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Wise words from the (Australian) Productivity Commission

One of the best things done recently by governments on both sides of the Tasman has been the establishment of Productivity Commissions tasked with investigating the economic efficiency (or lack thereof) of various policy areas. The NZ Productivity Commission, which only started up in 2011, has been diligently building an evidence base on issues as diverse as international freight, service sector productivity, and land use policies.

Transportblog reviewed their recent inquiry on using land for housing, which had some excellent insights and recommendations. Not all of the recommendations made by the Commission have been picked up (yet), but they form a useful basis for future policymaking.

We’ve been paying attention to the NZ Productivity Commission, but it’s also worth keeping an eye on the Australian version, which is grappling with many of the same issues. They recently published a nice summary of their 2014 inquiry into public infrastructure, which highlighted some key steps for improving the efficiency of public investment.

The Commission highlighted the scale of capital investment. Australia’s expecting to spend megabucks on new capital investment, most of which will go into the built environment – i.e. houses, roads, railways, water infrastructure, etc:

In 2013-14, there was an estimated $5.1 trillion or more of installed capital that was available for use in the Australian economy — over three times the value of production in that year (figure 3.1, top panel). Over the next 50 year period, the Commission has estimated that new capital investment will be more than five times the cumulative investment made over the last half century to around $38 trillion in today’s prices (PC 2013).

The largest component of today’s installed capital is in the form of non-dwelling constructions — which consists of non-residential buildings (i.e. buildings other than dwellings, including fixtures, facilities and equipment integral to the structure) and other structures (including streets, sewers, railways and runways) — which amount to over $2 trillion (or 43 per cent of the total). The next single most important component relates to dwellings, amounting to around 35 per cent of the total installed capital (figure 3.1, bottom panel).

Given this, it’s important to get new public investments right:

Additions to the stock of capital will usually increase output and add to labour productivity. However, for productivity to improve, the growth in output must exceed the growth in inputs. Poorly selected projects can detract from productivity as the resources they use would have delivered a higher output elsewhere in the economy.

The Commission had some stern words about the quality of decision-making about public investments. Their analysis suggests that “there is considerable scope to improve the quality and efficiency of government investment in public infrastructure investment in Australia”.

This could probably be translated as: “You guys are doing a bunch of stupid stuff. For the love of god, please stop it!”

traffic avoids clem 7 tunnel

Brisbane’s Clem 7 tunnel cost heaps and has lost money for all of its investors.

So how could infrastructure investment improve? The Commission discusses public-private partnerships (PPPs) as a potentially useful option, but observes that they are not a magic panacea for bad project selection. In some cases, the PPP process can drive governments towards costly, oversized solutions:

Most relevant to enhancing the efficiency of the provision of public infrastructure is improving project selection processes. Australia’s cities and towns generally function adequately and assets undergo usual maintenance, although problems have emerged in some major cities. Nevertheless, the Commission found numerous examples of poor value for money arising from inadequate project selection and prioritisation. In particular, there was a bias toward large investments despite the returns to public investment often being higher for smaller, more incremental investments. In part, this was because the private sector is more interested in financing large investments (due to the costs involved), and governments have increasingly seen public private partnerships (PPPs) as a way of harnessing not just finance, but expertise in project delivery and operation.

Furthermore, the fact that PPPs typically involve complex negotiations and ongoing relationships between governments and private investors can make it difficult to properly assess costs, benefits, and risks. In essence, this creates a situation in which private sector involvement does not result in a better outcome, due to muddled incentives.

The Commission concluded by encouraging Australian public infrastructure providers to conduct rigorous, consistent cost-benefit analysis for all major projects and – equally important – to publish the results prior to committing to a project:

A key recommendation of the report was that governments should undertake a comprehensive and rigorous social cost—benefit analysis to all public infrastructure investment projects above $50 million. Such analyses should be publicly released during the commitment phase and be made available for due diligence. In general, cost-benefit analyses should be done prior to any in-principle commitment to a project or as soon as practicable thereafter.

