Economic Rates of Return

Accountability and transparency and are key principles of MCC’s evidence-based approach to reducing poverty through economic growth. Economic Rates of Return (ERRs) provide a single metric showing how a project’s economic benefits compare to its costs. MCC requires that its projects have an ERR that passes a 10 percent hurdle rate to be considered for investment. In the interest of transparency, MCC makes its ERR analyses available via interactive, downloadable spreadsheets. These spreadsheets are unique to a project or activity as defined within a compact, or a set of closely related interventions with the same benefit stream.

Each spreadsheet includes:

  • A description of the project, including its economic rationale;
  • The expected impacts, including detailed cost and benefit estimates;
  • A tool allowing users to modify key assumptions and study the effects of those modifications on the project’s returns.

Some familiarity with cost-benefit analysis is essential to using these spreadsheets.

The Essence of the Economic Rate of Return (ERR)

An ERR provides a convenient metric, produced from a cost benefit analysis comparing the economic costs and benefits of a program and/or policy measure. In MCC’s cost benefit analyses, the costs of a project include all necessary economic costs—financial expenses covered by MCC and other parties, as well as opportunity costs of non-financial resources expended. Benefits include the increased income of a country’s population or the increased value-added generated by producers (firms and households) that can be attributed to the proposed project.  [Value-added is defined as the value of gross production (or sales) minus the cost of intermediate inputs produced (and purchased from) outside the firm.]

Calculating ERRs

MCC’s methodology for cost benefit analysis is best described as micro-economic growth analysis, which captures the expected increases in local incomes. These ERRs include income or value-added that is expected to be generated through environmental and social improvements, such as the effect of clean water on health outcomes, or improved female educational attainment on incomes. However, they do not incorporate the non-income related value of environmental and social improvements, given MCC’s mission.
Every ERR calculation considers two scenarios:

  • The expected outcome with the project; and
  • The expected outcome without the project.

Scenario 1:
Expected Outcome with Project

This scenario reflects the increases in income or value-added generated by the proposed program, as well as the full costs related to the program.

Scenario 2:
Expected Outcome without Project

The second scenario, called the counterfactual, reflects an estimate of what is likely to happen in the future if the project does not take place. While this may be considered a “status quo” scenario, the estimation of future economic outcomes without the project also accounts for dynamic trends. For example, a growing economy would be expected to continue on its recent (or projected) growth trajectory without the project, and private investments would likely be made.  In other cases, investments could be expected to decline in the counterfactual, for example if electrical outages would be expected to increase without the project.

Economic analysis compares the difference in incomes or value-added between the two scenarios, factoring in the timing of accrued costs and benefits. Since the value of a benefit accruing to people sooner is greater than the value of the same benefit accruing later, benefits and costs are discounted over time. The ERR is expressed in percentage terms and represents the discount rate at which benefits equal costs after discounting. Investments meeting MCC’s hurdle ERR of 10 percent, a common discount factor for development projects, are those for which benefits are at least as high as costs after adjusting for the time value of money. Projects that are likely to generate larger increases in household incomes per dollar invested will have higher ERRs.

MCC models incorporate the best information available at the time regarding core parameters.  Nonetheless, projections of future economic activity for both scenarios must account for uncertainty. MCC conducts sensitivity analysis on its ERRs using a range of plausible values on the major variables that drive the results. ERRs represent MCC’s best estimate of the expected economic returns of the project, while the sensitivity analysis captures the potential range of those outcomes.

Pre-Investment Cost-Benefit Analysis and Closeout ERRs

Conducting cost-benefit analysis of a proposed MCC project prior to investment decision entails making a forecast of its likely economic impact and its costs. The resulting ERR provides a measure of its cost-benefit relationship to inform investment decisions. MCC’s pre-investment ERRs represent its best estimate given the data and evidence available at that stage.

In addition to producing these ex ante ERRs, MCC began computing revised ERRs upon compact closeout in 2011, called “closeout ERRs.” These ERRs provide an estimate of a project’s cost-benefit relationship based upon the information available at the time of closeout, when MCC’s costs and some indicators of benefits are known. Closeout ERRs are still forecasts, given that for many projects benefits do not start until after compact closeout, and these benefits can continue for 20 years or more. Moreover, impact evaluation findings, which provide a measure of the degree of any project impact to date, are typically not available at time of closeout ERR estimation. Closeout ERRs are thus distinct from an ERR based on measured benefits resulting from the MCC’s projects (see “Evaluation-Based ERRs” below).

In 2014, MCC produced its first annual report on closeout ERRs, the main purpose of which was to document facts on ERRs updated upon compact closeout. The annual reports are available below:

Evaluation-Based ERRs

MCC often tasks its independent evaluators to re-estimate ERRs, based upon the best available evidence of project impact. Where feasible, this is done through rigorous and independent impact evaluation. Because these evaluations are conducted many years after a compact closes, they often can yield better evidence around the benefits of a project.

Other Inputs to Investment Decisions

Although economic returns are a key decision variable for MCC, the agency takes many factors into consideration when making its decisions to approve compact investments. MCC expects that programs will generate adequate benefit streams to justify the investment of resources. MCC also conducts a Beneficiary Analysis to assess whether its investments will deliver benefits to the poor. At the same time, MCC values country ownership and places a premium on supporting initiatives that enjoy broad support in the country and that are developed through a consultative process. It also examines whether the program proposal is consistent with MCC policies and guidelines on gender, the environment, and procurement procedures, among others. Finally, MCC also analyzes each investment to determine its sustainability—i.e., the degree to which benefits are likely to be sustained, or the degree to which costs (including potential environmental costs) may grow.

These spreadsheets provide a window into the assessment of economic impact used by the MCC in its consideration of a proposed project. MCC understands that key parameters will change over time, and project design may be revised during implementation. When project designs or model parameters change significantly, MCC may revise these models; updated information will be posted here as it becomes available.

What the spreadsheet data represent:

  • An overall impact estimate. The spreadsheets provide MCC’s best pre-investment estimate of the likely economic impact of the project and form the basis for monitoring and evaluation efforts.
  • Estimated benefits. The spreadsheets estimate the expected increases in either incomes or value-added of individuals, households, firms or sectors of economic activity.
  • A counterfactual scenario. Potential benefits are compared against what is likely to happen without the project (e.g., a growing economy would be expected to continue growing, even without the project).
  • A snapshot in time. The spreadsheets reflect the best data available to MCC at the time the project was approved for investment.

What the spreadsheet data do not represent:

  • The sole reason for an investment decision. Although ERRs are an integral part of MCC’s decision-making process, other factors are considered when MCC decides whether to undertake a project.
  • A detailed beneficiary analysisThe ERR spreadsheets portray the overall economic impact of a project rather than apportioning the income gains along various demographic dimensions.
  • Up-to-the-minute information for projects in implementation. Many of the parameters that are used in these pre-investment estimates change over time, so ERRs may not reflect the actual implementation experience. When project designs or model parameters change significantly, MCC may revise these models; updated information will be posted as it becomes available.

Country Spreadsheets

Download spreadsheets to see MCC ERR data which helped determine the approval of these compacts.