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How should we value the future?

Transport networks and urban planning can have extremely long-lived effects on society, the economy, and the environment. The government’s decision to invest in an electrified commuter rail network for Wellington in the 1930s led to an early form of transit-oriented development in the region. Wellington’s post-war urban growth has been concentrated in areas served by rail lines – providing the region with long-lasting benefits.

800px-WellingtonRailMap

Source: Wikipedia

In Auckland, of course, things were very different. After the role that rail played in Auckland’s early development, successive governments decided to:

And, of course, these years of refusal were coupled with a decision in the 1950s to invest heavily in a motorway network for the region. The Master Transportation Plan of the era contains some truly awe-inspiring concept designs, including an elevated Quay St motorway that would have doomed any chance of Auckland’s recent waterfront revival:

1950s Transportation Master Plan Quay St

Leaving aside a few extremely white elephants, many elements of the plan are quite familiar to modern Aucklanders. The Southern and Northwestern Motorways and the Harbour Bridge were built, kicking off development booms in Manukau, the North Shore, and West Auckland. In a 2010 Policy Quarterly article, Andrew Coleman assessed the effects of motorway development in Auckland and the US, concluding that:

transport infrastructure choices can have long-term and potentially irreversible effects on city form. A city that chooses to invest in roads rather than public transport infrastructure to improve its transport system is likely to reduce the efficiency of any subsequent public transport investments, by causing population and employment in the city to disperse widely over space. When making decisions to build roads, therefore, the city planners need to take into account the way roads affect the operation of subsequent transport infrastructure investment choices.

So it’s worth asking: Are we valuing future outcomes in the right way? In economese, this means asking about our “rate of time preference”, or the degree to which we value present-day outcomes over future outcomes.

A 2011 NZIER paper by Chris Parker provides a fairly accessible introduction to this topic. (Transportblog reviewed the paper when it originally came out.) Parker highlights how much of an effect different discount rates can have on our decisions about the future. As Figure 1 below shows, an 8% discount rate – recommended by the NZ Treasury – means that we place no weight on outcomes that occur 40 years in the future. (To put that in perspective, the average New Zealander lives twice as long as that. I certainly expect to be alive in 40 years!) A 3% discount rate, by comparison, means that we place a much higher value on outcomes that far in the future.

NZIER discount rate comparison

Last July, NZTA decided to lower its discount rate from 8% to 6%. This change means that transport evaluations now place a slightly greater weight on future outcomes than before. However, as NZTA’s documentation showed, we still discount the future to a much greater extent than countries like Germany (3% discount rate) and the UK (1% to 3.5%).

NZTA’s new discount rate might still be too high to properly account for the long-lived effect of infrastructure development on urban form. As we’ve seen, Auckland and Wellington are still benefitting from, or coping with, with the effects of investment decisions made 60 to 80 years in the past. Under current evaluation procedures, we wouldn’t have considered such long-lasting effects.

A new research paper by economists at the University of Chicago and New York University suggests that people place significant value on outcomes that occur dozens or even hundreds of years hence. The authors measure long-term discount rates using an innovative method that relies upon observing differences between the prices for freehold and leasehold houses in the UK and Singapore:

In Giglio, Maggiori and Stroebel (2014), we provide direct estimates of households’ discount rates for payments very far in the future, by studying the valuation of very long (but finite) assets. We exploit a unique feature of residential housing markets in the UK and Singapore, where property ownership takes the form of either very long-term leaseholds or freeholds. Leaseholds are temporary, pre-paid, and tradable ownership contracts with maturities ranging from 99 to 999 years, while freeholds are perpetual ownership contracts. The price discount for very long-term leaseholds relative to prices for otherwise similar properties that are traded as freeholds is informative about the implied discount rates of agents trading these housing assets. This allows us to gather information on discount rates much beyond the usual horizon of 20-30 years spanned by bond markets.

This analysis suggests that long-run discount rates are significantly lower than those we use for project evaluation – in the range of 2.6%. In other words, people making significant financial decisions today place some value on outcomes for future generations that they will never meet:

We use these estimated price discounts to back out the implied discount rate that households use to value cash flows to housing that arise more than 100 years from now. We find the discount rate for very long-run housing cash flows to be about 2.6% per year. Interestingly, we find similar implied discount rates in both the UK and in Singapore – two countries with very different institutional settings.

The authors suggest that their findings have implications for intergenerational fiscal policy and climate change policy. They’re also likely to have implications for the way we evaluate transport projects. Today’s planners should take care to preserve and improve transport options for future generations, rather than “locking in” a particular urban form.

Finally, with that in mind, it’s worth recalling the findings of the 2012 City Centre Future Access Study, which compared options for improving transport capacity to Auckland’s growing city centre. In Section 7 of the Technical Report, the authors found that when a longer evaluation period (60 years vs. 30 years) and a lower discount rate (5.7% vs. 8%) were used, the benefit-to-cost ratio of the City Rail Link almost doubled. In other words, the CRL looks even more valuable for Auckland if we take a longer-term view.

If our great-grandparents had decided to invest in Auckland’s rail system in the 1930s, we’d still be thanking them for it. Because they didn’t, though, we’re just getting around to electrifying Auckland’s rail network and still debating whether to build the CRL to unlock greater frequencies across the entire network. It is essential that we take a longer-term view on transport investments than we have previously done.

So, what’s your discount rate?

68 comments to How should we value the future?

  • Fred

    It’s always seemed odd for rail projects in particular that we ignore benefits past 30-40 years. Every day London and New York benefit hugely from investments in their underground rail systems made well over a century ago.

