INVESTMENT CRITERIA FOR DEVELOPMENT PROJECTS IN IRAQ.

Abstract

Formulating an investment plan requires choosing among alternative projects with different time-streams of costs and benefits. Planners have to define a decision criterion that reduces the stream of cost and benefit flows at different points in time to an index. This index can then be used to determine a project's admissibility and to select among admissible projects. Net present value, or cost-benefit analysis, is regarded as the most rational one for that purpose. However, application of cost-benefit analysis in a developing country involves many difficulties. A major one is estimation of the social rate of discount. This study is intended to develop a practical approach for measuring the social rate of discount under conditions in Iraq in order to improve the selection process for development projects. The study holds that any applicable methodology to determine this variable should be sensitive to the principal characteristics of the particular economy and to the underlying meanings of available data. Accordingly, it was shown that the supply of savings is not appropriate for that purpose, since neither the individual nor the social time preferences are adequately reflected in its information. Likewise, the alternative of calculating the social rate of discount by observing the pre-tax rates of return on investment will yield misleading results due to serious distortions in different markets. Based on the fact that more than 98 percent of investment funding is provided by revenues from crude oil exports, the study recommends the need for solvable models of optimal path with exhaustible resources. These models should maximize the social welfare of both current and future generations. Meanwhile, optimal growth calculations would yield the required rate of discount as a by-product of the maximization process. In the absence of such calculations, two methods were recommended to estimate the discount rate within the second best context. The first is to derive it from consumption information. The other way is to estimate the opportunity cost of investable funds by observing the long-term rate of interest prevailing in international capital markets.