Many of the debates on this blog and within in the wider community about the merits of projects, or lack of them, end up coming down to down to questions of economics. But as Peter Nunns pointed out a few weeks ago in his excellent guest post, most people aren’t aware of the specific aspects that go into the economic assessment
Readers of this blog will be familiar with the notion of the benefit cost ratio (BCR), a figure that compares the forecasted benefits of a project with the financial cost of building it. It’s often used as a shorthand for the quality of a project: If the BCR is high (i.e. substantially above 1) it is seen as a good use of public money; if not, it can be criticised as a boondoggle.
Everyone plays this game. Opposition politicians often criticise motorway projects such as Puhoi-Wellsford and the Kapiti Expressway on the basis of BCRs that fall below 1, while the Minister of Transport has in the past expressed scepticism about the City Rail Link on the same grounds.
However, there is relatively little public discussion of the hows and whys of these seemingly consequential numbers. How, exactly, does one calculate a BCR?
The procedures for conducting an economic evaluation of a transport project are set out in excruciating detail in the Economic Evaluation Manual (EEM) published by the New Zealand Transport Agency. This manual defines the exact procedures that need to be followed when evaluating any transport project and specifies the values that should be used in the evaluation.
He then went on explain one of the biggest issues that exists within the EEM being the value of time figures used for travel time saving calculations and how it differed depending on the region, type of road or what mode you are using.
Well last year we learned that the NZTA were in the process of reviewing the EEM and now they have released what those changes will be. The good news is they are positive and appear to address the issues raised by Peter in his post as well as many other issues. The changes are:
- A revised discount rate of 6%, along with an extended evaluation period of 40 years.
- The addition of wider economic benefits relating to imperfect competition and increased labour supply.
- Greater emphasis on a multi-modal approach to evaluation, including:
- public transport evaluation periods made consistent with other modes, and
- equal values of travel time across modes for monetising the total value of travel time benefits.
- Discontinuing the use of default traffic growth rates. Evidence will be required to support any traffic growth assumptions.
As mentioned some of these are quite positive so let’s look at them a little closer.
Lower discount rate and longer evaluation period
These two changes primarily will benefit larger and longer term projects like the Roads of National Significance and the City Rail Link where the benefits accrue over a long period of time. This isn’t actually as low or as long as what was proposed in April last year (4% and 60 years) but is at least an improvement on what exists now (8% and 30 years). The effects of the lower discount rate and a longer time period are excellently shown in the graph below which compares the original business case of the CRL from 2011 using the NZ methodogy with that used in the UK which has a 3.5% discount rate and a 60 year evaluation period. The differences are staggering with in the UK model suggesting the total benefits would be 6 time higher than how we assessed them.
Interestingly in their FAQs about the changes the NZTA say that 6% is in line with other nations yet this chart from a few years ago shows that 6% is still at the upper end compared to many countries.
The addition of wider economic benefits relating to imperfect competition and increased labour supply.
I’m not an expert so hopefully some of you economists can explain exactly the impact that this will have.
Greater emphasis on a multi-modal approach to evaluation:
Both of the changes suggested make absolute sense and should mean that public transport projects are assessed equally rather than PT having one hand tied behind its back. The issue of value of time was covered really well by Peter and I’m not going to try and rehash it.
Discontinuing the use of default traffic growth rates
For roading projects this is a significant change as it means business cases won’t be able to just assume traffic will always grow. Constant traffic growth was a feature seen in NZ and overseas but then over the last decade or so things have changed with fewer people driving and those that do driving less. It should hopefully mean that projects like the Additional Waitemata Harbour Crossing won’t be able to just predict growth even when the numbers already show that growth hasn’t been happening.
Ak Harbour Bridge Traffic volumes
Along with the changes to the EEM, the NZTA will also be taking changing their strategic fit assessments to ensure that crash prediction is consistently taken into account.
While they came into effect on July 1, we are unlikely to see a lot of change as a result of them in the short term. The NZTA say that all proposals in the 2015-2018 National Land Transport Programme will be subject to these changes while existing projects and even new ones that enter the 2012-2015 NLTP may still use the older methodology depending on certain criteria.
All up these changes seem fairly positive so it’s pleasing to see the NZTA improving how things are done. The next stage in the EEM update process will look at the procedures within the assessment framework and importantly the particular values used in the calculations e.g. the actual value of time, vehicle operating costs and crash costs used in the assessments.