    • mfwic

      Yes but the longevity of the project isn’t the point. The point is how much would you spend today for a benefit that will accrue to someone in 30-40 years? Personally I wouldn’t spend anything for additional benefits in 100 years because I don’t know how they will want to travel so it would probably be wasted. Benefits in 30-40 years are worth something to me but not much. In 30-40 years if people still want the facility then they will make a decision to keep it open for the next 30-40 years, they inherit it for free but that has no real value to me.

      • Dave B (Wellington)

        Mmmm. Good reason for questioning the proposed investment of $Billions in Roads of National Significance. Will they turn out to be poor investments in 10, 20, 40 years’ time?

      • Peter Nunns

        That’s exactly the point – we’re talking about rate of time preference here. I definitely acknowledge that different people may have very different views on discount rates.

        However, my point in publicising the research by Giglio, Maggiori and Stroebel (2014) was to draw attention to the fact that many people explicitly _do_ choose to value future outcomes quite highly. On average, people are willing to pay 10% more for a freehold than a 100+ year leasehold property, in spite of the fact that they won’t even be alive to enjoy the house at that point.

        In other words, high discount rates don’t seem to be the norm for long-lived assets…

    • Chris

      Yea mfwic is right. Discounting future benefits is not ignoring them. It’s just saying that a benefit in 40 years time is not as valuable as a benefit now. If someone promised to give you $1 in 40 years time it’s not as valuable as someone giving you $1 right now (in which case you could invest that $1 and have turned it into around $10 in 40 years time). If someone then asked you to spend that $1 on a transport project for which you’d get a benefit in 40 years time, that benefit would need to be worth around $10 (not just $1) for it to be a sensible investment. The difference in value due to timing is what discounting tries to account for.

      I don’t know if further reducing the discount rate is very responsible though. Whilst it would make the CRL look better, it would also make a whole lot of other projects all around the country look better as well. The economics of all the motorway projects might just get the same treatment and have their BCR’s doubled as well. In the end it would generally encourage more spending, which I’m not sure is a good thing at the moment.

  • The Harbour bridge is 55 years old which means we must get no benefits from it, does that mean we should shut it down?

  • Patrick R

    Everyday thousands and thousands of train journeys are taken in a tunnel under the Thames that was dug in 1843. It has had one refit. Rail tunnels in particular are hugely long lived.

    To evaluate the the CRL with a model that says it will have only 20% of its current value (if open today) in 2031 and no value at all in 2051 is clearly absurd. This is how we are poorly served by our institutions and why we have such tatty cities built only for the day after tomorrow.

    Auto-dependency is the ultimate in short termism. Beggaring our kids and grand kids.

    • mfwic

      But they are not trying to predict future values of the asset to people in the future. We discount to reflect the present worth of a future benefit the value of their benefit to us right now. I used to walk to work along a road build by Roman soldiers but it would have been daft for them to include any value to me in their decision to build the road. Noone is saying CRL will be worth 20% of its current value in 2031, they are saying its effects in 2031 are only comparable to 20% of something that has benefit right now. We all discount in our values, politicians by about 30% given the 3-year cycle, the rest of us have an opportunity cost for our capital, if you owe money on your credit card it is 20%, if you have a mortgage it is around 7% and if you save it is maybe 4%. The issue is what level should we use for infrastructure spending.

      • Greg N

        mfwic,

        The CRL would officially be only be worth 20% of its current value in 2031 (if it was built now), not because 80% of it has been used up by then, but because the projected life-time of its benefits is artificially set to only 30 years.

        So what that 30 years really means is that the economists believe all the “additional” benefits from building the CRL are assumed to have been realised (aka “consumed”) within the 30 years and after that time the cost of maintaining it more or less equals the value of the remaining benefits you’ll get from it – i.e. its neutral after that point at best, and may even start costing more money than benefits.

        The lifespan and discount rate are important and the Benefit-Cost Ratio (BCR) factor both together to allow the relative merits of similar projects to be determined.

        The Discount rate used has a big impact on the BCR of a project as that determines how much large the benefits the project can deliver over it lifetime, then puts a value on those benefits “now”.
        Witness how a 5.7% discount rate and longer life span to 60 years doubled CRL BCR.

        For things like rail tunnels and the like, the ongoing costs are bugger-all and they keep giving benefits – yes not as much benefits maybe as when it was newer, but still gives benefits for quite a long time.

        Whereas a road, is a different kettle of fish, after 30 years its a liability usually and needs lots of expensive maintenance to keep it going and is only kept in use usually because the cost of building a bigger/newer road is so horrendous.

        NZTA treats all non-road projects as if they were roads (and thus giving them high discount rates) and does everyone a huge disservice as it makes the roading projects “worth more” as they deliver the benefits sooner so have a higher “present value” – while ignoring their ongoing and true lifetime costs.

        Higher discount rates reward/encourage mostly short-term projects as they deliver valued benefits sooner but then don’t/can’t (by design) deliver them for as long as the projects with longer life spans or lower discount rates – whose value in todays terms is less.

        So you end favouring a never-ending stream of roading projects each one designed to extend or replace the benefits of the previous roading projects who have now reached their end of life.
        Sound familiar?

        It’s basically the same as how frakking works – you tap each well, rape and pillage it to release all its oil as quickly as possible, flare off the gas a nuisance by-product, pollute the crap out of the clean water supply, use up the oil quickly, then rinse and repeat on the next one and the one after that (and hoping for their being one after that). Of course, if the number of possible oil wells (and clean water supplies) was infinite wouldn’t be a problem, but we know the number of both is a (small and) finite number.

        And yet we carry on like there is no tomorrow, that these wells will never run dry or that there are no long term consequences.

        • Chris

          Here’s the NZTA paper explaining why a 6% discount rate was chosen: http://www.nzta.govt.nz/planning/investment/docs/research-paper-on-discount-rate-revisions.pdf

          Here’s a quote from it…
          “In the absence of any taxes or other distortions, the selection of a discount rate is conceptually straight forward. In this case the marginal return on capital in the private sector and the rate of time preference (or the consumer interest rate) would be equal, and either rate would be appropriate as the public sector discount rate.”