Doing this would have avoided the farcical situation facing Melbourne’s East-West Link, an A$8.6 billion project to build a massive tunnel to link up several motorways:

Melbourne East-West Link tunnel portal

As far as I can tell, the project was announced and confirmed before a business case was completed or published. As a result, nobody really knew whether it was a good idea. The project was subsequently cancelled, albeit at a significant cost for cancelling the contract.

Do the figures stack up?

The truth is that we don’t know. Those against all new major road projects may not care about the figures one way or the other, but those who follow these things closely say the project is unprecedented for its lack of transparency. It’s been a nagging political problem for the government, and a key reason the East West Link is so contentious.

“Normally we would see more detail, and historically it’s been much clearer on what basis we are proceeding with projects like this,” [infrastructure consultant William] McDougall says.

“This is new for Australia,” says [transport policy lecturer John] Stone. “The fact that through all these court cases and all this political focus the government has never released its business plan – it released a back of envelope estimate – means probably there’s nothing to back it up. If they had a better number they would have put it out there.“

Fortunately, New Zealand seems to do a better job when it comes to consistent cost-benefit analysis of transport projects (although we don’t always take the findings seriously). However, there is always room for improvement. The Commission highlights three key factors that can undermine the effectiveness of cost-benefit analysis:

  • Optimism bias. There is a systematic tendency for project appraisers conducting cost-benefit analysis to be overly optimistic — the bias is toward overstating benefits, and understating timings and costs, both with respect to initial capital commitment and operation costs. Over estimates of traffic forecasts on toll roads and tunnels are a particular problem…
  • Treatment of risk and uncertainty. Costs and benefits are expected values based on the probability of different outcomes. Cost-benefit ratios may be sensitive to certain assumptions which have to be made without sufficient evidential support. For example, inappropriate assumptions about allowance for project risk in the discount rate (that is, the risk premium) may alter the ranking of projects and lead to suboptimal project selection…
  • Treatment of ‘wider economic benefits’. Infrastructure projects create direct benefits for users of the resulting service provided by public infrastructure. Where cost-benefit analysis is done, such benefits are routinely estimated and included. However, projects can also create wider economic benefits and costs. For example, investment in transportation infrastructure brings consumers closer to more businesses, potentially facilitating greater competition and leading to a more innovative and a dynamic economy. However, such wider economic benefits are hard to quantify and their inclusion in a cost-benefit analysis has the potential to show one project to be superior to another purely because of differences in the way such benefits are defined and estimated. Cautious and consistent treatment across options of wider economic benefits is warranted.

Transportblog’s highlighted a few of these issues in the past. I’ve discussed optimism bias on the benefits/usage side here and optimism bias on costs here and here. Stu’s covered off treatment of wider economic benefits here. And it’s probably high time we took another look at discount rates / risk premia…

18 comments to Wise words from the (Australian) Productivity Commission

  • JimboJones

    How about a third party does the cost benefit analysis and they have to fork out some money if they are significantly wrong?

    • Peter Nunns

      That may happen in a few cases in Australia… private investors in toll road PPPs are currently suing the engineering firms that provided the traffic modelling. (Basically, the modelling was incredibly wrong, and people lost a bunch of money.) However, the odds of this happening in NZ are significantly lower as (a) PPPs are being structured to allow private investors to avoid bearing any demand risk and (b) traffic modelling is generally conducted by public agencies, such as AT or NZTA, rather than private companies.

      Another approach is to have an independent public agency responsible for assessing projects or policies. The advantage of this is that it divorces project assessment from specific ministers/agencies, who may want the analysis to come out a certain way. This approach is currently in use in various places – e.g. the US’s Congressional Budget Office is responsible for “scoring” the cost of various budget proposals.

      The devil’s always in the details, but I’m generally in favour of having a well-resourced independent body responsible for CBAs across all of government.

      • Sailor Boy

        Is there the possibility for the government to sue the consultancies who have forecasted use on their projects far too high?

