Economics and technical consultancyT.W. Berrie. B.Sc, C.Eng. F.I.E.E.

Indexing terms: Project and production engineering, Engineering administration and management, Educationand Training, Consultancy, Economics

Abstract: Although it has never been defined, engineering economics is a discipline accepted by technical con-sultancies. It is basically used in making choices between alternative technologies with respect to the client'sfinances not the national economy. Outputs are assumed equal from all alternatives and are ignored. Becausethere has been no general agreement among engineers concerning what comprises engineering economics, someconfusion surrounds the whole subject. Today, many technical consultancy clients are in developing countrieswho obtain much investment capital from bilateral and multilateral lending agencies, requiring optimisation tobe done with respect to the economy at all stages in the project cycle and benefits from outputs to be included.Technical consultancies have often found it difficult to obtain the right type of economic expertise, partlybecause they are faced with the challenge of remaining in the lead, while accepting that only economists canproperly address their clients' socioeconomic problems. This difficulty would at least be partly solved by bettercommunication between engineers and economists, which can only come about after each has had some train-ing in the other's discipline. The problems with integrating in-house economists into technical consultanciesneed further consideration.

1 Introduction

Engineering economics is a discpline widely spoken of intechnical consultancies but has no precise definition. Someforms of engineering economics have been used by techni-cal consultancies for as long as the latter have existed; forexample:

(a) choosing the overall least-cost technology, from allthe alternative technologies, for producing a given output

(b) permitting additional capital costs in an equipmentdesign because these are more than balanced by savings inrunning costs, over the life time of the equipment con-cerned

(c) postponing the building of a project for a year or twobecause of savings in capital cost under circumstances ofrapid changes in technology, e.g. of the kind presentlybeing experienced in the telecommunications sector.

The economics-type calculations described above all fallinto the classification, or 'genus' of financial cost mini-misation. The outputs or purposes of all alternatives beingconsidered in any particular calculation of this type areassumed to be equal. The benefits (revenues) from eachalternative are, therefore, assumed to be equal, and can beignored in the sums. The costs, usually made up of capitaland running components, are measured with respect to theclient's finances basically as seen from his accountingbooks. They thus include taxes, subsidies, developmentgrants etc. Many accountancy ground rules and techniqueshave been borrowed by engineering economics; e.g. (i) dis-counting and present valuing, to reflect the time value ofmoney, (ii) annuitising, to be able to compare alternativedesigns, tenders, projects etc. with different economic lives,and (iii) discounted-cash-flow techniques, to be able totrade off incremental/decremental capital costs againstdecremental/incremental running costs over the project'slife. Perhaps the greatest single confusion concerning engi-neering economics, at least as is seen by economists, is themixing up of the terms of lending of any capital investmentobtained, i.e. repayment period and interest charged, withthe economic life of the project being financed and thenational opportunity costs of capital. These two rather

Paper 3265A, first received 11th January and in revised form 4th March 1984

The author is an independent consultant and resides at 'Wheels', l l a Preston ParkAvenue, Brighton BN1 6HJ, England

378

fundamental concepts belong in accountancy and eco-nomics, respectively.

Most engineers in technical consultancies have becomeskilled in those parts of engineering economics which theyneed to know to do their own particular job; e.g. preparingspecifications, comparing tenders, optimising designs,choosing between differing technologies for projects. Someengineers have had to learn to handle a much wider rangeof economic techniques to do their jobs, e.g. power systemplanners, but these engineers are comparatively few innumber in technical consultancies. However, it is theseengineers who today urgently need to widen their eco-nomic horizons most. Meanwhile, it is suggested thatserious consideration is given by technical consultancies to:

(i) defining more precisely what is meant by engineeringeconomics

(ii) asking some national body, such as the UK Associ-ation of Consulting Engineers, or some internationalauthority, such as FIDIC, to issue guidelines.

A definition of the discipline of economics, which isbroader than that presently assumed in engineering eco-nomics in technical consultancies, is required, in general, todeal with two fundamental and interrelated situations:

(a) where benefits (revenues) from outputs, designs orprojects need to be included in the calculation; e.g. becausethey are different for each alternative being compared, orbecause they are too important not to portray them, and

(b) when costs and benefits are measured, not withrespect to the client's finances and accounts books, butrather with respect to the national economy, i.e. expresseddevoid of taxes, subsidies, grants etc. which are but inter-nal transfers within the national economy.