          The discount rate is based on the economic conditions like interest rates, not on project-specific things like expected maintenance costs.

          • Peter Nunns

            Correct. However, I would note that discount rates derived from private bond markets are inevitably going to be on the high side, as these markets have a time horizon of 10-30 years at most. (The longest-term bond issued by the NZ government is 10 years, while the US government issues bonds with maturities up to 30 years.)

            My point in this post was to point out that data from other markets could be used to gauge discount rates over a much longer period – 100+ years. In my view, such an approach might be better-suited for evaluating outcomes from long-lived infrastructure investments.

        • mfwic

          No Greg you have missed the point entirely. Life span and discounting benefits are not in any way related. Discounting is figuring out how much of the future benefits to put into the present year analysis and is completely independent of the lifespan of a project. Economists don’t believe the benefits are ‘used up’ quite the opposite and they don’t think the CRL will be worth 20% of its value in 2031. They are only trying to assess what proportion of its future benefits belong in the present year analysis and should influence the decision to build or do something else with the money. In 2031 CRL will be worth 100% of its value if you do an assessment then. It’s true that higher dicount rates favour investment decisions that have higher short term benefits, thats why we argued treasury down from 10% to 8% and now to 6%. At 10% we only built projects that answered immediate problems and didn’t build for growth. But that didnt mean the projects had less value in the future. You have to discount because a dollar now is worth more than a dollar in 1 year. The question is what level to you use and that can only be answered by looking at your cost of capital and risk. Some other countries have lower costs of capital and less risk.

    • MFD

      “To evaluate the the CRL with a model that says it will have only 20% of its current value (if open today) in 2031 and no value at all in 2051 is clearly absurd.”

      You are correct – it is absurd…but it’s also a strawman argument. The CRL has not been evaluated with such a model.

      1. The figures from Chris Parker’s paper are incorrect so there’s one of the absurdities dealt with.
      2. Discounted cashflow analysis states that a dollar of net benefit in 2051 is worth the same to the beneficiaries in 2051 as a dollar of net benefit in 2014 is worth to the beneficiaries in 2014. It’s how much a dollar of net benefits in 2051 is worth to an “investor” in 2014 that is the issue.

      • Peter Nunns

        Nope, Parker’s figures are correct. They can be verified in under a minute with some basic arithmetic. However, his presentation of the 40-year outcome under an 8% discount rate is slightly misleading, as (1-0.08)^39 equals ~4% rather than 0%.

        However, the NZTA’s procedures at that point specified that no value was to be placed on outcomes more than 30 years in the future. (I.E. an evaluation period of 30 years.) Consequently, his graph accurately reflects the existing evaluation procedures.

        • MFD

          It’s 2014 now Peter and it is reasonable for the reader to expect that “now” refers to 2014. Parker’s figures are no longer correct and the title of figure 1 clearly refers to the effect of discount rate and not term limits.

          • Peter Nunns

            That’s funny. I thought it would be reasonable to assume that anyone who was pedantic enough to quibble about a few percentage points of difference in a graph would also have noticed my comment that the paper was published in 2011.

          • MFD

            “an 8% discount rate…means that we place no weight on outcomes that occur 40 years in the future”

            Your words. The fact is it was an edict that outcomes 40 years in the future should not be accounted for, not the 8% discount rate. The net result was a perception for those unfamiliar with DCF that added to the perception that somehow there is no value in net benefits 40 years out.

            I don’t dispute that lower discount rates should be considered but, as I have noted elsewhere, the assumptions re net cashflow (or proxies thereof) have a major bearing on BCR (revenue streams for RONS being a particular case in point).

  • Greg N

    I think that part of the problem here is that NZTA is using a higher discount rate to offset the known higher maintenance costs of roading projects versus rail/tunnel/bridge type projects.
    Compare the Thames tunnel having had 1 major refit in 170 years, versus any motorway project in NZ which is seemingly continually maintained and the roadway resurfaced more than once in its lifetime.

    I have no problem with a higher discount rate for roading projects as they will invariably need higher ongoing operational maintenance and renewal over the “30 year” or whatever projected lifetime of a road. So their BCR’s should be subject to the higher discount rate to offset that higher maintenance.

    But for tunnels and bridges, a lower rate is justified to account for the lower maintenance costs.

    As is pointed out above, the harbour bridge is still returning benefits some 55 years later, yet by most NZTA discount models would have assumed to have been scrapped by now and have replaced with a new bridge and be halfway through that lifecycle as well.

    The same with the St Johns Rail tunnel on the Eastern Line – built in the 1920’s, its still going strong after 85 years and will no doubt do so for another 85+ years to 2100 and beyond.
    Yet the adjacent tunnel that would be needed for the 3rd (and 4th) main lines there, if an when built would be subject to a much higher discount rate even though its ostensibly nothing but a newer version of the same.

    CRL will be more like the Thames tunnel for its lifespane and maintenance requirements than the Waterview tunnel.

    All this really does is underscore how much the NZTA is actually the “NZ Tar-seal Agency”, both in their thinking and practises.

  • Neil

    The new discount rate is very similar to that used by the Commerce Commission to determine fair pricing for regulated companies such as Vector, Chorus and airports. It is related to what these companies must pay to borrow money in NZ, and is a mix of required dividend rate and long term bond rates. Such rates are much lower than in countries such as Singapore. The maximum rate for a bank term deposit in Singapore is about 1.5%. Dividend yield for a property trust are about 4% against 78% in NZ.

    What Greg has highlighted is the very conservative life of major assets, and estimated maintenance costs. I agree with him that the lives in particular need to be challenged. Engineers tend to be hopelessly conservative.

