Recently at the Warren Centre (http://thewarrencentre.org.au/ip30-panel-investigates-the-infrastructure-governance-opportunity/) there was some commentary around the cost of duplicating Brisbane’s Gateway Motorway Bridge. Namely, between the original and the duplicate, costs increased fivefold. On the surface that would be a stunning thing. However, when we consider 24 intervening years (1986-2010) between the costings for the two projects, we are looking at an annualised increase in costs of 6.9%. This is still significant when inflation only increased 3.4%p.a. over the same period. I know there are construction price indices around as well. However, I wonder whether design and materials were significantly different, and the connecting road infrastructure was more challenging. That might explain some of the residual increase. Also, the duplicate would have been constructed in a much tighter market for engineering and construction services. Should we have bought the extra lanes way back in 1986 or would the opportunity cost have been too large?
How do you find out what an economic cost benefit analysis should contain?
Reference materials run to hundreds of pages, with detailed explanations depending on the nature and purpose of the investigation and the field under consideration.
I thought a simple introduction would help explain what is involved and prepared Intro to CBA for my clients.
One of the largest public health projects in NSW has been slowly releasing more and more information about the total cost of the project. Like some other public private partnership arrangements this project is a combination of capital investment and operating service payments.
The Northern Beaches Hospital project was belatedly revealed to the public to cost $2.14 billion cost, up from “over $1 billion” in December 2014. See: http://www.brisbanetimes.com.au/nsw/revealed-the-real-2-billion-cost-of-privatised-northern-beaches-hospital-20150501-1mxgqd.html
A lot of information was shrouded in commercial secrecy and the Health Minister has indicated she did not get involved in the financing.
So let’s have a look at what the good taxpayers of NSW may be getting.
From public information, the hospital development itself will cost $600 million. The NSW government plans to chip in some $400 million in adjacent transport improvements. A big assumption is that this is actually delivered on schedule and budget.
That basically handles the capital investment side of the equation and may leave $1.14 billion for the hospital services NSW is purchasing up to 2038 from the consortium.
Let’s say the hospital is operational in 2018, so there is a 20 year service period. According to some reports, 488 public beds will be provided.
This means the average daily cost per bed – occupied or not – is around $320 over this period.
Across the NSW health system the average cost per occupied bed was around $1,400 per night in 2012-13, based on information given to the NSW Auditor General.
So this looks like it might actually be a good deal even at low occupancy rates. But since we do not know the basis of the service payments we simply cannot be sure. The consortium get to make some extra cash on the side by selling private services through the site.
At about this point I can hear a lot of health economists scream.
So let’s recognise there is a lot of detailed, good work being done by the Independent Hospital Pricing Authority (see: http://www.ihpa.gov.au/internet/ihpa/publishing.nsf) that is putting evidence-based price signals into the hospital funding system, allowing funding arrangements to move from block grants to activity-based funding payments.
Over time this should help improve the efficiency of our hospital systems.
When we look at infrastructure services we should also consider the context in which they are provided.
Currently I am on assignment in PNG. Telekom here in the past week has slashed mobile broadband top up prices by 50% to around A$25 per gigabyte (GB). It sounds impressive and may have a meaningful impact. However even that level it is still eyewateringly expensive compared to Australia. But stop and think about it in the context of purchasing power.
Some data I looked at recently suggested GDP per person in PNG was probably A$2,500. In Australia GDP per person is around $45,000, some eighteen times the level in PNG. Depending on the definition the actual figures can vary but consider that as a rough context for income.
If Australian’s faced the same share of GDP spent on broadband top ups as in PNG that would look iike a cost of $450 per GB. How fast a rate of uptake would you expect if Australia faced that price? Mind you it was not that long ago we were paying those prices for dial-up.
This also supports earlier analysis by the International Telecommunications Union:
“By early 2013, the price of an entry-level mobile-broadband plan represents between 1.2-2.2% of monthly GNI p.c. in developed countries and between 11.3- 24.7% in developing countries, depending on the type of service.”
Clearly further, lower prices are needed in PNG along with relative increases in GDP per person. The digital divide remains huge and the context remains relevant whether you are looking at PNG or Australia.
Image source: comparebroadband.com.au
As we head towards $100,000 university degrees, the investment decision becomes increasingly critical. No longer is an undergraduate degree simply three or four years in a person’s life. Large debts are going to be attached. So will the expected increase in lifetime earnings offset this?
It is hard to say because there are a lot of factors at play. However doing an economics degree still looks like a good return on investment for school leavers:
Decisions made just days or weeks into an infrastructure project – assumptions of end user needs, commitments to a schedule, the shape and size of the proposed infrastructure asset – have the most significant impacts on design, feasibility and cost. This is particularly true for large infrastructure projects with complex procurement and construction processes.
As decisions are made later and later in the planning process, their influence decreases. Options to change direction are either closed or become more problematic. Consider road congestion and a decision to proceed with an expensive built infrastructure solution. Not considering demand management opportunities misses valuable benefits in being able to avoid or delay that built cost.
