Many of the debates on this blog and within in the wider community about the merits of projects, or lack of them, end up coming down to down to questions of economics. But as Peter Nunns pointed out a few weeks ago in his excellent guest post, most people aren’t aware of the specific aspects that go into the economic assessment
Readers of this blog will be familiar with the notion of the benefit cost ratio (BCR), a figure that compares the forecasted benefits of a project with the financial cost of building it. It’s often used as a shorthand for the quality of a project: If the BCR is high (i.e. substantially above 1) it is seen as a good use of public money; if not, it can be criticised as a boondoggle.
Everyone plays this game. Opposition politicians often criticise motorway projects such as Puhoi-Wellsford and the Kapiti Expressway on the basis of BCRs that fall below 1, while the Minister of Transport has in the past expressed scepticism about the City Rail Link on the same grounds.
However, there is relatively little public discussion of the hows and whys of these seemingly consequential numbers. How, exactly, does one calculate a BCR?
The procedures for conducting an economic evaluation of a transport project are set out in excruciating detail in the Economic Evaluation Manual (EEM) published by the New Zealand Transport Agency. This manual defines the exact procedures that need to be followed when evaluating any transport project and specifies the values that should be used in the evaluation.
He then went on explain one of the biggest issues that exists within the EEM being the value of time figures used for travel time saving calculations and how it differed depending on the region, type of road or what mode you are using.
Well last year we learned that the NZTA were in the process of reviewing the EEM and now they have released what those changes will be. The good news is they are positive and appear to address the issues raised by Peter in his post as well as many other issues. The changes are:
- A revised discount rate of 6%, along with an extended evaluation period of 40 years.
- The addition of wider economic benefits relating to imperfect competition and increased labour supply.
- Greater emphasis on a multi-modal approach to evaluation, including:
- public transport evaluation periods made consistent with other modes, and
- equal values of travel time across modes for monetising the total value of travel time benefits.
- Discontinuing the use of default traffic growth rates. Evidence will be required to support any traffic growth assumptions.
As mentioned some of these are quite positive so let’s look at them a little closer.
Lower discount rate and longer evaluation period
These two changes primarily will benefit larger and longer term projects like the Roads of National Significance and the City Rail Link where the benefits accrue over a long period of time. This isn’t actually as low or as long as what was proposed in April last year (4% and 60 years) but is at least an improvement on what exists now (8% and 30 years). The effects of the lower discount rate and a longer time period are excellently shown in the graph below which compares the original business case of the CRL from 2011 using the NZ methodogy with that used in the UK which has a 3.5% discount rate and a 60 year evaluation period. The differences are staggering with in the UK model suggesting the total benefits would be 6 time higher than how we assessed them.
Interestingly in their FAQs about the changes the NZTA say that 6% is in line with other nations yet this chart from a few years ago shows that 6% is still at the upper end compared to many countries.
The addition of wider economic benefits relating to imperfect competition and increased labour supply.
I’m not an expert so hopefully some of you economists can explain exactly the impact that this will have.
Greater emphasis on a multi-modal approach to evaluation:
Both of the changes suggested make absolute sense and should mean that public transport projects are assessed equally rather than PT having one hand tied behind its back. The issue of value of time was covered really well by Peter and I’m not going to try and rehash it.
Discontinuing the use of default traffic growth rates
For roading projects this is a significant change as it means business cases won’t be able to just assume traffic will always grow. Constant traffic growth was a feature seen in NZ and overseas but then over the last decade or so things have changed with fewer people driving and those that do driving less. It should hopefully mean that projects like the Additional Waitemata Harbour Crossing won’t be able to just predict growth even when the numbers already show that growth hasn’t been happening.
Along with the changes to the EEM, the NZTA will also be taking changing their strategic fit assessments to ensure that crash prediction is consistently taken into account.
While they came into effect on July 1, we are unlikely to see a lot of change as a result of them in the short term. The NZTA say that all proposals in the 2015-2018 National Land Transport Programme will be subject to these changes while existing projects and even new ones that enter the 2012-2015 NLTP may still use the older methodology depending on certain criteria.
All up these changes seem fairly positive so it’s pleasing to see the NZTA improving how things are done. The next stage in the EEM update process will look at the procedures within the assessment framework and importantly the particular values used in the calculations e.g. the actual value of time, vehicle operating costs and crash costs used in the assessments.