It was when first dealing with situations (a) and (b) above,and because these situations are directly related to macro-and micro-economics, that economists and economicspecialists (who may not strictly be economists) were firstinvited into technical consultancies. Under situation (b)they were asked to convert money or financial costs andbenefits (revenues), obtained from the client's accountingbooks, into economic costs and benefits by 'shadowpricing', to reflect the effect of these on the nationaleconomy. Under (a) they were asked to calculate increasesin total net (benefit minus cost) present value over the lifeof the equipment/project, when designs/projects are

IEE PROCEEDINGS, Vol. 131, Pt. A, No. 6, AUGUST 1984

improved on. Although some engineers in technical consul-tancies have become, at least to a degree, economicspecialists in their own right, the discipline of economics ishighly complex and sometimes 'a little learning has been adangerous thing'. At times this has led to (i) engineersaccepting economists' data, e.g. on shadow prices, withoutquestion or understanding, and (ii) engineers obtaining afalse impression about the depth of economic theory. Also,it has not always been easy for technical consultancies toobtain the right type, scope and level of economic help.Further consideration of this important point is given laterin the paper.

2 Influence of the funding agencies [1]

There has been a trend over the last 15 to 20 yearsor so for an increasing proportion of the clients of techni-cal consultancies to come from developing countries.Much of the capital, at least for public sector investment indeveloping countries, is supplied either by bilateral devel-opment authorities, such as the UK Overseas Develop-ment Administration [2], or by multilateral lendingagencies, such as the World Bank. Such funding sourcesemphasise the impact of the project, or that part of theproject which they are being asked to finance on thenational economy, and less emphasis on the impacts ofsuch items on the technical consultancy's client, apart fromshort-term accountancy effects on prices of output andprofitability. Furthermore, these funding agencies requirethis economic emphasis to be given at all stages in theproject cycle [3]: identification, preparation, design,selection/justification, specification, tender evaluation,implementation and operation. This continuous emphasison 'national' economics means that economists and eco-nomic specialists should, if possible, be brought into theproject cycle by technical consultancies at the earlieststage, if the client is requesting funding, or likely to requestfunding, for his design or project from a national or aninternational lending agency. Today many governmentsare also following this independently.

Lending agencies tend to insist that both costs andbenefits, both as viewed from the national economy, areconsidered alongside technical aspects, at all stages in theproject cycle which they are being asked to finance, butespecially when carrying out the following work:

(a) studies concerning project identification and prep-aration, including preliminary design

(b) studies for determining project choice and demon-strating project justification

(c) project final design and specification(d) tender evaluation(e) project implementation and operation.

The justification given by the funding agencies, forrequiring that a strong element of national economics isintroduced into the project cycle, is spelled out in theirannual reports, somewhat along the following lines: Theagencies claim that, because they are development institu-tions, they must ensure that economic and engineeringaspects are jointly considered so that four requirements aremet. First, an adequate number of mutually exclusive alter-native technologies must be identified and evaluated prop-erly, i.e. as viewed from the national economy; theobjective is to find from the engineering viewpoint thatleast-cost technology (excluding benefits/revenues), whichfrom the economic viewpoint, has also an acceptable netpresent value (including benefits/revenues) over its eco-nomic life. Secondly, any capital costs above those strictly

minimal for technical requirements must be at least com-pensated for by lower running costs and/or additionalbenefits as viewed from the national economy. Thirdly,investment capital, and especially scarce foreign exchange,must make a sufficiently large internal rate of economicreturn over the life of the project which it is financing towarrant going ahead with the project, possibly instead ofwith projects in other sectors. Fourthly, national fiscal andsocioeconomic policies must be obeyed, e.g. with respect tonational economic growth, pricing policy and incomeredistribution.

Introducing the discipline of economics by technicalconsultancies, at an early stage of the project cycle, has theimportant advantage of encouraging communicationbetween engineers and economists from the stage of aproject's formulation. This gives more chance for a mean-ingful dialogue to take place at the later, possibly morecrucial, stages of the cycle than would otherwise occur. Onthe other hand, viewing everything with a national eco-nomic bias has the disadvantage that the financial costsand benefits of the project to its owner, the technical con-sultancy's client, can be lost sight of. It also has the dis-advantage that the important aspects of the impact ofthese finances on the project owner's business can be eitherconsidered somewhat perfunctorily at a late stage in theproject cycle or, more commonly, considered outside theproject cycle altogether. This approach means that suchfinancial costs and benefits can sometimes have little, ifanything, to do with the selection of the optimum designor project, although they may have still an important influ-ence on project implementation and operation.