Some minor cost savings can still be realized through value engineering in the latter stages of design, but the biggest cost factors are embedded at the outset in a project’s DNA. Once locked in the project becomes the monster you planned.
I am currently in Port Moresby on an assignment. It is a three hour flight from Brisbane but a world away in many other respects. The UN releases reports on human development. Some contrasts are quite stark.
PNG Australia Measure
0.411 0.933 Human Development Index
157th 2nd Human Development Index rank
7.25 23.3 Population (million)
17.07 950.65 GDP (US$billion 2011)
2,381 42,278 GDP per capital (US$ 2011)
0.617 0.113 Gender inequality (lower is better)
62.42 82.5 Life expectancy at birth
When we look at infrastructure it makes you think vey hard about what is important. It really is all about context.
There are many different approaches to understanding economics. Here is one that sets out three broad fields:
- How people make decisions
- How the economy works as a whole
- How people interact
Read for yourself about ten economic principles that support this and save yourself years of study. A lot of applied economics addresses the issues below.
How People Make Decisions
- People Face Tradeoffs. To get one thing, you have to give up something else. Making decisions requires trading off one goal against another.
- The Cost of Something is What You Give Up to Get It. Decision-makers have to consider both the obvious and implicit costs of their actions.
- Rational People Think at the Margin. A rational decision-maker takes action if and only if the marginal benefit of the action exceeds the marginal cost.
- People Respond to Incentives. Behavior changes when costs or benefits change.
How the Economy as a Whole Works
- Trade Can Make Everyone Better Off. Trade allows each person to specialize in the activities he or she does best. By trading with others, people can buy a greater variety of goods or services.
- Markets Are Usually a Good Way to Organize Economic Activity. Households and firms that interact in market economies act as if they are guided by an “invisible hand” that leads the market to allocate resources efficiently. The opposite of this is economic activity that is organized by a central planner within the government.
- Governments Can Sometimes Improve Market Outcomes. When a market fails to allocate resources efficiently, the government can change the outcome through public policy. Examples are regulations against monopolies and pollution.
How People Interact
- A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services. Countries whose workers produce a large quantity of goods and services per unit of time enjoy a high standard of living. Similarly, as a nation’s productivity grows, so does its average income.
- Prices Rise When the Government Prints Too Much Money. When a government creates large quantities of the nation’s money, the value of the money falls. As a result, prices increase, requiring more of the same money to buy goods and services.
- Society Faces a Short-Run Tradeoff Between Inflation and Unemployment. Reducing inflation often causes a temporary rise in unemployment. This tradeoff is crucial for understanding the short-run effects of changes in taxes, government spending and monetary policy.
Source: Mankiw, Principles of Economics, 2e
The effort invested in ‘getting it right’ should be commensurate with the importance of the decision – Daniel Kahneman
Accuracy is the absence of error; precision is the level of detail. Often in infrastructure planning and analysis we see an unnecessary need for precision in the early stages with not much emphasis on accuracy.
Effective problem solving requires always being accurate but only being as precise as is helpful at any given stage of problem solving. This is about delivering analysis that is sufficient to proceed to the next stage in developing an infrastructure project. Many project approval gateway processes recognize this, but it is often poorly implemented.
Early in the problem solving process, accurate but imprecise methods, rather than very exact methods, will allow consideration of all reasonable approaches and minimize the tracking of needlessly detailed data. In this way, less apparent but potentially higher value options and scenarios can be considered and compared with the standard approaches.
Suppose you are given a cost benefit analysis. Without an economics degree, how do you know it has been properly completed?
Economic CBAs are a decision support tool used to determine the net benefit to an economy of a proposed course of action, a policy or a project. A ‘do something’ case is typically compared to a ‘business as usual’ case to identify incremental changes in benefits and costs, explicitly recognising that not doing a project has implications as well. Costs and benefits occur in different time periods and values are brought to the present to enable comparison of net economic benefits.
If you are wading through one of these reports here is a cheat sheet with questions you can ask the analyst to pierce the veil of certainty these reports often convey. It is based on longstanding advice the Commonwealth Government has given its own agencies when confronted with this kind of economic analysis.
Ask the following questions:
- What questions does the study attempt to answer?
- What alternative strategies are considered?
- Do you have any comments on the way the choices could have been set out?
- Are there other choices that could/should have been considered at the same time?
- Are you happy with the cost estimates made?
- Are the methods of evaluation satisfactory?
- Are any relevant costs omitted?
- Is the study based on reliable evidence?
- What further information would you require?
- Is such information available and, if so, where and from whom?
- Are you happy with the methods of benefit measurement employed in the study?
- If not, what method or approach would you propose?
- If yes, are you content with the values derived?
- Does the study allow for:
- Uncertainty (or errors) in the expected costs and benefits?
- The differential timing of costs and benefits?
- Finally, assuming you were advising the decision makers, what would be your recommendation?
Any analyst should have no problems or hesitancy answering these. If they do, the report probably needs more work.