  • Brendon Harre

    Lyttleton rail tunnel -147 years old and still going strong. http://en.wikipedia.org/wiki/Lyttelton_Rail_Tunnel.

  • Brendon Harre

    I think the most important factor not considered is that transport infrastructure should go in advance of urbanisation (or al least the setting aside of ‘right of ways’). That insufficient funding of transport should not an excuse to impose UGB that double house prices and more than double buildable plot costs. Transport infrastructure should play its part in keeping property values low and stable. It is foolish to insufficiently fund transport if the end result is that kiwis are paying many times the amount in higher property prices and lost productivity.

  • Brendon Harre

    From http://www.interest.co.nz/opinion/70493/fridays-top-10-brendon-harr%C3%A9-national-vs-labour-housing-affordability-uk-councils-spy-

    9. The NZ Initiative recently came out with their latest thoughts on housing affordability. There is much of merit there especially the chart on page 27 comparing Ikea’s prices in various European countries. Britain being 20% higher than ‘right to build’ Germany.

    I think Alain Bertaud discusses agglomeration economies better though. He explains in ‘Cities as Labor Markets’ that these result from cities generating scale economies by firms reducing costs per unit, knowledge spillovers, and lowered transaction costs due to more competing suppliers and consumers in close proximity. Importantly he gives some empirical data on this effect.

    In Korean cities, a 10% increase in the number of jobs accessible per worker corresponds to a 2.4% increase in workers’ productivity.

    Additionally, for 25 French cities, a 10% increase in average commuting speed, all other things remaining constant, increases the size of the labor market by 15 to 18%.

    In the US, Melo et al. show that the productivity effect of accessibility, measured by an increase in wages, is correlated to the number of jobs per worker accessible within a 60 minute commuting range. The maximum impact on wages is obtained when the number of jobs accessible within 20 minutes increases; within this travel time, a doubling in the number of jobs results in an increase in real wages of 6.5%. Beyond 20 minutes of travel time, worker productivity still increases, but its rate decays and practically disappears beyond 60 minutes.

    Both papers demonstrate that workers’ mobility –their ability to reach a large number of potential jobs in as short a travel time as possible, is a key factor in increasing the productivity of large cities and the welfare of their workers. Large agglomerations of workers do not insure a high productivity in the absence of worker mobility. The time spent commuting should, therefore, be a key indicator in assessing the way large cities are managed. (p. 24, 25).

    • Agree that plumbing is key. As a method of planning, I’d argue it’s number one on the list as you can plumb or connect anywhere, but the business case will vary.

      Without plumbing, you’re on a hiding to unhappy people. I forget who posted it here, but someone did suggest Auckland simply focus on connectivity ( plumbing ), and leave the types of building that occurs as a result largely to the market or “what works”.

      We could and do, do worse.

  • Sailor Boy

    I think it is important to note as well that rail benefits being bigger in 30, 50,100 years, versus roading benefits being more immediate and reducing overtime due to the urban development outcomes. So it is very difficult to actually compare them directly….

  • Stu Donovan

    The (very important) question raised in this post is not “why discount” but “how discount”.

    As Peter points out, NZTA uses a relatively “high” discount rate compared to 1) how other countries evaluate transport investment and 2) how people themselves seem to value long-term discount rates. I also disagree with those that suggest reducing the discount rate will *necessarily* lead to more spending. The reason being that under NZ’s hypothecated transport funding policy, the budget constraint is imposed by future revenues – not by the value, or otherwise, of projects.

    So to re-phrase the point Peter is making: Of the $4 billion p.a. we invest in transport projects, perhaps we should tilt the balanced more towards projects that deliver long-term benefits? As someone who values the world my children and grandchildren live in, I tend to agree with him (NB: That’s not implying people with a higher rate of time preference don’t share my values, I’m just pointing out that many people do value benefits that extend well beyond their lifetimes for what are, well, “human” reasons).

    • mfwic

      The great cathedral builders of Europe certainly had a lower cost of capital and were prepared to spend money and their lifetimes building something that could never be finished in their own life. But that required faith that their work would still be relevant to future generations. The problem with transport is we cant know what will be wanted in 100 years as things change so much. Look at how the harbour bridge was built to allow ships to the Pollen Island port that didn’t get built. And now ships are so much larger that it could never be built even if people wanted it. Guessing transport 50 years out is just a guess. The 10% discount rate was simply short-termism. But at 6% we are close to the cost of capital (risk adjusted, and there is risk here). A lower discount rate doesnt result in higher spending as the funding cutoff changes to suit, but efficient decisions require a realistic cost of capital.

      • Stu Donovan

        sorry mfwic but in this case I think your comments are blurring the line between *opinions* and *facts* (easy to do I know, I do it myself).

        I think your suggestion we *don’t know what will happen* actually stems from your expectation that technological change in the future could render present-day investments redundant. As a result, of course you will argue for a higher discount rate. But it’s important that the discount rate used when making public investment decisions represents not just your time preferences, but that of wider society.

        I also reject the suggestion private “cost of capital” (as defined for example by 5 year Government bonds) is a reasonable way to make public investment decisions. As Peter points out, economic research into the value attached to leasehold properties shows *the private sector* attaches a much lower discount rate to some long-term investments. Indeed, the relevant discount rate is very much a function of 1) the cost of capital of the investor and 2) the nature of the investment. Hence it is not necessarily reasonable to use the same generic discount rate applied to private sector investment.

        I guess what I’m saying is that your entitled to your rate of time preference, but don’t think it’s representative of the discount rates that are held by wider society. As the evidence presented above suggests, I think you have an uncommonly high rate of time preference. I actually think the Government’s ability to get away with the RoNS programme without losing too much support partly reflects the fact that most people are actually prepared to invest now to realise longer term payoffs. Another example is people’s willingness to invest in other people’s education, even though the benefits are both dispersed and relatively long term.

