The inflationary impact of road spend-ups

It’s time for a quick round of everyone’s favourite game, Ask An Economist. Today’s question is: What happens when the government decides to spend up large in a growing economy?

If you guessed that the answer is that it will drive up inflation and crowd out private sector spending, congratulations! You win a hug from the invisible hand. You’ve obviously either paid attention to the lessons of history or the words of latter-day popularisers of economic theory such as Bill English, who recently said that:

It was also important for the Government to run a counter-cyclical fiscal policy which, right now, meant running surpluses, paying down debt, and limiting future initiatives in spending and tax cuts to what would not push interest rates higher than they need be.

However, the government is acting as though the normal rules of prudent fiscal management don’t apply to the road budget. Instead of taking a conservative approach to transport spending, and focusing on the projects that offer the best long-term value at a relatively low cost, they’re pushing ahead with plans to build a number of expensive road projects. For example, the 2014 Budget announced another $800m in motorway projects in Auckland, paid for in part by borrowing, along with $212m in regional road projects paid for out asset sale proceeds.

As an economist, I’m nervous that the motorway spend-up will have perverse economic effects, driving up prices and crowding out other activity. When I went to look at the data, I found reasons to worry.

First, I looked at the data on New Zealand’s spending on roads (from OECD.Stat). The following graph shows investment in new or improved roads as a share of GDP. Essentially, New Zealand spent a fairly consistent amount on roads – and much less on public transport! – in the 1990s. In 2004, road spending started to increase rapidly, rising from about 0.3% of GDP to 0.7%. Unfortunately, the OECD’s data doesn’t cover the last few years, but NZTA’s data suggest that road infrastructure spending has risen further.

NZ road spending, 1995-2011

So the government has boosted spending on roads over the last decade. Has this had any impacts on inflation?

I used Statistics NZ data on inflation to examine the effects. The following graph compares the Capital Goods Price Index for civil construction, a measure of construction cost inflation, with the Consumer Price Index, which measures inflation in the general economy. (NZTA uses a slightly different composite measure of road construction prices, but I’ve chosen to look at civil construction prices as they provide a better indication of potential crowding-out effects on private construction.)

As you can see, the CGPI for civil construction tracked closely with CPI from 1995 to 2003, when road spending made up a relatively constant share of GDP. Between 2004, when the road spend-up started, and the Global Financial Crisis in 2008, civil construction prices rose much more rapidly than the CPI. Construction price inflation briefly cooled off in the aftermath of the GFC, due to falling private-sector demand for construction. But over the past two years it has again started rising faster than CPI, as a result of the economic recovery and spending on major road projects such as Waterview.

NZ civil construction inflation, 1995-2014

In short, spending an increasing amount of money building roads has coincided with a big increase in the cost to build roads. This is exactly what most economists, along with the current Finance Minister, would have predicted to happen.

Moreover, this is likely to have a significant negative effect on private construction. If you want to build an apartment building or a warehouse, you’ll have to compete with NZTA for bulldozers, cranes, and construction labour. Expect to pay higher prices as a result. If civil construction prices had continued to rise in line with CPI over the last decade, rather than being bid up by road spending, big construction projects would be almost 20% cheaper than they are now.

To be fair, other factors may have also played a role, such as the run-up in house prices in the 2000s and increased oil prices. But as Bill English says, government spending shouldn’t exacerbate the inflationary pressures that exist in a growing economy.

This is a tricky dilemma for any government. On the one hand, we do need to invest in a transport network that can accommodate future growth in Auckland. On the other hand, it would be better if the government’s spending didn’t create perverse outcomes for the private sector. If it wants to steer clear of the Scylla of underinvestment and the Charybdis of inflation, it would make sense to look at cheaper alternatives – e.g. the Congestion-Free Network.

