Showing posts with label cost-benefit analysis. Show all posts
Showing posts with label cost-benefit analysis. Show all posts

Saturday, August 22, 2015

More to infrastructure than just spending more

Everyone knows our federal and state governments haven't been spending nearly as much as they should on public infrastructure. But, sorry, the full story isn't nearly that simple.

Adequate and well-functioning infrastructure has an important role to play in the efficiency of the economy by raising the productivity (productiveness) of our labour.

According to figures quoted by Adrian Hart, of BIS Shrapnel, we went through much of the 1980s and '90s with little increase in annual federal and state spending on infrastructure. This, no doubt, is how we got it into our heads that we have a huge "backlog" of investment in infrastructure.

Over the noughties, however, annual spending just about doubled, reaching a peak of $76 billion in 2009-10. So don't think we haven't been spending a lot – we have.

Since then, however, annual spending has actually fallen in real terms. By 12 per cent to 2013-14 and, according to Hart's estimates, by another 10 per cent in 2014-15.

Now, the macro-economic commentators are right when they say this is crazy at a time when the mining construction boom is coming to an end and leaving a vacuum in the heavy engineering construction industry and the long-term interest rates paid by governments are at record lows.

But this is where the story gets interesting. As the Productivity Commission says in a recent report, "not all public infrastructure supports productivity and generates economic growth and wellbeing". Poorly selected projects may actually make things worse.

As the Grattan Institute put it more bluntly, "the capacity to waste money is a serious risk for infrastructure, given the very large amounts of money involved".

Get it? If we take the attitude that more is always better, and more is never enough, the pollies will happily spend more of our money, but much of it will be wasted.

So just as important as making sure our infrastructure spending is adequate is making sure what we do spend is spent wisely. But how?

First point, at a time when budgets are tight, governments face a temptation to underspend on maintenance. This can shorten the useful life of existing infrastructure, bringing forward the need to spend a fortune building a new one.

The trouble here is that maintenance spending is politically invisible, whereas opening a new facility offers visible, concrete proof of progress on the pollies' watch, gives them a ribbon-cutting photo op and leaves their name on the plaque for decades to come.

Next, consumers and businesses often have to pay a price for the services of infrastructure – for power and water, for instance. Where no price is charged – road use, for instance – it often should be.

If you undercharge you get excessive demand for the service, which prompts you to build more infrastructure than you really need. Overcharge, however, and you get suppressed demand and don't build as much infrastructure as would be in our interests.

The correct price will incorporate the "social" costs involved in the activity, such as the cost its users impose on the rest of the community arising from its adverse effect on the environment.

So get infrastructure pricing right before you rush off and build more stuff.

Case in point: part of the reason for the recent fall in infrastructure spending is the fall in spending by the electricity poles-and-wires businesses now the regulation of their prices has been tightened up.

Before that, they were being granted big price rises to allow them to gold-plate their networks to cope with imagined future peak-load problems, which weren't going to happen and, in any case, should have been solved by the use of smart meters. This stuff-up was brought to you by the nation's economic reformers.

Finally, pick your projects carefully by undertaking rigorous, published comparisons of each project's benefits and costs. The commission says it "found numerous examples of poor value for money arising from inadequate project selection and prioritisation".

To ensure you pick projects with the highest return to the community as a whole, you need to assess social benefits and costs. That is, you also take account of benefits other than the revenue stream the project would generate so as to include any positive or negative effects on economic activity, social activities and the environment.

The point is to analyse information in a logical, consistent way and encourage decision-makers to consider all the costs and benefits of a project rather than focusing on just a few. You should be evaluating the other ways of achieving the same objective – recycling water rather than building a desalination plant, for instance.

Some important costs or benefits may be hard to quantify. You should quantify as much as you can, then compare this result with the unquantifiable factors, so they don't get overlooked.

As a general rule, you should rank all potential projects according to the extent to which their benefits exceed their costs, then implement the most beneficial until you've hit your budget limit.

The experience of the feds' review body, Infrastructure Australia, is that smaller projects (such as fixing rail crossings or traffic hotspots) tend to have much higher benefit-cost ratios than big projects (such as expressways), many of which have benefits only marginally exceeding costs.

But the commission finds that governments prefer the bigger projects because the private firms participating in public-private partnerships need bigger projects to cover their fixed costs.