A couple of weeks back the NZ Institute of Economic Research released a paper which looks into the traditional cost-benefit analysis used for appraising transport projects and asks the question of whether the current process fully recognises all the costs and benefits of those projects.
Existing transport cost-benefit analysis misses critical impacts “Standard cost-benefit techniques significantly under-estimate the costs and benefits from transformational infrastructure projects like motorways.” said NZIER.
“Transformational projects change economic activity, regional population, and land use – changes missed by standard cost-benefit techniques.” “For instance, a standard cost-benefit appraisal of Transmission Gully ignores whether Transmission Gully increases the number of people living along the Kapiti Coast and the costs and benefits associated with this.”
Understanding how major transport strategies affect the way we live and work is crucial for allocating limited public funding. Getting it wrong wastes money and can harm the long-term prospects of cities. The problem of accounting for changes in land use occurs worldwide with transport appraisal. It happens because people generally don’t know how to value these sorts of impacts.
In short, existing appraisals don’t assess the main long-run impacts of major projects. NZIER has researched ways to broaden the scope of appraisals.
It’s important to note that the paper highlights the breadth of both costs and benefits is likely to have been under-estimated previously. In other words, doing appraisals in a more robust manner isn’t necessarily going to boost the argument for all transport projects, but instead likely shift some projects upwards and some downwards on a priority list.
The relationship between travel time savings and land-use impacts has been discussed previously on this blog, particularly in relation to the work done by David Metz a UK transport expert. The NZIER study once again highlights this really critical point:In many respects this is just highlighting the Marchetti Constant – that people will on average spend a certain amount of their day travelling and the faster you make it to travel from point A to point B, the longer distance people will travel (rather than them spending less time travelling).
The paper itself is full of lots of complex equations which probably only really make sense to economists, but it comes to a particularly interesting conclusion:My translation of this is along the lines that projects which induce a land-use change which spreads development across a wider area and encourages longer trips may well create problems which undermine the benefits supposedly generated by the project. Basically that if a motorway encourages people to travel longer distances than they did before the motorway existed, then in the longer run (something current appraisal methods ignore) there may be little justification for said motorway project. This is particularly true if (as is the case) roads are not priced according to their use.
NZTA are currently reviewing the Economic Evaluation Manual – the guide for assessing transport projects. Let’s hope that some of the thinking in this paper gets incorporated into that review.
You would expect a mega corporation with the name of Citi to be interested in how cities function – and it appears they are. The banking giant has an initiative called Citi for Cities which while obviously channel for their business, also provides some interesting information on cities. They describe it as.
Cities generate prosperity and advance society. They are where citizens strive, where businesses drive growth, and where governments create the conditions for success. As over 100 million people move to urban areas each year, our cities are in the midst of an unprecedented transformation. Citi for Cities applies the full capabilities and global expertise of Citi to meet urban challenges in more than 1,000 cities across the globe, every day.
One thing they have done as part of this initiative is to commission The Economist’s Intelligence Unit (EIU) to produce a benchmarking study looking at the future competitiveness of cities. They have then compared the results for 2025 to see how they are expected to change from 2012. All up they compared 120 different cities across the world. Here is the list of cities they assessed
Competitiveness is obviously quite a complex measure so this is the methodology they used.
Competitiveness is a holistic concept. While economic size and growth matter, several other factors determine a city’s competitiveness, including its business and regulatory environment, its institutions, the quality of human capital, cultural aspects and the quality of environmental governance. These factors not only help a city to sustain high economic growth, but also secure its future competitiveness.
Against this backdrop, the Economist Intelligence Unit deﬁnes a city’s competitiveness as its ability to attract capital, businesses, talent and visitors. The 2025 City Competitiveness Index benchmarks the competitiveness of 120 cities across the world at two distinct points in time: today and in 2025. We do so by examining 32 indicators for each city. Indicators are grouped into eight distinct, thematic categories and assigned weights: economic strength 30%, physical capital and ﬁnancial maturity 10% each, institutional character and human capital 15% each, global appeal 10%, social and cultural character 5%, and environment and natural hazards 5%.
The Index includes a total of 27 qualitative and ﬁve quantitative indicators.
A city’s overall ranking in the benchmark Index is a weighted score of the individual categories. For a full breakdown of the categories, individual indicators and sub-indicators, weightings and data sources, see the Appendix.