CFN_4_SMALL

Bill English on Intensification vs Sprawl

Bill English has provided a fairly blunt but accurate explanation of the issues with urban development in Auckland. Interest.co.nz reports

With respect to so-called urban sprawl, I think that’s a nonsense. If you’re against urban sprawl and that means lower to middle income Kiwis can’t buy a house and you can’t build an apartment in the middle of Auckland for less than NZ$600,000, then that’s too high a price to pay. And if it means driving up house prices in a way that wrecks the economy then that’s too high a price to pay,” he said.

“Funnily enough the people who are most worried about urban sprawl live in the middle of the city. They don’t get to see it. How much time to they really spend out the end of the Western motorway or Botany? None actually. They think you should be able to walk to the countryside. Well…welcome to Gore. If you’re really mad, that’s where you should go. But they don’t. They stay in Auckland Central,” he said to laughter from the audience.

“What’s actually happened is that the local authorities were keen for a denser city, but the inhabitants weren’t, so they’ve jettisoned a fair bit of the densification aspect,” he said.

“So if Auckland wants to grow now, it has to grow out because you don’t want it to grow up. Now that’s a fair choice, but please don’t stop it from growing out as well, otherwise we’ll get another few years of 15% house price growth and you get a real mess when it crashes,” he said, adding the special housing areas agreed under the Housing Accord with the Auckland Council “do spread the city because the planning rules don’t let you do anything else.”

“We’re indifferent as a government as to whether you grow up or out. But you said don’t grow up, so we expect to help you grow out.”

I don’t think that all government ministers were indifferent as to whether Auckland develops up or out but from I’ve seen Bill didn’t seem too concerned with either option. As for his other comments though, he is quite correct, if intensification isn’t allowed then the only option would be to sprawl. I think it’s a message that many of those opposing intensification completely ignored.

What I don’t agree with him on is that an apartment can’t be built for less than 600,000. Many of the projects on our development tracker are certainly well under that price.

Don’t forget to make a submission on the Unitary Plan if you haven’t already they close tomorrow afternoon.

Julie Anne Genter and Bill English in Parliament

One of the most frustrating things about the process the CRL has gone through is not that the government is forcing it to go though extremely rigid analysis, but that it doesn’t require other projects to do the same. Bill English was questioned on this today by Julie Anne Genter but never seemed to be able to directly answer the question. I will say one thing though, he at least wasn’t dismissive of the project.

Also in the news about politics and the RoNS. National’s Northland MP, Mike Sabin has come out yesterday extolling the virtues of Puhoi to Wellsford. Yet at the same time he has confirmed some of the voodoo economics that seems to surround this, and many of the RoNS projects. He claims:

“The Greens would scrap this project in favour of Auckland’s rail loop, because they see it has better cost benefits than the Puhoi to Wellsford project, yet NZTA estimates this RoNS will benefit Northland’s economy in order of $35-$45 million a year, giving a cost benefit ratio of 2 to 1.”

Well let’s just look at that a bit closer. $35-$45 million a year seems fairly significant but in the context of this road is nothing. Being generous let’s say that the benefits start coming in as soon as the project starts and we use the normal 30 year assessment period, ‘et’s also ignore any of the benefits being discounted. That would give us benefits in the range of $1.05 billion to $1.35 billion over a 30 year period. Yet the road is expected to cost around $1.6 billion and that was before the recent announcement that the shorter and easier Puhoi to Warkworth section will cost around $1 billion. I don’t know how on earth you can get a BCR of 2 to 1 when the benefits achieved are less than the construction costs but that is why they are called voodoo economics.

Transmission Gully PPP discussed in Parliament

Yesterday in Parliament Julie Anne Genter asked Bill English about the PPP that is going to be used for Transmission Gully. I think the thing I am most concerned about from the answers is just how little he appears to know about the deal, something you would think he would have a good understanding of due to being the minister of finance.