3 Obtaining a proper economic input

There are three basic ways for technical consultancies toobtain a proper level, scope and competence of economicinput, and various combinations of all three ways existtoday. The first way is for the consultancy to build up itsown economic department. This method of approach hasthe big advantage of keeping the economic input entirelyunder the control of the consultancy, but it has the dis-advantages of:

(a) not providing economists with a proper career struc-ture with the consultancy

(b) not providing sufficiently strict supervision for theeconomics discipline from within the consultancy

(c) not being able to cater for all specialisms in that dis-cipline, from macroeconomics through sector and micro-economics to project and engineering economics.

Because of these three disadvantages, despite the one largeadvantage of this first approach, there is a tendency fortechnical consultancies today to deal with the matter bythe second way described below, or at least by some com-bination of the first and second methods.

The second way is for technical consultancies to makean agreement with some firm(s) of economic or manage-ment consultancies, for the latter to provide the right eco-nomic help at the right time. The agreement(s) can beeither formal or informal. This way has as advantages thedisadvantages of the first method of approach, and viceversa with respect to its disadvantages. If rigorouslyapplied, this second way can lead to difficulties of commu-nication between technical and economic consultancies,even during joint working on a study or a project, becauseengineers and economists do not know enough about eachother's discipline to make adequate communication pos-

IEE PROCEEDINGS, Vol. 131, Pt. A, No. 6, AUGUST 1984 379

sible at the necessary level. A practical combination of thefirst and second ways of approach is for

(i) the technical consultancy to have a basic 'core' ofeconomists on its own staff and a panel of independentindividual consultants

(ii) the economic consultancy to likewise hold a (smaller)basic number of engineers.

The second approach is quite popular today, but manyengineers argue that, if the technical consultancy in anycase must hold a core of economists on its books, then thethird way of approaching the question of joint workingwith economists is the best. In this third way the technicalconsultancy has no agreements, either formal or informal,with any economic consultancies. The technical consul-tancy has a small number of economists specialists to drawon, either from its own staff or from a panel of consultants,in order to carry out the base load of economic work.Whenever more than the base load of economics-orientedwork is required, then the whole range of management andeconomic consultancies can be canvassed by the technicalconsultancy to obtain the right input at the right price.Some technical consultancies consider this approach hasthe advantage of not requiring a core of more than a smallnumber of economists or economic specialists andenabling an economic deal to be sought if this core cannotcope. Because of this advantage, it is popular, despite twodisadvantages which are well known but can be moreserious than often realised:

(a) no proper means exists by which the technical con-sultancy can either supervise the work of the economicconsultancy or judge whether the latter is giving value formoney

(b) related to the last point, because the economic con-sultancies have no general agreement with the technicalconsultancy, and because the very nature of the work is'bitty', the management or economic consultancies tend tocharge higher fees per man-day on the same joint projector study than do technical consultancies; especially underthis third way of obtaining economic input.

4 Organising the economic specialists

Taken overall, there is an increasing tendency today fortechnical consultancies to take on economists and eco-nomic specialists in related disciplines, e.g. econometrics,operations research, statistics, sector modelling etc., asboth full-time and part-time staff. An important questionwhich arises, therefore, is how much staff should beorganised in a technical consultancy, e.g. within a small,central economists department, or spread out betweenseparate specialist technical departments. The argumentsin favour of a central economics department centre aroundensuring both adequate supervision and also a propercareer structure for the staff. However, such a centraldepartment tends to become bureaucratic, and the argu-ments in favour of farming economists out to these special-ist departments who need them is gaining support todaydue to (i) the comparatively recent realisation by engineersthat economists are just as diverse in the various sub-headings of specialisation of their own discipline as areengineers, and (ii) the functions of an in-house economistare, on the whole, helpful, e.g.

(a) the ability to spot, at an early stage, the economics-related problems concerning a technical study, design, spe-cification, tender evaluation, project selection, projectimplementation or operation

(b) the ability to break down these problems into aprogramme of work for finding the economic solution,

alongside the programme of work for solving the technicalproblems.

It is suggested that it would also be overall helpful tothe consultancy if the in-house economists were given thefollowing external duties, i.e. in addition to the internalduties listed above. First, they could provide generaloverall guidance to the management of the technical con-sultancy, as required on all economics-related matters. Sec-ondly, they could write guidelines on economics-relatedtechniques and methodologies for their engineering col-leagues to use in the normal course of the latters' work, i.e.when there is no need to call in the in-house economists.Thirdly, they could work alongside the client's economists,financial analysts, corporate planners etc., i.e. so far as theclient requests this. Fourthly, they could act as advisersand possibly even discussion group 'moderators' to theirengineering colleagues, e.g. when the consultancy is tocome to a corporate decision at the working level whenthere are a number of engineering subdisciplines to con-sider, as economists are not likely to take sides betweenthe subdisciplines.

