2024 CE6304 Principles of Economic Evaluation of Transport Projects PDF

CENG6304 Planning & Economic Evaluation of Transport Projects Week 4 Fitsum Teklu Last week: costs Different types of cost: capital, operational, external costs etc. Costing Approaches Firms' costs and economies Capture as many of the costs Do not double count There were some exerci...

CENG6304 Planning & Economic Evaluation of Transport Projects Week 4 Fitsum Teklu Last week: costs Different types of cost: capital, operational, external costs etc. Costing Approaches Firms' costs and economies Capture as many of the costs Do not double count There were some exercise questions for you to try too … 2 Principles of Economic Appraisal Week 4 3 Objective of Economic Appraisal To assess the economic viability of transport projects. This involves comparing the expected benefits (such as reduced travel time, improved safety, and increased economic activity) against the costs (including construction, maintenance, and operational expenses). Reminder: Appraisal is undertaken before the project/policy is implemented; evaluation is undertaken afterwards. 4 Principles of appraisal Appraisal is a comparative form of analysis It compares different courses of action (for the public) Do Something (DS) = with project/policy Do Minimum (DM) = realistic alternative state of the world (usually includes committed projects) Do Nothing (DN) = no change Not used as often Typically, the DM is the reference case against which the DS is compared, but some countries use the DN as the reference case! Impacts are the differences between DS and DM: on indicators such as travel time, CO2, casualties, change in regional Gross Value Added (GVA) … at specified times (e.g.: 0, 5, 10, 20, etc. years after project completion) spatial levels (e.g.: transport model zones/aggregations), etc Benefits and costs are the differences between DS and DM expressed in money units The choice of the reference case can be vital for the result of the appraisal What is the change in benefits? ABC? ADC? AEC? And what is the cost of different reference alternatives? Politics Socio-economy Transport What other projects are Influence area Traffic level Benefit C funded/approved Land use Modal share Planned Development in key Cost of maintenance Potentials variables: and/or reinvestment income, Technology E Long term targets population, Length of life (Climate target plan) car ownership, employment, B etc. A D There is never a do-nothing option in practical terms (e.g the reference alternative will always require a degree of maintenance) Project Ex-post completed situation Source: Welde and Volden (2022) Do-nothing, do-minimum or do- something: the reference alternative in cost-benefit analysis. 6 Principles of Social Cost Benefit Analysis 1. Consider all costs and benefits, to everyone (users and non-users) … but avoid double counting 2. Consider the long-term: future costs and benefits should be discounted 3. Forecast always on the basis of expected behaviour 4. Value items of benefits and costs using a common numeraire 5. Ensure consistency in evaluating different projects (e.g. across different modes). 6. Assess the distributional effects of alternative projects (i.e. impacts different groups (e.g. in terms of equity)) 7. Uncertainty should be accounted for 1. Social CBA considers costs and benefits to all people Assessment of welfare change for all people, 𝑖 σ𝑖 𝐵𝑖 − 𝐶𝑖 where 𝐵𝑖 = benefits to person 𝑖 and 𝐶𝑖 = costs to person 𝑖 Net Social Benefit includes impact on: users, operators, government and 3rd parties (externalities such as CO2, noise...) 𝑁𝑆𝐵 = ΔCS + ΔPS + ΔGS + Δ 𝐸𝑥𝑡𝑒𝑟𝑛𝑎𝑙𝑖𝑡𝑖𝑒𝑠 Government surplus Consumer surplus Producer surplus 8 2. Consider the long term (Discounting) Appraisal horizon is set by the longest-lived asset created In the UK, default appraisal period is 60 yrs. to ensure the full range of long-term benefits and costs of a project are taken into account. This is not a fixed rule, however, and can be adjusted depending on project/policy specifics (e.g. bus specific interventions tend to have shorter appraisal periods, 15 – 20 years) Discount future costs and benefits using a social discount rate Discount back to a common base year (= 2010 in the UK) Appraisal is carried out at constant 2010 prices means that general price inflation after 2010 should be stripped out relative prices may change – e.g. real values of time do grow Discounting is solely concerned with adjusting for Social Time Preference and has nothing to do with adjusting for inflation Best practice