Investing in Public Transport is a Chicken or Egg debate

In New Zealand, the provision of public transport seems to have really gotten into a chicken or egg debate. This is especially so with the current government who are very reluctant to spend any money on improving public transport using the argument that because most people drive, then we should invest in roads. Of course that ignores the point that so many people use roads because that was all we invested in for almost 60 years. An example of what I am talking about, skip to the 10 minute mark in this video

The reality is people aren’t going to magically use PT if is slow, expensive and not very attractive and the recent improvements in PT use have shown that even with some comparatively moderate investment, we seen patronage take off. Further most signs, especially in Auckland point to people wanting much investment in PT and it consistently seems to rate as one of the key things that people want to see improved. So with that in mind the question really becomes whether we should be using current results as the basis for our investment or something else. The council of course has produced its vision for the future as part of the Auckland Plan however transport is one of the key areas that the government disagrees with so perhaps its time the government started actually expressing their own vision for how they see the future. Developing to a vision, what ever it is, is surely going to provide better outcomes than just building more of something just because that is always what you have done. After all isn’t repeating the same thing over and over again and expecting a different result a definition of insanity?

NZTA borrowing discussed further

A lot of discussion in parliament yesterday around the news that NZTA will be able to borrow money to a greater extent than it has been able to previously.

It seems that Brownlee is playing down the impact of the proposed change – saying that it’s not much change from the status quo and perhaps even that the change is only related to changing the mechanism for funding toll roads. I’m not quite sure whether that’s correct.

Reading through comments on the earlier post has been quite educational and I think Stu perhaps put it best by saying the following:

I think we need to split out the issues here. Are the RoNS an appropriate use of public funds? Generally not. Is is in principle a reasonable idea to borrow against future revenue streams so as to fund capital improvements? Probably yes, if the improvements are worthwhile.

If NZTA does have the capacity, through the legislation change, to borrow much much more than it has previously been able to, then I think it puts a greater requirement on ensuring that money gets spent on projects that stack up well. It’s pretty clear that a number of the RoNS projects really don’t fit that criteria. To be fair, until there is a business case for the City Rail Link that finds general agreement on the project’s merit, it probably falls into the same basket. Of course I’m a bit more confident the CRL will meet that grade than projects such as Puhoi-Wellsford and the Wellington Northern Corridor.

RoNS and Treasury Guidelines

There was an intriguing question and answer session in parliament today between the Greens’ Russel Norman and Finance Minister Bill English, around Treasury’s Guidelines for Better Business Cases and the various Roads of National Significance.


The transcript can be read here.

I think Russel Norman did a pretty good job of walking Bill English into sounding like a huge hypocrite – in that supposedly the RoNS projects are the only bits of capital investment (and we’re talking $14 billion here) which don’t need to pass through the better business case guidelines. Most amusingly, it seems that the reason the RoNS projects get to bypass the process is because they were an election promise, even though the very existence of the guidelines is to temper over-enthusiastic promises that haven’t been properly assessed.

The importance of applying the business case guidelines to the RoNS projects becomes clearer when you actually look at Treasury’s process in more detail: most particularly a requirement to assess alternatives, come up with a robust ‘problem definition’, look for small-scale interventions which might delay the need for large-scale spending and largely go about justifying a project in a more robust way. From what we heard after the review of the City Rail Link’s business case last year, this is the exact process the CRL is going through at the moment.

Yet a project like Puhoi to Wellsford avoids having to have alternatives assessed, avoids having to develop a robust ‘problem definition’ (what is the project actually trying to solve) and perhaps most of all, avoids questions such as “what if we bypass Warkworth, how much does that solve the problem and delay the need for a super expensive motorway?”

Talk about a double-standard!

Oil prices and transport priorities

There was an interesting question and answer session in parliament today between the Green Party’s Gareth Hughes and Finance Minister Bill English, over the government’s infrastructure investment priorities and how they may be affected by rising fuel prices:

The full text of the debate can be read here.

If I’m being somewhat generous to Bill English, it seems that he has finally gathered a slightly better understanding of the fact that rising fuel prices may actually impact on things like road use and public transport use. In the past it seemed that many of his responses on this issue amounted to nothing more than “people will drive no matter what the price is”, which is pretty stupid and ignores what’s actually been happening in recent years.