      • Stu Donovan

        that’s also the approach taken in the Netherlands, where the CPB undertakes benefit-cost analysis of government policies: http://www.cpb.nl/en/about-cpb

      • stevenz

        The Dynamic Scoring that CBO does is looking at macro effects of the budget or major legislation, on the GDP level, US budget, and behaviour on the national level. It isn’t used for specific projects at all, so isn’t comparable to the kind of CBA that is – or isn’t – done for transport projects They simply don’t have enough fiscal impact to warrant that kind of analysis. And since CBO works for Congress, it is not in a position to analyse the work of the various departments like Transportation which work for the President.

  • Dave B (Wellington)

    Thank goodness for the Board of Enquiry that called out NZTA’s “optimism bias” (figure-fudging) over the Basin Reserve flyover.
    A pity the same level of scrutiny was not given to certain other uneconomic, over-stated RoNS projects.

  • Brendon Harre

    The issue I have with cost benefit analysis of transport spending is the benefits of providing a grid of urban transport options (without mode bias) in advance of development in order to keep land, commercial and residential property affordable is not measured.

    This being the argument of Alain Bertaud as discussed recently on Interest.co.nz

    http://www.interest.co.nz/opinion/77329/jason-krupp-cautions-against-allowing-urban-planning-idealogues-have-their-way-looking (especially read the comments)

    A video of Alain Bertaud’s speaking tour last year is here.

    Transportblog have discussed Alain Bertuad ideas here

    http://transportblog.co.nz/2014/11/03/the-geography-of-joblessness/

    and here

    http://transportblog.co.nz/2015/01/13/the-geometry-of-urban-labour-markets/

    • Peter Nunns

      “the benefits of providing a grid of urban transport options (without mode bias) in advance of development in order to keep land, commercial and residential property affordable is not measured”

      This isn’t quite true. Or rather, it probably isn’t quite true, but it’s difficult to be certain given current modelling tools.

      The key issue here is induced traffic. As I’ve discussed here, building new roads tends to lead to an increase in traffic, not a reduction in travel times/congestion. The reason for this is that people change their behaviour in response to having more (zero priced) road capacity – i.e they shift modes, shift time of travel, or change where they live or work.

      In other words, rather than “banking” travel time savings from more roads, people tend to “re-invest” travel time savings into other things, such as living in a larger or cheaper house in a different location. (There are reasons to think that this might not be a great idea – Charles Montgomery argues that people overestimate the benefits they get from a bigger house, and underestimate the misery of longer commutes. But whatever.)

      Now, it’s logical to think that the perceived benefits from living somewhere else, including lower housing costs, should be roughly equal to the added travel time cost of doing so. For example, it wouldn’t make sense for someone to incur extra commuting costs of $100 a week to save $50 on their rent.

      Consequently, I’d argue that a standard BCR calculation for transport projects should indirectly reflect benefits in terms of increased housing supply.

      However, a more subtle issue is that our capital budget may be too constrained to deliver sufficient transport capacity increases to enable sufficient increase in housing capacity. If that’s the case, then we really need to ask a different question, which is whether we have cheaper opportunities to expand peak capacity on the transport network.

      • But the capital constraint in Transport is because of the RoNS. There is a strong argument to use more of the NLTF for urban high quality Rapid Transit [capex and opex] because the primary beneficiaries of a cities based on Transit for people moving are road users, especially commercial road users, because of reduction in low value driving for people moving. It is proven that investment in quality Rapid Transit generates strong uptake, particularly now in Auckland. The problem of induced traffic you mention is avoided with this type of investment.

        Building traffic congestion is current government policy. In the accelerated provision of additional roadspace years in advance of demand they are actively creating more driving and underfunding alternatives. The contrast between the funding approach to Puhoi to Warkworth and the CRL is stark. Before gov will even half fund the CRL, the existing rail network has to be broken with under capacity, whereas they attempt to justify the road with the following:

        “A key departure from road planning in the past is that the RoNS projects represent a ‘lead infrastructure’ approach. This means the Government is investing in infrastructure now to encourage future economic growth rather than wait until the strain on the network becomes a handbrake on progress.”

