The macroeconomics of transport – and should it influence NZ’s investment priorities?

In this recent post John explored some of the links between transport and economic growth.

In this post I wanted to expand on some interesting macroeconomic issues related to transport investment. These issues have been rolling around in my head for some time and John’s post prompted me to stay up late writing a blog post. But before I begin I want to openly acknowledge that 1) these issues are complex and 2) like always, I pretend to have all the answers.

Nevertheless I think the issues are worth raising and debating.

First, let’s carefully define some terms so we can create a shared sense of understanding, rather than having to slash and stumble our way through a jungle of jargon and prejudice.

When I say “economics” I am referring to the social science which concerns itself with understanding people’s values based on how they allocate their scarce means, such as time. Some people simply refer to economics as “the science of scarcity”. Others prefer the “dismal science”, either way I think you get it. If you don’t, then the cartoon below should help (source).

Now, what is the difference between micro and macro economics?

Wikipedia describes microeconomics thusly (source):

“Microeconomics … is a branch of economics that studies the behavior of individuals and small impacting organizations in making decisions on the allocation of limited resources (see scarcity).^[1] Typically, it applies to markets where goods or services are bought and sold. Microeconomics examines how these decisions and behaviors affect the supply and demand for goods and services, which determines prices, and how prices, in turn, determine the quantity supplied and quantity demanded of goods and services.“

Generally, we evaluate transport projects on a microeconomic basis.

That is, we analyse the impacts of transport investment by considering how it affects individuals, or in some instances firms. The only “trick” is that in many cases the impacts of transport investment are “non-monetary”, in the sense that we are analysing things that are not openly traded in a market in response to supply/demand. Travel-time is an example of a non-monetary good. When faced with non-monetary goods, transport economists must impute values from other data, e.g. wage rates and/or surveys. Where the microeconomic benefits of a transport investment exceeds its costs, then we typically consider it to be economically worthwhile (source).

In contrast, Wikipedia defines macroeconomics in the following terms (source):

Macroeconomics … is a branch of economics dealing with the performance, structure, behavior, and decision-making of an economy as a whole, rather than individual markets. This includes national, regional, and global economies. With microeconomics, macroeconomics is one of the two most general fields in economics. Macroeconomists study aggregated indicators such as GDP, unemployment rates, and price indexes to understand how the whole economy functions. Macroeconomists develop models that explain the relationship between such factors as national income, output, consumption, unemployment, inflation, savings, investment, international trade and international finance.

Personally, I’m an avid microeconomist. As regular commentator mwfic astutely  noted in John’s post:

One of the weaknesses of GDP is that it misses out any measure of quality of the items we buy or the utility we get from those items. I could sell two cars and walk everywhere and even at a pinch ride on a bus and it might lift GDP ever so slightly. But GDP wouldn’t include how annoyed I would be walking in the rain and standing wondering if the bus will actually turn up and then having to stand up and get thrown around, or sit squashed against a stranger while the driver does his best to give me motion sickness. Yes cars cost me money and so does the petrol but I spend that money happily because I get back a benefit that outweighs the cost.

Notwithstanding my personal preference for analysing people rather than arbitrary aggregations of people (“economies”), I do consider that macroeconomics makes an important and useful contribution to public policy decisions. Indeed, “it’s the economy stupid”.

More specifically, macroeconomic indicators can tell us a lot of useful things about microeconomic decisions. High inflation, for example, will tend to cause interest rates to be higher than they would be otherwise. This in turn will tend to skew individual decisions to those investments that deliver short-term returns. As an aside, this is one reason why I believe that people who are “Green” should strongly support monetary policy settings that are likely to contribute to lower long-run inflation (and lower interest rates). Environmentalists and monetarists unite!

The links between macro and micro economics don’t end with interest rates and inflation; there are a number of other aggregate economic indicators, such as exchange rates, unemployment rates, and tax levels which impact on the decisions that individuals make on a day-to-day basis.

So microeconomics and macroeconomics are ultimately linked; they differ primarily in the level of aggregation. My theory of aggregation is illustrated below (source).

But how is all this relevant to transport investment?

The reason it matters is because there seems to be two (inter-related) macroeconomic channels that are plausibly affected by transport investment: 1) the size of the domestic economy and 2) the demand for labour.

First, in terms of the size domestic economy, John’s post shows that all other (microeconomic) factors being equal, New Zealand would be better off with greater uptake of non-car transport modes, because this would reduce the need to import fuel and vehicles. In turn our GDP per capita would likely be higher, simply because more of what we spent on the latter is likely to be spent locally.

Second, in terms of the demand for labour, different types of transport investment have different levels of labour input. Generally most studies I have read (such as this one) find that investment in local roads, walking/cycling, and public transport requires greater labour input than the same investment in highways. It’s fairly easy to understand why: The former require more workers, whereas the latter require more machinery. Hence, shifts in our transport investment towards local roads, walking/cycling, and public transport is likely to increase the demand for labour, reduce under-employment, and ultimately strengthen the government’s fiscal position.

The key caveat on all this is “all other factors being equal”, especially in this case the microeconomic value of transport investment. That is, we are not arbitrarily interested in a so-called “make work” scheme. What we are observing, however, is that different transport investments do have different impacts on the labour market and indeed the size of the domestic economy.

So where does this leave us? Well in my mind, we should continue to evaluate the merits of transport investment primarily within a microeconomic framework. However, where two different transport investments have the same microeconomic value, i.e. they have identical benefit-cost ratios, then why would we not consider their macroeconomic effects as a way of breaking the tie?

This would likely mean that investment in local roads, walking/cycling, and public transport was prioritised ahead of investment in highways, especially during times of underemployment. At times of low underemployment and/or high inflation, we could similarly favour transport investments that don’t employ many people and thereby don’t divert our human resources away from more productive endeavours. Or we could spend less on transport overall, and instead bank the money for times when interest rates are lower. This is less about “stimulus spending” and more about saving money when prices are high (e.g. cost of capital, wage inflation), and spending it when prices are low. In some ways this is simply matching investment levels to prices, in much the same way as anyone in the private sector would.

But these are all just half-baked ideas; I’d be keen to hear other people’s ideas. Assuming someone read past the first few sentences? Time is, after all, the scarcest resource of them all … ;).

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