Rail 543: Pessimistic Treasury is stifling major railway projects

A new report warning that a ‘pessimism bias’ is preventing Britain from getting the large-scale rail infrastructure projects it needs is applauded by CHRISTIAN WOLMAR.

Why is Britain so hopeless at building major infrastructure projects? The answer people always give is that the Treasury is very reluctant to approve schemes. This has always been a mysterious area since successive Chancellors (there were some before Gordon!) always talk about what is best for UK plc, and yet having a decent infrastructure is a prerequisite for economic effi ciency.

Therefore, it is vital to understand where this negative view of infrastructure projects comes from, and Rana Roy, the economist who has carried out several projects for the Railway Forum, has done us all a favour by writing a pamphlet – ‘Investing in the new century: towards an undistorted appraisal process’ (available online) – which attempts to explain where the system lets us all down.

This may sound an arcane and academic subject, but the pamphlet produces crucial evidence on why the Government fails to appreciate the value of investing in projects ranging from those of national importance such as Crossrail or a North-South high-speed rail line, to local tram schemes. Indeed, it explains why we just do not build enough ‘stuff’ and why, as Roy sadly mentions, there are countless past projects which may well have been perfectly viable but were sunk ‘gleefully’ by Treasury boffi ns eager to prove they were not worthwhile so that they would not have to put their hands in taxpayers’ pockets.

The Treasury is always worried that money will be wasted, leaving a legacy of ‘white elephants’ as a permanent monument to the profl igacy of government. In fact, there are as few white elephants as you will fi nd on the African savannah. I was chatting to a senior Labour MP the other day who asked me why Croydon Tramlink was such a failure. I had to explain that it was, in fact, very well used, but that it had been built on over-optimistic revenue forecasts in order to ensure it had a business case for the private companies who built and operated it, and they were sore that they had lost money, but the people of Croydon and south London love it. The Treasury, however, ignores such niceties and is always eager to point out that such schemes, which are part-funded by taxpayers, are a waste of money.

Remember the fuss about the overrun on the Jubilee Line Extension which took the cost from £1.8billion to £2.8billion? Again, given the huge success of the scheme and the massive rise in property prices, both residential and commercial, along the route, who would say now that it should not have been built? I have expressed scepticism about Crossrail in this column recently (RAIL 539) but that is about the precise nature of the scheme (and, indeed, the fact that successive cutbacks to the original concept have reduced its usefulness) and the tunnel section under central London is the only game in town. No one doubts that London needs more transport infrastructure.

As a non-transport example, does anyone question the value of the wonderful British Library which was the subject of a fi erce opposition campaign as it was being built because it cost more than originally envisaged? There have been the odd Lotteryfunded schemes that should never have seen the light of day, notably the Millennium Dome, but that was a politically-determined building that would never have passed any realistic cost-benefi t assessment.

With hindsight, therefore, more major schemes should have got the go-ahead and we have to learn from that mistake. Roy suggests there is a pessimism bias which manifests itself in several ways that prevent a proper assessment of projected schemes and which leave our transport system inadequately funded.

This is complicated stuff with lots of algebraic formulae which, dear reader, I will spare you, but a little bit of explanation is necessary. Detailed cost-benefi t analysis methodology is used to assess the worth of a project, by assessing its Net Present Value and comparing that with the cost. The Net Present Value is calculated by rolling up the benefi ts – mostly time savings by both users and non-users, who benefi t by having clearer roads – over forthcoming years, and discounting them by a set percentage rate. The discount rate is used in order to take account of the fact that the benefi t in year one is worth more than in year two and so on, on the basis that if the money had been spent on something else, it would earn interest.

Here there is good news. The lower the discount rate, the greater the benefi ts, and the Treasury did change it from 6% to 3.5% recently because we now live in a world of far lower interest rates than in the last three decades of the 20th century. However, on the negative side, the Treasury continues to assume that the long-term economic growth rate is 2%, rather than last century’s 3%, and this reduces the expected benefi ts from schemes because the expectation is that fewer people will use them.

Roy also highlights the fact that the Treasury requires a particularly high benefit- to-cost ratio before it will give the go-ahead to any project. In an ideal world, anything with a ratio above one ought to be given the go-ahead, but in practice not even all those projects with a ratio above two get to be built. There is no logic to that – if the analysis suggests that society will benefi t greatly from the project, it should go ahead just as a business would always agree to a project which guaranteed a good rate of return.

Another notable bias identifi ed by Roy is that the increase in land prices generated by infrastructure schemes – so clear in the case of the Jubilee Line Extension where the rise in land value mentioned above has been estimated at £2.8bn, virtually the precise cost of the project – is not included in the appraisal process. The trouble is that these benefi ciaries, mostly property developers, are in receipt of a lucky windfall which does not contribute to the cost of the project. Roy points out that such unearned extra rents should be taxed which, of course, would be a way of helping to fund such projects – a point made by Dave Wetzel of Transport for London who has long been campaigning for a land value tax.

Of course, the whole idea of these schemes being assessed by tiny savings in time by people travelling – which is the main form of ‘benefi ts’ – and then multiplying that by different amounts depending on whether they are leisure or business travellers is a wonderful academic exercise, but is a pretty arbitrary way of assessing the viability of schemes. However, it is the best we have got. It is a proxy method of valuing societal gains which cannot be obtained through the fare box, and it is only needed for projects which require government subsidy (for example, BAA did not need to go through such an exercise for its new terminal at Heathrow because that is expected to earn it an economic rate of return).

A vast amount of guesswork is involved and the precise numbers cannot be taken as gospel. That said, if we use this system, we may as well do it properly, without the ‘pessimism bias’ identifi ed by Roy. Perhaps, then, we will get the transport (and other) infrastructure we need since, as he points out, the pessimism bias mitigates particularly against larger, longer-term projects on which our growth depends.

More reasons to wonder what franchises are for

The fiasco over the ban by First Capital Connect (Thameslink and Great Northern in old money) on people using cheap tickets in the evening peak is reported elsewhere in this magazine, but I just want to pick up on the political aspect.

The proposal was contained in the franchise bid and since the department gave First the contract, the change should not be a surprise to ministers – while poor Douglas Alexander may not have been around at the time, the Rail Minister, Derek Twigg certainly was. Therefore, when the residents of that swathe of the Home Counties, containing many marginal seats, protest to FirstGroup, they should be redirected to the Department for Transport’s HQ in Marsham Street.

It was all part of the effort to squeeze as much premium payment out of the franchisees as possible, irrespective of the impact on overall transport policy – one side-effect could be putting more people on the roads at peak times, for example. So will the near-doubling of car park charges by GNER.

Whether that is a sensible business proposition for GNER, as some people will clearly not let the train take the strain as a result, is another matter. It certainly demonstrates just how desperate the company is to milk any potential source of revenue in order to pay the premium being exacted by the department. So remind me, exactly what is franchising for? Is it to enable the train companies to squeeze passengers so much that they give up on using the railways?