How Economists Routinely Screw Up HSR Cost Benefit Analysis
The main purpose of any transportation project is to help people get to where they want to go. Cost should be a subsidiary factor in the planning of any transportation project. Unfortunately, in the 30 years since right-wing ideology became politically ascendant, keeping costs down so that rich people didn’t have to pay higher taxes started taking precedence over building effective transportation projects. This may have been tenable as long as oil prices remained low. But once prices began rising again, it was clear that building electric passenger trains was a top priority for modern societies.
Problem is, when the economists got a hold of these projects, they regularly criticized them because in their very narrow analysis, the benefits didn’t match the costs. But as a new World Bank report argues, such analyses are deeply flawed due to their unwarranted limitations:
Traditional economic evaluations of major transport infrastructure investments focus on the direct costs and benefits arising from travel, including user time savings, operator cost savings, and reductions in externalities including air pollution, noise, and accidents. There is an emerging consensus that major transport investments may have significant impacts that are not well captured by this type of conventional cost-benefit analysis. In China, the World Bank transport team has supported both econometric studies and on-the-ground surveys that begin to identify and quantify these impacts in the context of China’s emerging High Speed Rail (HSR) program. Based on this and other research, the Bank team has begun to pilot a methodology to evaluate wider economic development benefits for several HSR projects, and has found them to be significant – of the same order as, but additional to the direct transport benefits that are traditionally measured. Crucially, these benefits of larger and better connected markets accrue to businesses and individuals even when they themselves do not travel.
This is similar to an argument Richard Florida has been making for some time now – that one of the emerging trends out of the Great Recession is that regions are going to be more deeply interconnected to each other, and that when this happens new economic value is created. Agglomerations of multiple metropolises have a significant competitive advantage over individual metropolises, just as the individual metropolis emerged with a competitive advantage over the individual industrial city over a century ago.
The World Bank study argues that there are demonstrable economic benefits to agglomeration and that HSR plays a role in this:
Quantifying these benefits relies on a concept known as ‘Economic Mass’. Economic mass is a measurement that combines the size of a city’s own economy with its accessibility to other regions. Economic mass in a given location can therefore increase through one of two means: the level of economic activity can increase, or the surrounding areas can become more easily accessible, as measured by a combination of the time and cost of travel. So if HSR (or other transport improvements) can reduce the friction of travel between regions, it can increase the ‘economic mass’ of the cities it serves.
The concept and measurement of economic mass is relatively straightforward; where research has progressed in recent years has been in identifying the relationship between the economic mass of a region and its overall level of productivity. This link is based on four propositions:
a) economic mass rises with transport improvements;
b) the average output of employees, and hence their wages, varies directly with economic mass, even after controlling for other variables;
c) there are positive externalities from transport improvements which increase output for some firms independently of their use of the transport network; and
d) this increase in output is not included in the standard evaluation of transport projects.
A major UK study that attempted to quantify this relationship estimated that, other things being equal, a doubling of economic mass would give rise to an increase in per worker productivity of 3.5%. Crucially, these productivity benefits accrue to businesses and individuals even where they do not themselves travel.
The study then argued that these benefits are already present in China thanks to agglomerations enabled by that country’s huge expansion in HSR in recent years:
Benefits were calculated for the 30-year period following project completion [of the Nanning-Guangdong HSR line]. Direct benefits including time savings for passengers and freight, reductions in operator cost, and generated traffic, yielded net present benefits of approximately 50 billion RMB in 2009 RMB. Using the elasticity of productivity with respect to economic mass adopted above, the agglomeration benefits were estimated at 49 billion RMB (both weighed against the 2009 present value of project costs of 47.9 billion RMB, all discounted at 12%). In our analysis, then, agglomeration benefits were found on the order of (and in this case only slightly lower than) traditional project benefits.
Agglomeration benefits and traditional benefits show that HSR is a powerful creator of new economic value well in excess of its costs. And that’s before you throw in the economic value generated by savings on oil – the “green dividend.” For the Los Angeles area alone the green dividend for HSR was estimated at $10 billion per year. Across the entire state it could be nearly $30 billion – again, per year. Add in the traditional benefits and the agglomeration benefits and it’s clear that HSR would more than pay for its construction costs.
But traditional neo-classical economics, with its narrow focus on an arbitrarily limited set of costs and benefits, ignores those larger and demonstrable benefits. So their reporting makes HSR look like a bigger risk than it really is.
A classic example of getting the HSR economic analysis massively wrong was in Spain’s El País newspaper last week:
Twenty years after the first high-speed train cut a swath through the Castilian uplands, the evidence suggests that they are simply not viable economically, or even necessary to provide rapid links between the country’s cities. But no politician seems able, or willing, to put a stop to the spread of the AVE….
Spain has spent 46 billion euros on high-speed railways over the last two decades, but the final bill will end up being much higher. Paying off the cost of Spain’s ambitious public works program is growing, in much the same way that mortgage payments increase over time. It is part of the country’s deficit problem, notes [Daniel] Albalate, who employs the following metaphor to describe the benefits of the AVE: “It is like building infrastructure in the desert.”
But the article doesn’t make any mention at all of agglomeration benefits. It doesn’t make any mention at all of the green dividend or oil costs. The article describes at length Spain’s current economic crisis without noting that Spain, like the other so-called “PIIGS” are the most oil-dependent nations in Europe. While mainstream media outlets like El País seem to believe that government spending on things like trains is part of the problem, they are totally blind to the actual causes of the problem – oil dependence – and ignorant of the emerging economic geography of the 21st century where agglomerations matter a lot to creating economic opportunity and value.
Spain is going to emerge from this crisis as one of the European nations best poised for success thanks to its AVE network, which agglomerates metropolises such as Madrid, Sevilla, and Barcelona (whether or not Catalunya votes for independence in 2014) by transportation methods that are independent of oil. The same is true of China, and it will be true for California as well, assuming the HSR project continues on its current path.
By any sensible cost benefit analysis, HSR is a sensible thing to do. Let’s hope the media abandons the failed neo-classical model and starts listening to folks like the World Bank who have a better understanding of how HSR actually works in practice.