Question

The government is considering building a major infrastructure project at a cost of €200m. The expected benefits of the project are €500m. (i) Based on the Kaldor-Hicks criteria should the government implement this project? Justify your answer. (ii) A project that satisfies the Kaldor-Hicks criteria is always guaranteed to increase aggregate welfare. True or false? Explain your answer using a numerical example. In your example use the cost and benefits of the project outlined above ( approx 160 words total)

Answer 1

i. Hicks Kaldor criteria says that the government should go ahead with the project if there is a net gain to the society. This is because any potential losers will then be compensated out of that net gain to the society.

In this case, since the estimated benefit is greater than the cost, there is a net gain of €(500-200)m=€300m to the society. Thus, according to Hicks Kaldor criteria, government should take up this project.

ii. The given statement is false. This is because all the costs resulting out of a project cannot be monetized and sometimes it is not possible to compensate or even identify all the losers. Hicks Kaldor criteria simply assumes all this away and takes for granted that the losers will always be ready to accept the compenation.

For example, let us suppose that the government is planning to undertake a mega dam project. Now, thousands of people might lose their homes in this case and many acres of forest land might get submerged. The government may not be able to monetize all these costs and include in the total cost while using the criteria for taking uo the project.

You can take up similar examples where the governmet projects have certain benefits. However, the costs are such that they cannot be fully monetized and included. Thus, the welfare resulting from a project might actually be much less as compared to what has been predicted by the criteria. In some case, there might be losses. Thus, the given statement is false.