III.1 Economic, financial and distributional analysis
Scoping Paper - Terms of Reference

1.0 BACKGROUND

1.1 Changing Context

1. Traditional methods for assessing dams focussed primarily on the calculation of financial rates of return and economic cost-benefit ratios using a limited set of quantifiable parameters. As concerns over the distributional and non-economic impacts of dams have become more prominent, the limitations of these approaches and tools have become increasingly apparent.

2. It is now generally accepted that financial and economic analysis of options for sustainable water resources and energy development and management requires the internalisation of externalities as well as the inclusion (and quantification to the extent possible) of non-market factors such as archeological remains or natural habitats. In addition, evaluation of the distributional risks and impacts associated with different options is increasingly being demanded by various stakeholders. But there remains very little consensus on what are the best practices with respect to the financial, economic and distributional analysis of dams and alternatives.

3. Improving the financial and economic as well as integrating the distributional analysis of dams and alternatives will directly contribute to addressing several aspects of the big dams debate. For example, it is clear that the choice of discount rate and time period can significantly affect the present value of future costs and benefits. While a discount rate of 10% has generally been the rule of thumb in the past, greater emphasis on inter-generational equity as critical to sustainable development raises the question of whether a lower rate might be more appropriate in future financial and economic analysis of dams and alternatives. On the other hand, it might be more appropriate to employ some other decision rule rather than altering the discount rate such as applying a real term escalation factor to certain factors (such as natural resources) to ensure that the increasing scarcity value of these factors are more appropriately reflected in financial and economic analyses.

4. Distributional analysis is progressively becoming a central component in the economic analysis of all development projects and policies. But the economic tools for evaluating the equity consequences of dams and alternatives in terms of the distribution of costs, benefits, impacts and risks at the local, regional, national, international and global levels as well as among different social groups remains underdeveloped. The issue of the quantification and integration of multiplier and induced effects in distributional analysis also requires additional examination.

5. Similarly, risk and sensitivity analysis that more accurately reflects future dangers and ways to minimise them can contribute to addressing the uncertainty that is inherent in dams-related options assessment and decision-making. This includes more realistically reflecting the potential inaccuracy and variability of key parameters, particularly incorporating the lessons learned from earlier projects.

6. Another critical set of tools required in this area are those that deal with the internalisation of externalities and the valuation of non-priced factors such as ecosystem functions, species diversity, and cultural partrimony. For example, the valuation of the net GHG effects of dams (especially hydropower dams) is an increasingly important calculation in the economic analysis of options for some stakeholders.

7. Finally, better financial, economic and distributional analysis can contribute to improved governance in the water and energy sectors. As societies change the values ascribed to different types of development outcomes, better or even novel tools and methods that are transparent and effective are required to ensure that decision-making is made in an informed manner and accountable to those evolving values. All of the improved tools and methods mentioned above contribute to a more rigorous and comprehensive options’ assessment of the broader development effectiveness of large dams and alternatives.

8. The focus of this thematic review is to assess the effectiveness of and identify good practices among the various approaches, methods and tools for the financial, economic and distributional analysis of dams and alternatives. The review will thus include the following components:

• assessment of the importance of various approaches, methods and tools for the financial, economic and distributional analysis of dams and alternatives;

• assessment of the effects of discounting benefits and costs under different decision-rules on project selection and the possible conflicting outcomes from economic and financial analysis (the long run benefits and costs from economic analysis may yield different results from financial analysis);

• explication of good practices (such as willingness to pay models, property valuation models, added or adverted cost models, contingent valuation, etc.) and currently accepted ranges for the valuation, quantification and integration of non-market factors such as habitats and spiritual sites among others in dams-related options assessment and decision-making;

• assessment and explication of good practices for more rigorous and comprehensive distributional analysis of costs, benefits, impacts and risks of options for water resources and energy development and management;

• explication of good practices for risk and sensitivity analysis for dams and alternatives;

• recommendations on how these approaches, methods and tools can be more appropriately and thoroughly integrated into the planning and project cycles with respect to dams in a participatory and transparent manner.

9. Financial, economic and distributional analysis of the focal dams is a central component of the case study methodology. Analysis of decision-making processes in the case studies will also involve assessment of the approaches, methods, and tools applied to the focal dams. A more limited form of financial and economic analysis will be conducted on the dams included in the cross-check survey. Perhaps most importantly, the economists that are hired for the case study teams will all be included on the review panel for this thematic review to increase the level of cross-fertilisation between the thematic reviews and case studies.

10. On what types of benefits, costs, and impacts should be valued and included in financial, economic and distributional analysis, there are strong linkages between this thematic review and thematic review I.1 on social impacts and equity, I.2 on indigenous peoples and ethnic minorities, I.3 on displacement, II.1 on ecosystems, II.2 on global change. On the planning and project cycle decision-making process, there are clear linkages with the other thematic reviews on options as well as institutional processes.

11. The thematic review on financial, economic and distributional analysis will provide a knowledge base that will assist the WCD in formulating relevant criteria, guidelines and standards in this area. The tools, methods and best practices will contribute directly to the framework for options assessment and decision-making processes.

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