Yet many of his responses still seem somewhat ‘out of touch’. Does he realise how expensive hybrid cars are? Does he realise how far away we are from mass producing fully electric cars at a price affordable to the general public? Could he please explain actually how public transport will benefit from the Roads of National Significance? One of these RoNS, Transmission Gully, is actually quite likely to completely undermine a big section of the Wellington rail network – something that a lot of money has just been spent (and continues to be spent) on significantly upgrading.

Furthermore, while it may be technically true that the government is spending more on public transport than ever before, inflation plus the significantly increasing number of people using PT mean that what really should be of interest is the share of transport funding that is being dedicated to PT. If funding is to follow the mode experiencing growth – which seems like a fairly logical thing to do – then the graph below indicates that PT funding should be increasing significantly and taking a larger slice of the funding pie than before: These figures just cover the Auckland area of course, but Auckland does seem to be the main area of transport debate at the moment.

Instead of responding to this growth rate, a cabinet paper by Steven Joyce noted how proud he was of “capping” public transport funding at 2008 levels, only adjusted for inflation:

I must say it seems kind of weird to boast about capping the funding of public transport services when patronage in your biggest city has increased by over 20% in three years; while you spend billions more on motorways when traffic on them is declining.

Rather weird indeed.

Bill English on transport & peak oil

An interesting question and answer session in parliament today between Russel Norman and Finance Minister Bill English. A transcript of the questions and answers can be read here.

The first thing that I noted was how hesitant Mr English was in answering these questions. Typically he answers his parliamentary questions pretty confidently – although it seems as though perhaps his knowledge of transport matters isn’t particularly great. That might explain why he often tries to get Steven Joyce to answer transport-related questions – the Greens did well to hide the transport focus of the session behind a pretty general main question or I suspect he would have flicked it on to Joyce to answer.

The other thing that I find a bit strange – and frustrating as well I might add – is how English wrote off rail projects as seemingly always having poor business cases. This may well be true for the money the government has pumped into KiwiRail over the past few years to keep it afloat (although the long-run cost of letting the rail network disappear outside the main centres and a few busy lines could well be much much higher), but it really isn’t true for urban rail projects in recent times. Rail electrification in Auckland was calculated as having a BCR of 1.5 to 1.7 – not spectacular but certainly worthwhile and certainly a lot higher the the BCR of the Puhoi-Wellsford “holiday highway”. On a smaller scale, the reopening of the Onehunga Branch Line railway was calculated as having a BCR of 3.1 – many times higher than the Puhoi-Wellsford road or the Transmission Gully motorway: both multi-billion dollar projects.

It’s also slightly disturbing that he admitted the government seems to have done little, if any, work on evaluating the effects of an oil price spike on transport investment. Just last week an excellent research paper by the Parliamentary Library was released – called “The next oil shock?” It is well worth the read, and is summarised below:

It would seem like this is a pretty important matter for the government to at least be thinking about what the impacts of a supply crunch might have on the transport sector. You know, if agencies like the IEA and the US Military reckon that a supply crunch might only be a couple of years away – it might be worth having a think about what the impacts might be on your transport spending priorities, right?

Getting back to what Bill English says in the video above, I also take issue where he says that no matter how high petrol prices get, more people are likely to drive than catch the train. Well of course, and that’s completely irrelevant. What really matters is the change in use, because that will impact on the capacity of the current systems: if the number of people driving starts declining (or even stays the same) then you probably don’t need too many more roads. Similarly, if the number of people using public transport skyrockets (even if it is far less than the number of people driving) then chances are your current system will need its capacity expanded.

This isn’t just guess-work – it clearly happened back in mid 2008 when petrol prices jumped to above $2 a litre. We saw public transport patronage skyrocket, while use of roads dropped dramatically. Is it that impossible to think that the same thing might happen again?

Seems a bit of an odd time to be spending $11 billion on more motorways over the next decade.