The paper is too long for conveying the message that shadow
pricing used as a method of analysis in micro-economic issues of project
selection is also useful for analysing macro-economic issues, such as
foreign and domestic borrowing by the government, emigration, etc. Much
of the methodological discussion in the paper is available in a readily
accessible form in several publications of each of the coauthors; In
contrast, the specific application of the methodology to Pakistani
problems is much too cavalier. While it is hard to disagree with the
authors' claim that shadow pricing "constitutes a relatively informal
attempt to capture general equilibrium effects" (p. 89, emphasis added),
their depiction of traditional analysis is a bit of a caricature:
essentially it sets up a strawman to knock down. After all in the
traditional partial equilibrium analysis, the caveat is always entered
that the results are possibly sensitive to violation of the ceteris
paribus assumptions of the analysis, though often the analysts will
claim that extreme sensitivity is unlikely. Analogously, the shadow
pricing method presumes "stationarity" of shadow prices in the sense
that they are “independent of policy changes under review" (p. 90). The
essential point to be noted is that the validity of this assertion or of
the "not too extreme sensitivity" assertion of partial equilibrium
analysts can be tested only with a full scale general equilibrium model!
At any rate this reviewer would not pose the issue as one of traditional
partial equilibrium macro-analysis versus shadow pricing as an
approximate general equilibrium analysis, but would prefer a description
of project analysis as an approach in which a macro-general equilibrium
model of a manageable size (implicit or explicit) is used to derive a
set of key shadow prices which are then used in a detailed
micro-analysis of projects.
The price of risk and ambiguity in an intertemporal general equilibrium model of asset prices