5 2-way training

Whichever way a technical consultancy chooses toorganise its economics work, a minimum knowledge ofeach other's discipline is needed by both economists andengineers to enable proper communication to take place.The most efficient way of achieving this is by 2-way train-ing, i.e. by engineers taking a vital part in the basic train-ing of economists in the former's discipline and vice versa.Such 2-way training can take place either in a formal way,informally by on-the-job training, or by a mixture of bothmethods. The most important point today is that technicalconsultancies should address themselves to the subject of2-way training and, especially, to take steps to directlyencourage the basic training of economists in engineering.

In the past, technical consultancies have tended tocreate within their own fraternity a supply of engineersespecially interested in economics and finance. This oftenprovided sufficient economic specialist staff to meet mostpractical requirements. However, the circumstances underwhich this can occur are likely to become increasingly rare,as the importance of economics grows and the subject oftraining engineers and economists in each other's disciplinegrows in importance. Possibly national organisations likethe UK Association of Consulting Engineers, or interna-tional organisations such as FIDIC, should play a role, e.g.writing guidelines, making suggestions about trainingcourses and training packages and possibly evenorganising some types of the training themselves.

If the 2-way training is to be taken at all seriously, itfollows that technical consultancies must be prepared toencourage staff from economic consultancies to take part,at least temporarily, in the work of that technical consul-tancy, together with making some direct contribution tothe formal training of economists in the discipline of engi-neering. It also follows that the same technical consul-tancies must be prepared to encourage their own staff totake part, at least temporarily, in the work of economicconsultancies, together with allowing the latter to make adirect contribution to the formal training of engineers inthe discipline of economics. In this 2-way training, there islikely to be a quid pro quo between the efforts required andthe advantages received by technical and economic consul-tancies, although two factors need to be borne in mind.First, it is quite widely accepted by engineers, if not by

380 IEE PROCEEDINGS, Vol. 131, Pt. A, No. 6, AUGUST 1984

economists, that it is easier for engineers to obtain a basicknowledge in economics sufficient for the purpose ofproper communication with economists than it is for aneconomist to obtain a basic knowledge of engineering forproper communication. Secondly, 2-way training is just asimportant, whichever of the two disciplines involved islikely to be in the lead role, on most joint assignments inwhich they work together.

6 Taking the lead role

Up to and including the present time, technical consul-tancies have taken the lead position, e.g. in a consortiaconsisting of technical, economic, financial and manage-ment consultants, in project identification, preparation,selection/justification, implementation and operation. Thisis but a natural position for technical consultancies to havetaken historically in those sectors which consist of acomplex physical network at their base, e.g. the electricity,telecommunications and transport sectors.

However, this natural lead position is being eroded byother types of consultancies in those cases where nontech-nical aspects are important. It is suggested that technicalconsultancies should:

(a) take note of this trend, if they have not done soalready

(b) decide individually whether they wish to let thiserosion continue or whether they wish to try and stop it

(c) if they wish to try and stop the erosion, to determinewhich is the best way to do this.

The largest potential threat to technical consultancies con-tinuing to hold the lead position in consortia of consul-tants comes from economic and managementconsultancies, partly because of the increasing importancebeing given to the disciplines of accountancy andmanagement/organisation/institutions, but mainly becauseof the rise in prominence of the discipline of economics.

An important, narrower but related question for techni-cal consultancies to address is whether they wish to retainthe present lead position with their clients, even underthose circumstances when there is quite an appreciableamount of effort required in the discipline of economics.To help themselves to decide this, it should be of assistancefor them to go through a short list of the pros and consconnected with their yielding the lead position to econo-mists under such circumstances. There are four advantagesto technical consultancies which should be considered ifallowing nontechnical consultancies to take over the leadposition under such circumstances. First, the nontechnicalparts of the works should, all other things being equal,then automatically receive the correct level, scope andstandard of treatment. Secondly, the overall nontechnicalobjectives which the client has for preparing, designing andbuilding the project should be able to be addressed with adeeper degree of understanding, e.g. by a management oreconomic consultancy rather than by a technical consul-tancy. Thirdly, an economic consultancy should be betterable than a technical consultancy to deal on behalf of aclient, if this is considered desirable by the latter, with theeconomic planning agencies which exist today in so manycountries. Fourthly, technical consultancies need not thenbe responsible for those aspects of the work which arenontechnical.

