An Estimate of the Shadow Wage Rate in Pakistan

In the past few years, increasing attention has been given to the methods by which investments in developing countries should be appraised. Benefit-cost analyses, based on market prices and costs, do not indicate whether an investment would be profitable from a social point of view. The methods of project evaluation developed in the past decade suggest ways in which private costs and benefits can be adjusted to reflect positive or negative externalities and to eliminate the effects of distorting taxes and subsidies which influence private decisions but which do not affect an investment’s fundamental economic value. One item in an investment’s cost for which the market value is widely believed to be unrepresentative of its social value is labour. Much of development theory has been built around the notion that labour is misallocated, largely because it is mis-priced. Urban labour commands a wage above its equilibrium price because of the effects of unions, minimum wage legislation and other institutional rigidities. For institutional reasons as well, rural labour is paid a wage which is in excess of its marginal contribution to agricultural output. Determining the social opportunity cost of labour is consequently essential to the proper evaluation of investment in both rural and urban areas.