While the report doesn’t give detailed breakdowns of how cities perform in each of the categories, it does say that Auckland is in the top 20 for Institutional Character which looks at Electoral process and pluralism, Local government ﬁscal autonomy, Taxation, Rule of law and Government effectiveness.
The report also noted that there was no major correlation between the size or density of a city to its competitiveness rating however they did find a strong correlation to the quality of the cities physical capital.
The quality of a city’s physical capital is highly correlated with its overall competitiveness. Statistically, the correlation between a city’s competitiveness and the quality of its physical capital—deﬁned in the Index as the quality of physical infrastructure, public transport and telecommunications infrastructure—is the strongest among the eight sub-categories that make up the Index. Two Chinese cities, Shanghai and Beijing, ascend to the top 20 in terms of their physical capital in 2025 and are among a group that is otherwise dominated by a mix of rich, well established global cities. Eleven of them are also among the 20 most competitive overall.
What’s interesting is how strong the mention of public transport is, the quality of the road network is one of the sub categories within the physical infrastructure group. The rankings come from the EIUs Global Liveability Index and we know from that the one thing that really lets us down is our PT infrastructure. Anyway enough about the methodology, on to the rankings – here are the top 10
While Auckland is a bit further down the list ranking 42nd overall. While our score does improve slightly, it isn’t enough and sees us slip 11 places from 2012.
As mentioned earlier, there is a strong correlation between the quality of physical infrastructure and competitiveness. We also know that one of the biggest areas that lets us down is the quality of our PT yet despite that, current plans still see 60-70% of all new funding going towards more roads. Perhaps it’s time to flip that funding around and focus on fixing one of the key areas that is letting us down.
While also looking around the Citi for Cities website, I came across this section which looked at different parts of the urban ecosystem and naturally I went to look at the transport section which contains:
To be prosperous, sustainable, and globally competitive, cities must increase their transport capacity, upgrade their transport technology, and make critical infrastructure investments.
The reason I found this interesting is that the focus is not on improving the speed of a single occupant vehicle but on improving transport capacity. I suspect that if we were to assess the various proposed transport project based on how much capacity they add to the overall transport system we might get some very different results in terms of project priorities.
Lastly a little something on one of the costs of parking that doesn’t often get thought about.
As you read this I’ll probably be sitting on a flight from Brisbane to Auckland that cost me $750. Sounds like a lot of money, and it is, but I’m happy nonetheless.
Why? Well, at late notice I had the opportunity of working for 2 months in Brisbane. This presented something of a conundrum, because I wanted to be home in NZ to spend the holidays with my Mum and a whole bunch of my favourite people. I therefore had to weigh up the price of the ticket against the benefits of what I could achieve while here (both in terms of financial and professional returns).
Obviously plane tickets around Christmas are expensive because many other want to travel at the same time, which signals to the airlines that they should put their prices up. This ensures 1) the airlines make more money and 2) there are seats available for people who really need them, like me. So despite the high price I’m more thankful I had the opportunity to both get to Brisbane and get back to NZ for holidays.
This got me wondering about what would happen if airfares were not priced this way; that is if the price of the ticket was set at the average price needed for the airline to do business. In this situation one would expect many planes to fly empty during off-peak times and sell-out over Christmas. There’d usually be either too many or too few seats and, in the case of the latter, you simply would not be able to get where you want to.
In this situation, I would have been faced with an even harder decision: Do I take the job in Brisbane and risk missing Christmas in NZ, or stay home but miss out on the work? Thankfully that’s not a choice I had to make because airlines price their seats in response to demand, or more specifically what economists refer to as “willingness-to-pay”. Willingness-to-pay describes what you are prepared to pay for goods and services.
From a layman’s perspective it means making economic hay while the sun shines. At this point people frequently assume that someone with high willingness-to-pay must be rich and vice versa. Well no, not exactly. In fact, detailed empirical studies of my purchasing behaviour over 31 years proves that willingness-to-pay has less to do with income than it has to do with my own personal preferences.
For example, on the same day as I booked my flight home from Brisbane I also booked a $150 return flight from Auckland to Christchurch. In this instance if the ticket had been more than, say, $300 I probably would not have traveled at all. The difference in what I was willing-to-pay for these tickets reflects that when travelling for work I’m prepared to pay a lot, whereas I’m more frugal when travelling for pleasure.