However, there are two disadvantages to this course ofaction, the second of these being considered by most engi-neers engaged in planning to be of sufficient seriousness toswamp the four above advantages. First, in practice, the

technical aspects are so crucial that it may be difficult toensure that the design, specification, tender or projectchosen is the optimum one overall, i.e. considering techni-cal as well as nontechnical factors, if the nontechnical con-sultancy is in the lead. Secondly, in those sectors of theeconomy covered by most technical consultancies the com-plexity of the physical network is such that, without thethorough understanding of the behaviour of this networkpossessed by technical consultancies, but not by nontech-nical consultancies, there is a grave danger that the 'wrong'design, specification, tender or project might be chosen.

It is likely that, under those comparatively rare circum-stances today, when the economic consultancies havetaken up the lead position in highly technical sectors, thishas happened by default rather than by deliberate plan-ning. For example, technical consultancies sometimes leavea vacuum with respect to some nontechnical aspects of thework, without being aware that they are doing so. It is intothis vacuum which economic consultants quite naturallystep. For the future in this matter is is suggested that tech-nical consultancies:

(i) take steps to study their terms of reference sufficientlyclosely so as not to leave such a vacuum in their work

(ii) make a deliberate decision as to whether they wishto remain in the lead position, when a fair measure of thework involved which they will be leading is nontechnical;bearing in mind the implications for supervision, staffing,training etc. mentioned earlier in this paper.

To be able to answer properly the question as towhether the best general remedy is for technical consul-tancies to deliberately choose to remain in the lead posi-tion in their own sectors under virtually all circumstances,these consultancies could start by addressing themselves tothe more easily definable advantages and disadvantages ofso remaining as outlined earlier in this paper. But theyshould also search the reasoning and logic behind theiranswers for prejudices unintentionally acquired by techni-cal consultancies towards economics over the years. In thecatalogue of possible prejudices are such outlooks as:

(a) most economics is an extra; in the old days onlysimple engineering economics was enough; it does notalways pay to be led by fashion

(b) economics is a less professional discipline than engi-neering, because it contains a lot of guesswork

(c) pandering too much to economics is not in the bestgeneral interest of the client, because many of the sumsdone are just 'twisting the figures round' to show an eco-nomic return large enough for a government or a fundingagency to advance the money for the project which they,not the client, want.

7 Using engineering techniques

Economists and financial analysts have achieved, on thewhole, a healthy symbiosis by the former making use ofsome of the techniques developed by the latter, as men-tioned earlier, e.g. discounting, present valuing and annu-itising. Now that economists are widely making use oftechniques developed by engineers, it is to be hoped that asimilar healthy relationship will develop between econo-mists and engineers. It seems likely that such a partnershipwill develop over time, in that more and more techniquesused in engineering are now being adapted for use in eco-nomics, e.g. linear programming, dynamic programming,Lagrangians, Boolean algebra, modelling, control theory,catastrophe theory etc. Such an opportunity to cementgood relationships between the two disciplines should notbe lost.

IEE PROCEEDINGS, Vol. 131, Pt. A, No. 6, AUGUST 1984 381

8 Conclusions

A good deal of further consideration needs to be given byeach technical consultancy to the many and varied matterstouched on in this paper before each can draw their ownconclusions on how to deal best with respect to economics.However, it is suggested that the following general conclu-sions can be tentatively drawn from the subject matter pre-sented in this paper:

(i) problems do exist with respect to technical consul-tancies covering work of an economic and other nontech-nical nature

(ii) these problems are often exacerbated by lack of com-munication between economists and engineers, due, inturn, to lack of knowledge about each other's disciplines

(iii) there is an urgent need for technical consultanciesto act positively in this matter with respect to (a)organising themselves properly vis-a-vis economic andmanagement consultants, (b) considering how to staffthemselves for work in economics and (c) how to train theappropriate staff

(iv) overall, technical consultancies must each deliber-ately decide whether they wish to remain in the lead posi-tion in their sectors when a distinct part of the work isnontechnical, bearing in mind their own unique positionwith respect to the detailed knowledge of that sector,which they alone possess

(v) the increasing use of engineering techniques, nowbeing used by economists, should be encouraged to help toproduce a healthier relationship between the disciplinesthan has existed in the past.

9 References

1 BAUM, W.: 'The project cycle' (The World Bank, Washington DC,USA, 1980)

2 BRIDGER, G.A., and WINPENNY, T.: 'Planning developmentprojects—a practical guide to the choice and appraisal of public sectorinvestments' (HMSO, 1983)

3 BAUM, W.: 'The project cycle', Finance and Development, December1978, Washington, DC, USA

382 IEE PROCEEDINGS, Vol. 131, Pt. A, No. 6, AUGUST 1984