Unfortunately, there can be ulterior motives: to get the debt associated with the project off the government's balance sheet and onto the private sector's. Or because fixing traffic lights doesn't impress the punters the way opening a new expressway does.

The commission doesn't say it, but what we need is to take an outfit like Infrastructure Australia and give it the statutory independence to conduct rigorous evaluations and make them public, so all of us can know whenever the pollies are planning to do something crazy.

Monday, August 18, 2014

Stop wasting money on infrastructure

Don't laugh too hard at the ABC's new satire, Utopia, and the wasteful and appearances-driven antics Rob Sitch gets up to as head of the Nation Building Authority. It's too close to the truth to be funny.

One of the foremost areas where governments need to lift the efficiency of their spending - as opposed to cutting payments to the needy or short-sighted cost-shifting - is infrastructure. It has become an area where too much spending is never enough and anything labelled "infrastructure" is above critical scrutiny.

In recent days, however, we've been given cause to cast a more sceptical eye over spending on capital works. Consider first the views of a highly experienced former econocrat, Dr Mike Keating: "Australia has a long history of over-investment in infrastructure, with the costs exceeding the benefits, and under-charging the beneficiaries so that they demand more and more.

"It is therefore most reprehensible that this budget prides itself that new spending decisions will add $58 billion to total infrastructure investment, when none of the projects announced have been ticked off by Infrastructure Australia as having completed proper cost-benefit appraisals, probably because a great deal of this investment never could pass any proper evaluation.

"And this from a government that was properly critical of the former government and its approach to the national broadband network. Clearly this improper use of the nation's savings is not an acceptable reason for the other budget cuts, and the increase in petrol excise should not be tied to an increase in uneconomic road funding."

Yes, indeed. It's disillusioning behaviour from Tony Abbott, who promised "rigorous, published, cost-benefit analysis" of infrastructure projects.

Last week, Garry Bowditch, chief executive of the University of Wollongong's SMART infrastructure facility, offered a sobering assessment of capital works spending, noting that cost overruns have reached between $4 billion and $5 billion a year.

Value for money is thrown out the window, he said, when governments fail to time the construction of infrastructure to make sure they're not inflating the prices of labour, materials and equipment by competing with the private sector during booms.

Adjusted for inflation, Brisbane's Gateway Bridge, built in 1986, cost about $300 million. But when a second, identical bridge was built in 2010, during the mining construction boom, it cost $1.7 billion.

Bowditch, a former econocrat, called on governments to release cost-benefit analyses for Sydney's proposed $11.5 billion WestConnex motorway and Melbourne's $8 billion East West Link tunnel.

He argued that poor long-term planning by federal and state governments, which don't communicate well with each other, had led to unnecessary costly construction methods, such as tunnels, because land corridors had not been reserved for rail and road development.

Sir John Armitt, former chairman of Britain's Olympic Delivery Authority, said we should be using technology to improve the capacity of existing rail, road and energy networks, and to prepare for driverless cars.

Good point. Politicians love cutting ribbons and announcing grand, nation-building projects. But they'd waste less taxpayers' money if they got the pricing of existing infrastructure right first, and so had a more realistic estimate of the demand for additional infrastructure. It's called efficiency.

The credibility of economic modelling by allegedly independent consultants is surely shrinking before our eyes. Not long ago we were treated to the spectacle of two leading firms of economic consultants producing diametrically opposed modelling of the cost of the renewable energy target. Why? Surely not because they were commissioned by outfits with rival axes to grind?

Last week we learnt that AMP, whose funds lost a lot of dough after the failure of the outfit owning Sydney's Lane Cove Tunnel in 2007, is suing the consultants who provided excessive forecasts of the likely traffic flows, accusing them of producing figures that were "reverse engineered" by working backward from their client's commercial objective. Surely not.

One reason it would be good to see cost-benefit analyses of the aforementioned infrastructure projects adopted by the Coalition is to test the efficiency of Abbott's insistence that he'll finance roads but not public transport.

So far the NSW and Victorian governments have done a hopeless job of limiting congestion. Since building extra motorways adds to demand rather than reducing delays, my guess is neglect of public transport is the culprit.

But the Grattan Institute's report on cities as engines of prosperity reminds us that the longer it takes people to move between home and job, the harder it is to fully exploit the "knowledge spillovers" that drive the knowledge economy. Didn't you guys say you were worried about slow productivity improvement?