        • mfwic

          Yes Stu but the government still has a cost of capital just as an individual has a different cost of capital. Many of us accept a lower return on a leasehold property because of the lower risk it presents ie it will still be a house at the end of the investment period while a cash investment might be worth less because the Government can allow inflation in order to reduce their own debt. In accepting a lower return we are paying a premium to keep our capital intact. It makes sense for the government to require a discount rate set at their cost of capital (plus risk) for future returns as otherwise they could invest elsewhere and purchase the asset later. Set the discount rate below that level can only result in inefficient decisions. Set it too high and same occurs. I dont think my cost of capital is higher but my value of risk is probably much higher than some people as I have experienced double digit inflation, 15.5% interest rates and seen the think big debacle where tax payers money was risked trying to predict future petrol prices.
          It is not just technological risk that matters, fuel supply risks have got to be considered both for motorways and for rail and buses ( the marginal cost of electricity is still determined by thermal generators). However you cut it transport returns have a risk that requires a premium over the risk free rate of return.

          • Stu Donovan

            Nawwwww I still disagree with you.

            You state: “It makes sense for the government to require a discount rate set at their cost of capital (plus risk) for future returns as otherwise they could invest elsewhere and purchase the asset later. Set the discount rate below that level can only result in inefficient decisions.”

            In a hypothecated transport fund (like we have) the amount we spend on transport is defined by revenues. Surplus revenue is not able to be transferred into other areas of Government expenditure, although the reverse can happen, i.e. Crown funds can be appropriated into the NLTF).

            In this policy context (which I fully admit is not ideal from an economic perspective), it seems entirely appropriate to set a lower discount rate than what would be applied to other parts of Government expenditure – provided that it aligns with the social rate of time preference that wider society attached to investment in transport.

            What you’re arguing seems to only make sense in a situation where the transport fund is not hypothecated.

          • mfwic

            In the not too distant past the Government has diverted transport revenues into other areas arguing that health costs and policing etc are caused by transport. The current funding arrangements are just that, the current ones. Capital rationing is a reality but the way to deal with that is the B/C cutoff. But as you say crown money can go to the NLTF so that represents the marginal revenue. The money has a cost to the crown and we can only get efficiency if the discount rate follows the cost of that capital. The level of risk could be argued form many directions, I say it requires a premium and a significant one.

          • Stu Donovan

            as far as I understand revenues from the NLTF are already diverted from transport into road policing.

            But my point is that the hypothecation of the NLTF is the policy framework we currently have, in which case your objection that transport funds should reflect a general cost of capital because they could be better used elsewhere is, well, a fallacy. Legally they can’t – apart from the funds for road policing noted above.

            Note also that (I think) Crown money can only go into NLTF when it’s tagged to specific projects, e.g. Northern Corridor upgrades. Hence it’s incorrect to suggest the marginal cost of capital of Crown appropriations should set the marginal cost of capital for all projects considered for funding under the NLTF. They’re legally separate.

            I agree the money has a cost to the crown, but that’s considerably lower than the current discount rate. And the latter is also higher than the risk premium that private investors attach to long-lived assets, e.g. leasehold land.

            You could also argue that transport investment has a lower risk premium than other areas of Government expenditure, because the outputs are typically tangible infrastructure/services.

          • mfwic

            Stu it makes little sense to say legally they cant divert funds. If politicians decided that is what they wanted to do then they would change the law, transport funding systems come and go with fairly short lifespans. The fallacy is your ‘appeal to authority’ not my claim that if increasing funding for transport was likely to gain votes or alternatively milking the transport cow was politically expedient then you can be sure that is what they would do. I accept that longer term rates are lower than shorter term but the risk profile is exactly the opposite. I am not saying 6% is the right rate but I am saying I think the rate should always reflect opportunity costs which include using the money for other activities or even not raising the money in the first place and allowing others to make better use of it.

    • MFD

      “under NZ’s hypothecated transport funding policy, the budget constraint is imposed by future revenues”

      *Assumed* future revenues or monetised equivalents. Isn’t that one of the weaknesses of the RONS BCRs? You can debate the value of the discount rate until the cows come home but the NPV is also sensitive to future cashflow assumptions and to how non-cash benefits (and dis-benefits) are quantified and timed.

  • Malcolm M

    All these discount values assume the investment has nil value at the end of the assessment period, and that there are no benefits due to increases in land value. For example, by how much has the Harbour Bridge increased the value of North Shore land relative to a “no-build” scenario ? The land value effect doesn’t stop at the end of the assessment period.

    The Melbourne City Loop at only 33 years old is still relatively young by world standards. It has enabled huge increases in density of the inner city, and I would expect increases in land value. For those who know Melbourne, compare the pre-Loop skyline photos below with the present.

    http://www.abc.net.au/news/2014-06-12/melbourne-underground-rail-city-loop-construction-photos/5516134

    • mfwic

      No it assumes that the present value of future asset value is nil. Its like saying it will have value to the people of the future but not to us now.

      • I understand your points 100%, but I think what Peter and Stu (and me) are saying is that the approach is just wrong – especially for non-motorway expenditure. It is not correct to say that the value it represents to people in the future means nothing now – we can definitely derive value now from the fact that the piece of infrastructure will still be there in 100 years. That is the kind of short term thinking that has caused so many problems.

        I also understand your point about transport developments – but how much real development has there been in transport infrastructure in the last 60 years? We are still travelling by automobile, omnibus, motorcycle, train, bicycle and foot. They may move faster and have more gadgets but they aren’t that different or require much different infrastructure.

        Why aren’t we learning from that? Shouldn’t we be questioning these rules when they don’t seem to match up with reality?