        For economic growth read traffic growth. They conflate the two. They are not the same thing. They used to correlate but no more. Furthermore traffic growth is congestion growth, maybe not on these two parallel oversupplied routes but certainly everywhere else on the network. Yet traffic congestion is what they claim they are fighting. It makes no sense.

        • Brendon Harre

          Patrick and Peter. I did say without mode bias, which is my take on Alain Bertaud work -he only cares about mobility of whatever form -including the ability to purchase housing close to employment. So that transport grid in advance of development can include PT, bike lanes etc. In Europe there is lots of places were PT is built before housing. There is reports of in Germany construction workers catching a train/tram/bus to work on their periphery urban development project.

          I believe that in our big cities -Auckland in particular, transit orientated developments are making more and more economic sense, but the way housing and transport infrastructure is assessed by our various local and national institutions this solution is not allowed to be the answer.

  • Graeme Easte,

    Be very wary of the various commissions and inquiries set up by this government – they are masters at obtaining pre-determined answers by ensuring that the terms of reference and the people chosen to do the inquiring are tailored to suit the government’s requirements – e.g. the inquiry on housing focussed on the supply side and in particular land supply with not a lot to say about demand – which suited a government intent on promoting sprawl and limiting regulations and plans that would encourage a more compact urban form.

    • Peter Nunns

      A fair point, but I do think that the Productivity Commissions have risen a bit above this sordid dynamic. They seem to be thinking independently, at least as far as they can within the terms of reference. It’s certainly reflected by the fact that governments seldom enact all (or even most) of their recommendations.

      This bit of work from the Australian Commission is a good example. It seems to be quite critical of infrastructure investment practices promoted by current state and federal governments – i.e. the build more at any cost, hang the BCRs, perspective. (I can’t imagine Tony Abbott being overjoyed by it.)

      Likewise, the most recent NZ Commission’s report on using land for housing had a lot of good stuff about removing barriers to developing a more compact urban form. I suspect what happened was that they realised they didn’t cover off all of the issues the first time, and came back to have a more in-depth look.

  • Ricardo

    Come on Peter. All PT costs heaps and continues to lose money for the investors (ratepayers and taxpayers) yet we continue to invest and rightly so, same as roading.

    • Yes all transport is subsidised; but not all transport is of the same value. And duplicated roads that will never reach capacity [wasteful LOS A for ever] is like building a parallel rail system next to one that isn’t near capacity and running mostly empty trains up and down it into the future, while also still running them on the old dangerous line that people have a habit of dying on because you’re now not fixing it because the money’s all gone on the new fancy one.

      Double dumb; right?

      • Just to expand on this analogy. Aiming for LOS A at all times on the roads is like saying on Transit that even at the peak of the peaks everybody must four to six seats each on trains and buses so as to nice and roomy, to reduce platform crowding, and make the whole journey optimum.

        No-one here argues for that. We expect the peak of the peak to be pretty much crush loading, the rest of the peaks to be full trains and buses, and off peak services likely to be roomy, with capacity to be filled. Anything else would be a waste.

        My opposition to this solution to the issues on SH1 north [need for a Warkworth bypass and safety improvements] is that is overkill in the same way as putting on rail services to Helensville right now would be too, as opposed to improving the bus services.

        The costs outweigh the benefits.

    • Peter Nunns

      Ricardo, this post didn’t talk about which modes we should invest in. It was solely focused on quality cost-benefit analysis, which both PT and road investments should aspire to.

      As for the cost of roads, I’ve discussed that here. Simply put, a roads-only investment policy has never been as affordable as its proponents claim.

    • Stu Donovan

      This post is talking about benefits/costs and arguing that investment should occur where the former exceed the latter. Makes sense to me.

      You’re talking about subsidies. In this context, that makes no sense to me.

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