Monday, November 22, 2010

NBN plan has the signs of a historic stuff-up

I am starting to get a really bad feeling about Labor's plan for a national broadband network. The more it resists subjecting the plan to scrutiny, the more you suspect it has something to hide.

I fear Julia Gillard is digging herself in deeper on a characteristically grandiose scheme her swaggering predecessor announced without thought to its daunting implications, when she should be looking for ways to scale the project down without too much loss of face.

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The obvious way to start that process would have been to accede to calls for the Productivity Commission to conduct a cost-benefit analysis. The determination of governments to keep their schemes away from the commission is always prima facie evidence they know the scheme's dodgy.

But as each day passes the issue is becoming more politicised, with too much of the government's ego riding on pretending the plan is without blemish. Part of the problem is the role the plan played in winning the support of the country independents.

The independents and Greens are doing the government no favours in using their votes to allow the plan to escape scrutiny. Are they, too, afraid it wouldn't withstand scrutiny?

This is not to support the inane demands from the opposition and the media for the government to release its ''business case'' immediately rather than in a week or two's time. Mere impatience is no virtue in the eternal quest for good policy.

But by the same token, the government's implication that we can't delay the broadband rollout by pausing to check whether it's a good idea, or is being done as cost effectively as possible, is insupportable. If it's a flawed idea, better to know now rather than after the money's spent.

It's no doubt true the Liberals are being quite hypocritical in demanding the release of a government report when the Howard government refused to release so many reports, and in demanding a cost-benefit analysis when John Howard never bothered with them.

But such objections make sense only to those more interested in party-political point scoring than achieving good policy.

The case for a thorough cost-benefit analysis needs no stronger argument than that, at $43 billion, this is the most expensive piece of infrastructure this country has seen.

It's true the plan has a lot of attractions. Top of the list is the structural separation of Telstra's network from its retail business so its retail competitors get fair access to the network. This is something the Howard government should have seen to before it privatised Telstra.

I accept that, if city people are going to continue cross-subsidising the bush - as they will; it's clearly the electorate's ''revealed preference'' - there's no more sensible way to do it than ensuring the bush has access to high-quality telecommunications, thereby doing what we can to reduce the tyranny of distance.

I don't have an in-principle objection to a network with natural-monopoly characteristics being owned publicly rather than privately, provided governments don't use their powers to shore up or abuse that monopoly in a way any private owner would and should be prevented doing.

And I admire the government's consciousness of the need for us to be ready to adopt and exploit the opportunities for benefit that future technological advance will make possible.

The Productivity Commission could be required to ensure its cost-benefit analysis ranged far more widely than a mere commercial evaluation, taking account of present and potential ''social'' benefits (''positive externalities'') and acknowledging those whose value it can't quantify.

But there are three aspects of the plan that worry me. They're things economists are trained to see but to which non-economists are often oblivious.

The first is the mentality that says we've got a lot of messy and inadequate telecom arrangements at present, so let's scrap 'em all and start afresh. Copper wire to the home - make Telstra turn it off. Telstra and Optus's existing rival optical fibre-coaxial cables to many capital-city homes - close 'em down.

This Ruddish approach would be fine if resources were infinite, or if getting a brand spanking new broadband network was the Australian public's only desire.

But resources are finite, both sides of politics have sworn to eliminate all government debt and we have an infrastructure backlog as long as your arm. In two words: opportunity cost.

Second is the idea of building a gold-plated broadband network up to eight times faster than any present application needs, so we're ready for anything that may come along some time in the future.

If you think that shows vision and foresight, you're innocent of ''the time value of money''. Every dollar you spend now rather than later comes at an extra cost: the interest you have to pay between now and when you start using the idle capacity.

True, it's false economy to build something today without allowing for reasonable growth in your use of the item. But there comes a point where allowing for more growth than you're likely to see in ages becomes a waste of money.

Private businesses that do this - such as home owners who overcapitalise their properties - do their dough. Government businesses survive either by overcharging their customers or falling back on the taxpayer.

The final worry is the way that - notwithstanding the break-up of Telstra - the plan involves deliberately reducing competition from other networks in the telecommunications market. Why's that a good idea?

And why would the government plan to do it? Because it knows its network will be hugely over-engineered and the only way of charging consumers the high prices needed to recoup that excess cost is to turn broadband into a monopoly.

If Gillard had any sense of self-preservation she'd be using the Productivity Commission to get herself off a nasty hook.