        • mfwic

          I think our disagreement is just about the correct rate to use rather than the concept of discounting future benefits and costs. For a government that has hospital waiting lists and child poverty the value they can get for each dollar now must be more than the value of a dollar of value they get in 2114. So it is about how to set a discount rate rather than should we use one. The Government can borrow and save and so they have a cost of capital (risk free) and so an efficient way to balance costs and returns now versus the future is to use that cost of capital, risk adjusted. As for the risk, 100 years ago most people walked or used a horse with only rich people having a car, how do we know it wont be like that in 100 years? Most of us would like to think the assets we build will still be useful in 100 years but my view is we shouldn’t place a monetary value on that in the decisions we make. Almost any discount rate makes sure we don’t.

          • Stu Donovan

            agree with you here! The disagreement is simply about what rate to use.

            And as argued above (by Peter, myself, and others) there’s some reasons to support applying a lower rate of time preference to transport investment – especially when you have a hypothecated transport fund that reduces your ability to divert revenue into other areas of government expenditure that may deliver more immediate returns.

          • mfwic

            yup and I disagree the discount rate should be lower. Where I think we go wrong with these analyses is we ignore the positive externalities of public transport, sure we get benefits of better car travel times but we miss the benefits a strong PT system can have to a city centre, we dont put a dollar value on sustainability (which can be done) and often we just find the whole assessment of PT benefits too hard so we dont do it well. But I do believe a stronger focus on economic assessment could help us get projects like CRL moving and kill off the Rons nonsense. In my view its a shame previous governments weakened the process rather than strengthened it.

          • Stu Donovan

            and I do agree with you here too.

          • Stu Donovan

            health impacts of PT use compared to other modes being the most notable example of what’s not in the EEM …

      • George D

        I will (inshallah) be alive in 40 years time, and I *right now* value that 40 year preference.

        With the very conservative assumption that life expectancy stays the same, and that New Zealanders under the age of 45 give *some* value to their future *right now* (they obviously do, or they wouldn’t save for retirement), then the discount rate does not reflect the values of New Zealanders.

        If we’re worried about future-proof investment, we should be building future-proof investments. (We don’t do much of this currently.)

  • Chris

    Points taken that in a hypothecated fund changes to the funding cutoff might be more likely than more actual expenditure.

    Even if the benefits of a transport project 50 years out were more certain, that still wouldn’t change the suitability of the discount rate would it? I thought the discount rate was determined more by the cost of capital than the uncertainty in benefits of a project? So even if we decided that we were confident that the CRL would have enduring benefits beyond 40 years, that in itself wouldn’t make it more appropriate to use a lower discount rate…

  • Mike

    Can we do Robbie the honour of spelling his name correctly? He was Dove-Myer, not Dove-Meyer, Robinson.

  • Dave B (Wellington)

    100-150 years ago, railway-building was seen as the way to go, and myriad lines sprung up all over the world ‘like there was no tomorrow’. Decisions were made to construct, often at high cost, but without a clear vision of the future. Nevertheless there was a firm belief that these assets would always be of value.

    50-100 years later, many of those same lines were falling into dis-use and being abandoned. This was especially noticeable in Britain where the “Beeching cuts” of the 1960’s slashed the network by a third. This time, decisions were made to destroy assets of huge replacement-value, again without a clear vision of the future, but this time with a strong belief that they would never be needed again.

    But “never” and “always” are easy words to say, but risky for making long-term decisions on. Today there is increasing realisation that at least some of those closed lines should have been retained, and the prospect of re-building them at even higher cost shows the dangers of “getting it wrong”.

    Over the last 50 years, governments in the English-speaking world have come to be very cautious about committing to rail schemes that may or may not have value in the future. And viewed in isolation, this might seem like a prudent measure. But what did these governments do instead? They rushed headlong into the latest mania which was of course to build roads like there is no tomorrow, and still without a clear vision of the future. No doubt many of the earlier roads have long-since repaid their costs, but the hugely-expensive and esoteric schemes proposed by our government today have all the hallmarks of yet another decision which will turn out to be wrong.

  • Darren

    An aside to the discussion: the lower the discount rate, the more emphasis is placed on our ability to forecast what the benefits will be further into the future. Not a reason not to lower discount rates (appropriate use of double negative?) but increases risk. There’s an interesting graph (French I think, Grubler?) summarizing estimated PKT by mode over the last 200 years (log scale), and not many modes feature heavily for 50+ years, TGV being the most recent facilitator of travel distance

    • Peter Nunns

      An excellent point! Investments, particularly long-lasting investments, entail both risk and uncertainty. (There is a fine but important distinction between the two concepts. Risk means that there is a known probability that an adverse outcome will occur. Uncertainty means that your estimate of those probabilities might be wrong.) That’s part of the reason why we discount future outcomes.

      Data from bond markets contains some information about this. Interest rates for private sector borrowing can be decomposed into two components: first, a rate that reflects the lender’s rate of time preference, and second, a “risk premium” that reflects the chances that the borrower fails to repay the loan. Risk premia are obviously higher for some investments than other – for example, venture capitalists demand higher returns than banks lending to creditworthy homebuyers.

      With that in mind, we might ask: Does the 2.6% discount rate estimated by Giglio, Maggiori and Stroebel (2014) include such a risk premium? I would say: perhaps. On the one hand, the legal environment in both the UK and Singapore is stable and credible, meaning that it’s possible to say with a high degree of certainty that future house ownership will be respected. On the other hand, there is still some risk and uncertainty about the future value of houses in those areas – if the UK economy collapses, houses in London may not be worth much in a century.

      On balance, however, I would expect transport investments to carry a slightly higher risk premium than housing investments.