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The changes are good. A big step in the right direction. A longer evaluation period would be nice, and so would a lower discount rate. Although it’s probably fair for NZ’s to be a little higher than other countries – we have a higher cost of capital, and our interest rates are inevitably higher.
Yes the treasury makes exactly that point in defense of their recommended rates – we are different from Europe. The changes look good though.
Referring to the post title, “chances” should be “changes”?
Changed, it was a late night 🙂
Turn and face the strain, GJP!
While I agree with most of these changes the use of a 6% discount rate is too low when the majority of funding comes from rates. It is a major issue in both local and national politics that money can be forcibly taken from people with an effective discount rate of 9‰ – 30% and then used on projects that only need to justify 6%.
I agree we should move to user pays where possible. But I don’t know what you are going about re rates.
Most of the projects are state highways so no rates money goes in to them.
So make it rates or taxation. Either way the ignoring of the actual effective cost of capital from the average of funding sources leads to an artificially low discount rate
My understanding is that this doesn’t represent a finance discount rate, but it is a rate factor that is the same for all projects.
Correct. The “discount rate” is used to conduct “net present value” calculations which turn the future value of a project back into today’s dollars, on the basis that a dollar today is always worth more than a dollar tomorrow. It’s nothing to do with finance costs, and everything to do with factoring in inflation. NPV calculations are then used to inform decisions about financing methods, acceptable rates of interest, etc.
Actually its nothing to do with inflation. It is (at least in part) based on the cost of capital.
So what are you sayin Iiq374? Are you trying to include the deadweight costs of taxation in the discount rate? I am not sure that is appropriate.
In most cases the discount rate only affects the benefits as the money used to build most projects here is money the government/council already has.
The exception is maintenance and PPP projects where the costs are ongoing and by using a lower discount rate future costs have a higher impact.
A construction project with 5 years of construction will discount the costs as the occur over the 5 years.
Even so, the choice of discount rate has a much larger effect on the benefits (over a few decades) than it does on the costs (applied over a few years at most)
“The addition of wider economic benefits relating to imperfect competition and increased labour supply.”
The wider economic benefits in the Manchester Hub Study gave a 20% increase in gross benefits, leading to a 25% improvement in BCR (because of the way rail revenue is treated in the UK). Assuming we can use a methodology somewhat similar to the UK, we might see a similar sort of increase in schemes where creating and capturing the wider economic benefits features in the scheme development,
Hopefully it will also capture more of the Wider Economic Disbenefits (WEDs) too so that the BCR will be further improved.
While I generally support these changes, the WEB are a bit of a poison chalice. They can also be used to shoe-horn in other politically preferred projects in the guise of “scientific proof” that they are benefitting the economy. Say that of Northland, for a certain project people here know well.
Wonder if wider economic benefits will also include wider economic costs. The most glaring one is that the cost of vehicle ownership is included for all rail projects, generally isn’t for bus projects, and never included for motorway projects.
Baby steps, Cameron, baby steps. A 1/3 increase in the evaluation period and a 25% decrease in the discount rate is big progress.
Yes I still find it baffling that the Waterview Business Case can claim some 500mil of ‘Congestion Benefits’ on top of ‘time savings’ as clearly any huge new road that encourages driving will in fact exacerbate congestion throughout the city even if it relieves some road for some trips. In this example clearly SH16 and the CBD will suffer increased traffic volumes from travellers incentivised to drive instead of use other modes, especially into the city. To be balanced by the relief this road should give to SH1 for journeys bypassing the CMJ [these they already count].
In other words all driving incentivising projects can surely be considered to generate general ‘congestion dis-benefits’ as they reinforce auto-dependency. Congestion, after all, is just too many vehicles; not the lack of an infinity of roadspace.
Same goes for that crazy WGTN project that is simply a multi billion dollar way to get people to stop using Transit and drive more [as the AECOM study showed]. This is clearly a poor outcome, or does the government and the agency want to stand up and that this is their aim and this is what we should be setting out to do? If not then this clear dis-benefit should be captured by the evaluation models.
Cam, your statement on buses is incorrect: Economic appraisals of bus projects include an annualised cost for vehicle depreciation in their estimates of operating costs. This charge is normally set at $40-$60k per vehicle per year. I.e. $500k over a 10-15 year lifetime.
