Why does this book contain a separate chapter on cost-benefit analysis in developing countries? CBA in developing countries has much in common with CBA in industrialized countries. The major distinguishing characteristic of CBA in developing countries is the need to place greater emphasis on shadow pricing, that is, adjusting the market prices of project outputs and inputs so that they more accurately reflect their value to society. This topic is obviously important for those who actually will apply CBA in developing countries. However, it also provides insight into shadow pricing in developed countries.

The reason for the emphasis on shadow pricing is that markets in some developing countries are much more distorted than in most developed countries. Analysts suggest, for example, that labor markets are segmented and labor mobility is limited by systems of land tenure; that official exchange rates do not accurately reflect the value of the national currency; that the prices of goods exchanged in international markets are distorted by trade taxes, import controls, and high tariffs; and that credit markets are divided between formal and informal sectors. Consequently, experts advocate that shadow prices, which are often and rather confusingly called accounting prices, be used instead of market prices in conducting CBAs in developing countries. Similar to shadow price adjustments used in industrialized countries for CBA, accounting prices may incorporate adjustments for market failures such as monopoly and externalities. Particular emphasis in developing countries, however, is placed on adjustments for taxes (especially tariffs), subsidies, and quotas that affect the market prices of imports and exports.

Surprisingly, perhaps, there is not only agreement among the experts on using shadow prices, but also on the basic methods to use in determining the values of these shadow prices. Nonetheless, considerable variation remains in the details of how these methods are applied in practice. These methods, which received much of their impetus from international organizations involved in the funding of projects in developing countries, were developed in the early 1970s by the United Nations Industrial Development Organization and by Ian Little and James Mirrlees.