  • Darren

    An aside to the discussion: the lower the discount rate, the more emphasis is placed on our ability to forecast what the benefits will be further into the future. Not a reason not to lower discount rates (appropriate use of double negative?) but increases risk. There’s an interesting graph (French I think, Grubler?) summarizing estimated PKT by mode over the last 200 years (log scale), and not many modes feature heavily for 50+ years, TGV being the most recent facilitator of travel distance.

  • mfwic

    On a different subject the photo of the elevated road along Quay St reminded me of the Fletchers plan in the late 1980’s to sink Quay St into a tunnel along its whole length with them then owning the real estate created! I learnt that when those ‘big-vision’ types of projects start coming up there is an economic correction going to occur soon.

  • MFD

    It’s 2014 now Peter and it is reasonable for the reader to expect that “now” refers to 2014. Parker’s figures are no longer correct and the title of figure 1 clearly refers to the effect of discount rate and not term limits.

  • Geoff Blackmore

    Unfortunately Auckland still makes these past planning mistakes, with a great example being the plan to cut back the proposed urban rail network from Kumeu to Swanson, in favour of a roading solution for Kumeu, at the very time that large scale development of the Kumeu area is getting underway.

    It’s difficult to see how Auckland will ever escape this mindset, when the PT planners themselves suffer from it.

    • Sailor Boy

      You still haven’t told us why the rail connection would be better than the busway?

      • Geoff Blackmore

        1) It’s already built.
        2) It’s faster to Henderson and New Lynn, and post-CRL to the CBD.
        3) More attractive to users.
        4) Can be implemented within months at low cost, compared to waiting decades for a Kumeu busway at great cost.

        • 1) No it’s not, significant works required at both ends to operate a regular timetable.
          2) May not be faster to Henderson and New Lynn, bus shoulders plus Lincoln Rd works will make the bus fast and reliable. Not faster to the CBD from Kumeu even with the CRL. Will be less than 50 minutes Kumeu to city with bus priority measures.
          3) Very debatable whether a once an hour shuttle to a transfer at Swanson is attractive to users. Perhaps users that have nothing important to do, don’t mind wasting their time but love trains. Everyone else would probably prefer the minimum half hourly direct bus from the RPTP.
          4) Decades? The bus already runs, and NZTA are building the bus lanes as we speak.

          • Geoff Blackmore

            1) Minor, not significant.
            2) Irrelevant, different catchments with different travel patterns.
            3) What you describe as unattractive is precisely how Pukekohe rail was established. It works.
            4) Not from Kumeu they are not. But somewhat moot, see point 2.

            Let’s face it, Auckland would have no trains if AT had come about 15 years earlier. Thank goodness the people who put Kumeu rail into the Rail Development Plan were in charge. Don’t kid yourself, AT has only supported the legacy projects it inherited. The one outstanding RDP project that they could rightly claim as theirs rather than inherited is the one they killed off.

            But all is not lost – when the new network goes to consult, AT is going to be bombarded with pro-Kumeu rail submissions.

          • Stu Donovan

            Geoff,

            As has been explain to you over and over before, the costs of a diesel shuttle btw Kumeu to Henderson would suffer from very high capital/operating costs and very low demands. So much so that you’d probably end up building the NW busway as well.

            More importantly, you’re off-topic. May I ask that you don’t comment on rail to Kumeu anymore on this blog? You bring it up over and over and add nothing new to the discussion. It’s a somewhat obsessive little hobby horse you have that I think detracts more than it adds to your comments …

            If you’re really passionate about it start your own blog on the topic.

          • Nick R

            I think you misunderstand me Geoff, I’m saying the bus may well be faster from Kumeu to Henderson , than a diesel shuttle with transfer to the western line at Swanson.

            As for AT only supporting ‘legacy’ rail projects, what would you have them do? Go out of their way to invent even more spurious rail extensions just for the sake of doing something different? Only doing thinks nobody has thought of it before sounds like a terrible approach to planning.

            It’s hardly a point to make, AT have done far more progressing the CRL and airport rail line than any other agency has in the past. Anyway, they fact they aren’t wasting time and money on bad ideas speaks more than if they went out to deliver every harebrained idea that ever go mentioned in an old report.

          • Dave B (Wellington)

            Agree with you Geoff.
            The “hourly shuttle” argument is a bit of a red herring, as this could only be justified as a temporary place-holder measure while a comprehensive strategy for electrification is developed. However it at least keeps alive the principle of rail services running beyond Swanson. Once this is reliquished it is likely to be that much harder to make a case for developing rail in the future.

            One interim solution I don’t believe was considered is to diesel-haul a CAF set from Swanson to Waitakere (or wherever). This used to be done with English Electric units between Paekakariki and Paraparaumu prior to the electrification being extended in the 1980’s and it worked well. Similarly, Ganz Mavag units are diesel-hauled through the Rimutaka Tunnel to provide special trains for Martinborough Fair days. Whether the CAF units have been designed to permit other-than-emergency diesel-hauling I don’t know, and if not then this option will have been closed off, but if do-able then it would present a far better and cheaper way of sustaining a service north of Swanson than maintaining a dedicated dmu shuttle.

            As far as express bus vs longer-term upgraded rail is concerned, I believe there would be no contest. An EMU running from Kumeu to Henderson, then limited-stops to the CBD via the CRL would win hands down. As indeed a high-quality rail service to the North Shore would offer something better than the North Shore busway, particularly if it offered a through-service without interchanging to other destinations on the existing system. The attractiveness of quality rail services over-and-above what buses can offer should not be downplayed.

            I agree Geoff, that we are “thinking small” in these matters, and I blame this on the mentality of the current Govt which forbids any consideration of largesse on anything other than roading.

