers, the value of the project to the national economy is higher than apparent from financial flows. A positive value of EUR12.4m (cell 18a in Table 5.3 and row 12 in Table 5.2) becomes a value of EUR17.4m (cell 19a).