approach is to first convert costs or benefits to a real price basis, and then perform the discounting adjustment Social discount rates reflects society's preferences for consuming goods and services over time social discount rate can vary depending on the specific context of the analysis "Present value" in 2010 of ETB 1m of benefits received in the time horizon, future years ETB 1,000 nature of the project, Thousands ETB 900 assumptions made about future economic ETB 800 conditions ETB 700 ETB 600 ETB 500 ETB 400 ETB 300 ETB 200 ETB 100 ETB 0 2010 2020 2030 2040 2050 2060 2070 0% 2% 3.5% 5% 10% 15% 10 OECD Social Discount Rates OECD Country Social Discount Rate Australia 4% Canada 3% - 7% France 4% Germany 3% - 6% Italy 3.5% Japan 1% - 3% Netherlands 3.5% - 4.5% Norway 3% - 4% Spain 3.5% The discount rate for Ethiopian Sweden 2% - 4% projects is 10.23%? Switzerland 2% - 4% UK 3.5% - 6% USA 2% - 7% 11 Social vs financial discount rate Social discount rate takes into account wider social and economic considerations, such as intergenerational equity, distributional effects, and the impact of public goods on society Financial discount rate measures the opportunity cost of investing on a project or the expected return that could be earned on an alternative investment of similar risk Social discount rate is typically lower than the financial discount rate Ongoing debate among economists and policy-makers about the appropriate level of the social discount rate, and how it should be calculated Some argue social discount rate should be less than the financial rate (to reflect the wider social and economic benefits of public investments), others argue the opposite (to reflect the opportunity cost of investing public funds in one project over another) Reading: https://blogs.worldbank.org/governance/using-zero-discount-rate-could-help- choose-better-projects-and-help-get-net-zero-carbon 12 Example: Official UK discount rates (HMT, 2022) Social Time Preference - STP Standard STP rate is used for most impacts in Transport Analysis Guidance Long term rates decline due to increasing uncertainty about the value of time preference Year 0 = the current year Difference between STPR standard and STPR reduced provides an estimate of the intergenerational wealth transfer attributable to pure social time preference ‘Health’ rate used for: noise, air quality, physical activity impacts and human costs of accidents – where values are ‘utility based’ 13 Measures of project/policy/programme performance: NPV, BCR and IRR Present Value of Benefits (𝑃𝑉𝐵) = sum of the discounted benefits = σ𝑦 𝐵𝑦 𝑑𝑦 Present Value of Costs (𝑃𝑉𝐶) = sum of the discounted costs = σ𝑦 𝐶𝑦 𝑑𝑦 Discount factor Net Present Value, 𝑁𝑃𝑉 = 𝑃𝑉𝐵 − 𝑃𝑉𝐶 in year y 𝑃𝑉𝐵 Benefit:Cost Ratio, 𝐵𝐶𝑅 = 𝑃𝑉𝐶 Interpretation is country specific UK Value for Money (VfM) categories: see table >> Internal Rate of Return, IRR is the discount rate that makes the NPV=0 14 3. Forecasting Always forecast on the basis of expected behaviour Modelling... aim for an objective description of the future (DS and DM/DN scenarios) Appraisal... calculate implications for benefits and costs, and distribution. 15 4. Value items of benefits and costs using a common numeraire use money as numeraire (ETB, $, €, £) use willingness-to-pay (WTP) to value non-marketed impacts (e. g. noise, safety, air pollution, time) but our underlying interest is in measuring welfare (wellbeing), therefore RAW WTP is not used in appraisal the value of an additional Low ‘marginal utility of money’ Birr of income may be higher for Wellbeing a low-income recipient than a high-income recipient Has important implications for the way we value costs and benefits in the future, and distributional impacts … High ‘marginal utility of money’ Income 16 Unit of account Unit of account: way to measure the value of goods and services in a consistent and uniform manner Two main approaches market prices (UK, USA and Sweden) ‘value costs and benefits in consumer prices’ Gross of indirect tax Different users perceive costs differently – businesses/government (net of tax), people (incl. tax such as VAT) e.g. values of commuting time from passenger stated preference research are naturally in market prices. factor cost (Germany, Australia, elsewhere) ‘value costs and benefits in producer prices’ exclusive of indirect taxes Whether factor or market prices are used does not affect the overall results of CBA, but it is essential that all impacts are expressed consistently 𝐵𝑒𝑛𝑒𝑓𝑖𝑡 £𝐵 𝑎𝑡 𝑚𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒𝑠 = £𝑏 𝑎𝑡 𝑓𝑎𝑐𝑡𝑜𝑟 𝑐𝑜𝑠𝑡 ∗ 1.19 (UK) 1.19 is the ‘indirect tax correction factor’ (1+t) t is 19%, the average rate of indirect taxation in the economy, HMRC data 17 5. Consistency and comparability across alternatives (modes) since the 1999 version of the UK Transport Analysis Guidance, TAG (then called the “Guidance on the Methodology for Multi-Modal Studies”) there has been a concerted effort to achieve comparability across modes Easier comparison of projects/policies for Government the basic maths is now fairly comparable (TAG Units A1.1-3) but issues sometimes arise in practice 18 6. Distributional effects Considers the variance of impacts across different social groups Mandatory in some countries Both beneficial and/or adverse need to be considered Reading: https://assets.publishing.service.gov.uk/media/649ad0fab4d6ef0012038f73/tag- unit-a4.2-distribution-impact-appraisal.pdf 19 7. Risk Several sources of risk Traffic Forecasts Uncertainty of inputs Error in model specification and parameters External factors Economic growth Cost escalation (e.g. foreign currency & fuel cost) Political stability Covid Network effects Other changes to the transport system which impact the impact of project/policy Etc. Risk and uncertainty is the subject of the penultimate week. 20 Optimism bias Demonstrated systematic tendency for appraisers to be over optimistic about key project parameters, including capital costs, operating costs, project duration and benefits delivery Source: GreenBook (HMT, 2022) 21 Some underlying principles 22 Kaldor-Hicks efficiency economic efficiency is increased when the measure-introduced leads to a situation whereby the winners could in principle fully compensate the losers and still retain a net advantage. Application of this principle does NOT require/demand that actual compensation takes place (and some people may in fact be left worse off) key to pricing measures and cost-benefit analysis Nicholas Kaldor (1908 - 1986) / John Hicks (1904 – 1989) >> 23 Consumer Surplus, User Benefit and the “Rule of the Half” Market for travel between 𝑖 and 𝑗 by mode 𝑚 at time 𝑡 Generalised Generalised user benefit (user) cost, ETB (user) cost, ETB = ∆𝑐𝑜𝑛𝑠𝑢𝑚𝑒𝑟 𝑠𝑢𝑟𝑝𝑙𝑢𝑠 consumer surplus in = 𝐶𝑆1 − 𝐶𝑆0 Do-Minimum scenario = CS0 𝟏 = 𝑮𝑪𝟎 − 𝑮𝑪𝟏 𝑻𝟎 + 𝑻𝟏 𝟐 (GC0,T0) (GC0,T0) GC0 GC0 GC1 (GC1,T1) 𝐷𝑒𝑚𝑎𝑛𝑑 = 𝑓(𝐺𝐶) “existing “new 𝐷𝑒𝑚𝑎𝑛𝑑 = 𝑓(𝐺𝐶) users” users” 0 T0 Trips, T 0 T0 T1 Trips, T 24 Notes on the Rule of the Half Lane, Powell and Prestwood Smith (1971) showed that the user benefit measure can be extended to networks (𝑖𝑗𝑚), the total benefit is sum of benefits in each 𝑖𝑗𝑚 market The rule-of-a-half may be inaccurate for large changes in generalised cost or demand, or new modes (see Nellthorp and Hyman, 2001) Geurs et al, 2012 Logsum measures offer an alternative to the rule-of-a-half (see Geurs et al, 2012 De Jong et al, 2005 and De Jong et al, 2005) 25 Revenue operators’ revenue (and costs) are relevant as well as the effects on users, government and any other group Toll roads Generalised Public transport fares (user) cost, ETB like user benefits, revenue is driven by the demand function... Consumer surplus in the Do-Minimum Scenario = CS0 (GC0,T0) GC0 revenue in the Do-Minimum scenario = R0 P0 𝐷𝑒𝑚𝑎𝑛𝑑 = 𝑓(𝐺𝐶) 0 T0 Trips, T 26 Example: Bus priority measures increase service speed, at a fixed fare Generalised (user) cost, ETB user benefit, ΔCS (GC0,T0) GC0 (GC1,T1) GC1 revenue gain, ΔR P 𝐷𝑒𝑚𝑎𝑛𝑑 = 𝑓(𝐺𝐶) 0 T 0 T1 Trips, T 27 User benefits and revenue are sensitive to pricing policy In example (1), the Operator prices up so as to convert all of the quality improvements into a fares/revenue increase, whereas in example (2), the Operator passes through the whole of the quality improvement to passengers. (1) (2) £ £ (GC0,T0) GC0=GC1 =(GC1,T1) GC0 (GC0,T0) GC1 (GC1,T1) D P1 D revenue P0=P1 revenue P0 gain, ΔR gain, ΔR 0 T0= T1 Trips, T 0 T0 T1 Trips, T 28 Examples of Appraisal Methods UK WebTAG (DfT, 2022) https://www.gov.uk/guidance/transport-analysis-guidance-tag EU countries have comparable methods: France: CGP, 2005; Netherlands: OEEI At European level: Transport: HEATCO harmonised guidelines, 2006 General: EC DG REGIO (2014) CBA guide World Bank Toolkit (2005) can be found at: https://openknowledge.worldbank.org/entities/publication/a448ca5f-7369-5103-8875-8795a93085d7 International comparisons - report by Mackie and Worsley (2013) https://www.gov.uk/government/publications/international-comparisons-of-transport-appraisal-practice Questions? [email protected] 30 Next week Cost Benefit Analysis 31 Thank you! 32