Hazarding a guess, the “imperfect competition” change will reflect that travel consumers don’t have perfect information or act in a perfectly rational (from the Chicago School’s perspective) manner, so inter-modal competition cannot be perfect. When looking at an empty road while jammed into a standing-room-only bus, even if the monetary cost of that bus journey is lower than the all-costs-included cost of the same journey by car, a human being (as opposed to a Chicago School economist) will be attracted by the comfort and convenience of their car even if the journey time is not significantly different.
Larger labour force likely refers to the widening of the practical travel area from which workers are drawn, which has economic benefits through increasing the size of the pool of potential workers. If it’s cost-neutral at worst to live and work further apart, some of the potential workforce will opt to live further away and get other benefits from the residence choice: peace and quiet, more land on which to indulge hobbies, choice of schools, proximity to family…
Based on yesterday’s discussions on per crossings and how agitated pedestrains get when they have to wait the same length of time as a car at an intersection I would say the travel time saving value needs to be increased to be the highest of the lot.
I suspect that your suggestion could lead to a perverse outcome SF, unless applied to Queens St saving a few seconds at ped crossings for many drivers at the cost of few pedestrians is a likely outcome, making it worse for peds
I could be cynical and say that the introduction of lower discount rate, longer evaluation period, and wider economic benefits are all to make some of the sicker looking RONS projects start to look at least half-decent (compared to safety and active trpt projects that have easily demonstrated high BCRs in the past). But then they also got rid of default traffic growth rates, which could make quite a difference to some numbers if we applied a zero growth rate (which might be generous in some cases).
It would be interesting to see whether wider econ benefits also get applied to smaller projects as well, or whether only the “mega-projects” will be worth doing the calcs for. Many projects that encourage active transport for example would be able to demonstrate plenty of societal benefits outside those prescribed by EEM. Same for projects introducing lower speed limits, which to date have largely had to pit crash savings against travel time increases using conventional evaluation.
The thinking behind having equal travel time costs by mode is arguably technically flawed for all the reasons discussed previously (time on PT or walk/bike is more productive and therefore less wasted cost/hr). But the upshot is that PT/walk/bike projects now have relatively better BCRs, so I’m not really complaining.
Might have missed the boat with this post, but here are a couple of comments from someone that consults on these topics:
— great news the discount rate has been lowered. But it’s still too high; it should be no more than about 4% real. If you want to know why, buy or borrow any cost-benefit analysis textbook and 8 out of 9 times it will explain it in detail
— contrary to what a few people are saying here, no the social discount rate shouldn’t be based on the returns to capital, but the latter is a crucially important part of the bigger story. The latter relates to opportunity costs, whereas the former relates to “society’s” willingness to trade welfare from one period to the next. Opportunity costs should feature as $ cost/benefit items in the analysis itself; afterall, that’s why we bother doing cost-benefit analysis at all. Mixing the two up makes the analysis absurd for anyone that wants to think real hard about it.
— it’s time for Treasury to do something useful in this space, particularly with the new RMA s32 demands for cost-benefit analysis to increase.
Re the WEBs, the imperfect competition one is fine (adds 10% markup to business benefits). The labour supply one raises a whole bunch of new inconsistencies and cherry picking that I’m troubled with (it counts the upside but not the downside such as increased congestion because that wasn’t even modelled in the baseline benefit estimates).
Re equalising the VTTS (value of travel time savings) across PT and cars for leisure travel, I’m in favour of trusting what the surveys of willingness to pay say. If people don’t care about saving 5 minutes while on the bus or train because they’re surfing their smartphone, then we shouldn’t spend other people’s money to save them the 5 minutes. If that’s what the PT patrons tell surveyors, who then dutifully report that the VTTS of PT is less than cars, then the result should stand. I know it gets hard when comparing mode shift etc, but that’s a second order complication. (And who said CBA had to be easy?)
Somebody lamented that road CBAs ignore the cost of buying cars, but PT appraisals don’t. Yes the cost of vehicles for both PT and road appraisals needs to be included, but it’s implicit in roads and explicit in PT. It features implicitly in roads by suppressing the amount of induced travel in the “equilibrium price elasticities”. The market for cars is a ‘related market’, and the more expensive cars are, the less the demand for car travel. It’s a complicated story of multi-dimensional calculus (line-integrals) that does even economists’ heads in; it ends up being a case of ‘trust what the mathematicians say’.
Cheers