          • Nah Dave, trying to keep this service alive for three people is ‘thinking small’. I’m glad AT are pursuing the big fish instead of this wasteful distraction. Let that development up there happen or not, while we seriously grow the rail ridership pie by chasing the big opportunities then we can revisit this route.

            By decade’s end we’ll have well doubled current ridership and Kumeu will have grown or not. Rail will be able to attract the investment it deserves on the back of this growth, and the way to make this work is with electrification, not a shuttle.

          • Stu Donovan

            Dave B – could not disagree with you more. Blowing PT’s capital and operating budgets on low value projects now is undermining the case for future investment. And there will always be a budget constraint of some form, even under a Green government.

            For this reason we’re better off abandoning poorly performing rail services (especially those that can only operate with diesel shuttles), thereby freeing up funds to re-build the core of the rail network (including CRL, rail to Pukekohe, and level crossings) and only then considering opportunities for network expansion.

            There’s a mountain of analysis internationally showing that rail networks benefit from strong economies of density, which is not surprising given their cost structures (i.e. high fixed costs). This means you’ll generally get more return (lower costs, greater benefits) from running additional KMs in the existing network than you will from expanding the network to new areas.

            So my argument is exactly the opposite: If you want Auckland’s rail network to grow in the future, then you’re better off consolidating services around areas that are performing well. If that means cutting services to some poorly performing stations then so be it. Once we have a kick ass rail network operating at metro frequencies in the metropolitan urban area then we can (and should) consider potential lower frequency expansions to more far-flung satellite areas (other than Pukekeohe).

            But you (and Geoff) are well and truly guilty of putting the cart before the horse. This is not about “aspiration” it’s about knowing the best strategies for getting a high-performing rail network in Auckland in the future. And that demands a strategy that focuses on patronage, not network coverage.

            P.s. Reinstating services to Kumeu at some later date is not that hard, provided the electrification costs (not insignificant given tunnel at Swanson) are able to be funded.

          • Geoff Blackmore

            Stu, it’s not off topic at all, the topic is about how Auckland rail plans throughout its history have been canned. It’s bang on topic actually. You’ve rationalised the canning in the same way that those responsible for earlier rail project cannings did. Their decisions made perfect sense to them as well.

            You say Dave and I are guilty of putting the cart before the horse, yet you totally ignore history when you say that. Every aspect of growing Auckland rail has been by starting small. Put simply, if your approach had been taken from the start, Auckland would today have a bus only PT system.

            Patrick, you say “and the way to make this work is with electrification, not a shuttle” – yet that’s not how outer urban trains in Wellington are set up is it? It’s also not how Pukekohe was established, or even how it will operate for the forseeable future. Why should Kumeu have to go with an expensive start-up cost, straight to fully electrified, when that’s never been a requirement anywhere else? I say treat Kumeu exactly the same as Pukekohe. Start small and grow it from there. In fact I put it to you that your method of going straight from nothing to something that will cost $100m+ to set up, is so unrealistic and unlikely that it will only ensure nothing ever happens, and roads remain the only option.

            Let’s not repeat the Botany/Flat Bush mistake in Kumeu. Not when there’s a railway already there that people will use if an outer urban service is provided.

          • Mike

            Dave B – even if the CAF units can routinely be diesel hauled, there are still major costs to be overcome before they could be hauled beyond Swanson:

            a) the new signalling at Swanson would need to be modified to allow splitting/joining trains;
            b) since no passenger diesels in NZ are double ended, if the CAFs aren’t equipped for push-pull operation either two crew members would have to be on the loco, or two locos would have to be used back to back, or a single loco would have to be turned at Waitakere (assuming the turntable there is still operational);
            c) the one/two locos would have to be allocated full time, probably dedicated and fitted with CAF-type couplers.

            So, an expensive business – much more expensive than a DMU shuttle, I would think.

          • You don’t get it Geoff, Wellington is no model. Rail in Auckland is out of the coffin and on the way moving serious volumes with high frequency high quality services at the heart of an pan-modal integrated system.

            We do have the enthusiasts, the passionate rail community, to thank for saving the network from total death but that phase is over now. Which is great, now is not the time for nostalgia and war stories, but time to build the new.

          • Geoff Blackmore

            Exactly Patrick, I totally agree with you – it’s time to build the new. And with the northwest set to become one of the fastest growing areas, and a railway already very conveniently linking the communities of Helensville, Waimauku and Kumeu to the also-fast growing metropolitan centres of Henderson and New Lynn, a rail service is a no-brainer.

            Interestingly, those who reject Auckland having an outer-urban rail service were saying just last year that the concept should be revisited in 20 years. The SHA’s have now accelerated that northwest growth so that what just 12 months ago was projected for 20 year’s time, will now eventuate within 5 years. So by their own assessment, it’s now time to revisit the concept again.

  • Well another way of looking at this to project it backwards. So instead of trying to guess the value of a project in 2031, or in 15 years, what if we consider what it’s value would have been if it had opened 15 years ago, ie 1999.

    Let’s take the CRL. Would it really only have 20% of the 1999 value to us now? Given how much it would have altered the whole shape of the city in those 15years improved connectivity and functionality of the whole wider city it is hard to imagine that this figure could be in anyway accurate.

    Especially as 15 years is such a short period, the majority of people choosing to fund it would still be working and many still using the asset itself and the wider city….

    Anyway, as Peter and Stu write above the decision about the level of the discount rate is essentially a value judgement about the future: should we only act with very short term interests, or should we attempt to build more ambitiously and generously for the future? What sort of world should we make for future generations, but given that 8% values even a short period like 15 years so low, it is also how much do we value the world of future selves?

    This high discount rate does go a long way to explain the crappy built environment we have built since the middle of the last century. Perhaps now the nation is a little older we can now grow up a little and not just think of tomorrow, but think a little more expansively about the kind of nation we are building…?

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