That frugality does not mean that I never travel at busy times, but it does mean that when I do I’m more flexible about when/where I travel (e.g. later at night). It’s ultimately got very little to do with how much money I have or don’t have. So it seems intuitive to me that willingness-to-pay to travel varies considerably for factors that are not related to our income, but instead depend on personal preferences.
Moreover, the fact that airlines use a demand-based pricing system tends to mean that the available capacity is allocated to the people who really want them. Of course that’s not why airlines price this way; they do it to make money. But in a competitive environment (such as trans-Tasman air travel) the ability of airlines to “price gouge” is of course limited by how other companies respond.
That’s why demand-based pricing makes so much sense. But despite it’s enormous advantages, we do not price parts of our transport system in response to demand. From what I can tell the debate about demand-based transport pricing often gets distracted by the following issues:
- “Alternatives” - i.e. we have to invest in public transport before we can price road capacity. In response I point out that even if we had no other transport options would it not still be in our interest to implement a demand-based pricing system to ensure road space was allocated to those who needed it most? Also, cities that have implemented demand-based pricing schemes, such as Stockholm, have not observed major increases in PT patronage, at least compared to the reduction in vehicle trips.
- “Social equity” - i.e. low-income people will be priced off the road. But low-income households a) tend to drive less, especially at peak times in metropolitan areas. So why not implement an efficient pricing system and then compensate those (few households) that are adversely affected? That way we provide the right signals to everyone, while supporting those affected who are unable to change (although that support should be tagged to people adversely affect at the time of implementation).
- “The devil’s in the details” – i.e. we need to flesh out the details before we sign up to demand-based transport pricing. I understand the sentiment but think we need to split the “strategic” and “operational” factors. Can we not as a society decide to support demand-based transport pricing “in principle” and then undertake research to flesh out the details? And then put the result to a public referendum? Indeed, if way back in 2005 if Auckland had not made a strategic commitment (through the RLTS) to support public transport, then we probably would not have seen the gains we have seen – simply because the operational details had not all been worked through at the time.
The first objection is the most common and deserves more attention than I can give it here because my flight is now boarding.
But very quickly, I will say that the disappearance of “traffic” in the presence of demand-based pricing has two interesting implications. First that there are many people on the roads at peak times that are not willing-to-pay very much, i.e. they’re just there because the price is low. Second, people have many more options open to them than public transport, i.e. PT is not an all-encompassing transport panacea.
And with that said this economic scrooge would like to wish you all a very merry and safe summer holiday.
Recently Auckland Transport and Ernst and Young hosted a seminar on the economics of urban transport. Sadly we didn’t get an invite but at least AT have videoed the presentations and put them up online.
First we have Paul Buchanan who is an international transport economist. The presentation is here.
There were a couple of things I found really interesting:
- His points on the use of travel time savings to justify projects as well as the failure to take into account land use changes as a result of the investment. Travel time savings are something that makes up the bulk of the benefits in projects like the RoNS and it suggests we need to radically change how we view our economic analysis.
- That we have to think stronger about how the impacts of safety as measures put in place in the name of safety often can have unforeseen negative impacts.
- The importance and impact that CBDs have on the economy.
- The importance of not only having a good natural environment but a good urban one to make it attractive to potential employees. This is something we are just starting to get with the improvements that have been happening in the CBD like the shared spaces.
- The development impacts that cars, buses and trains have on development patterns. In particular the upward spiral of development and demand that rail can generate that simply isn’t possible with cars.
- We have to be careful not to put too many buses into our city centre so that we don’t choke it and make it an unattractive place.
Next we have local economist John Williamson who gives a bit more detail on the things in Auckland and how they compare to the rest of NZ. You the presentation is here.
And last we have Joanne Ogg of Ernst and Young who talked about the move to their new offices right above the eastern entrance to Britomart. What I found interesting was once again more evidence of a generational shift that is occurring where young people are increasingly wanting different transport options and how rail in particular is key to that. My wife would fall into that category and chose the area we did because of the easy access to the train station simply because we want transport options available to us.
What I think these talks highlight is how important it is that we focus on the city centre if we are really keen to get good long term economic growth. Central to that is the need to be able to move more people into and out of the area at key times while at the same time making our street level environments much nicer places to be which will mean reducing road space. The only way we can really do that is through projects like the CRL. I wonder if any of those present were from the NZTA, MoT or Treasury because it seems like they could sure do with learning a bit more about this stuff.