Some sobering research on infrastructure

A wee while back I posted about the outstanding service a modest piece of infrastructure had provided to the Auckland region, and went on to make the case that there could often be unexpected spinoff benefits from infrastructure investment, over and above those envisaged at the time: I mentioned the example of the Auckland Harbour Bridge in particular. Hence and otherwise I got to the point that with government borrowing costs currently so low, there was a good case for the government to accelerate or increase the infrastructure spend.

But I was given pause for thought by a comment from 'Wellington Haiku' - I don't know for sure who that is, but one Wellington organisation is given to announcing its research in haiku - who referred me to the work done by Bent Flyvbjerg at Oxford University's Saïd Business School, and in particular to his paper, "Survival of the unfittest: why the worst infrastructure gets built—and what we can do about it".

The gist of his argument is that infrastructure projects typically cost far more, and are far less productive, than imagined in their planning:

Cost overruns in the order of 50 per cent in real terms are common for major infrastructure, and overruns above 100 per cent are not uncommon. Demand and benefit forecasts that are wrong by 20–70 per cent compared with actual development are common.

The reason that they turn out that way, is that infrastructure planners have been gaming the people who pay for the projects:

promoters and forecasters intentionally use the following formula in order to secure approval and funding for their projects:

               underestimated costs+overestimated benefits=funding

Using this formula...results in an inverted Darwinism, i.e the survival of the unfittest. It is not the best projects that get implemented, but the projects that look best on paper. And the projects that look best on paper are the projects with the largest cost underestimates and benefit overestimates, other things being equal...Therefore the projects that have been made to look best on paper in this manner become the worst, or unfittest, projects in reality, in the sense that they are the very projects that will encounter most problems during construction and operations in terms of the largest cost overruns,benefit shortfalls, and risks of non-viability.

And Flyvbjerg goes on to recommend a whole series of sensible improvements to the governance of infrastructure investment, including the compulsory introduction of private capital as 'skin in the game' to incentivise better financial performance.

I have to say, post Flyvbjerg, my optimism about infrastructure has taken something of a knock. But as I brooded a bit, I'm not sure that everything Flyvbjerg said made total sense to me.

One thing that seemed a bit strange was that, if a high proportion of infrastructure budgets really do run well adrift of plan, why isn't there more of a political fuss? We've had a few projects go awry in New Zealand - the INCIS police computer system, the Novopay payroll system - and they've invariably been heavily picked over afterwards (both were subject to formal ministerial inquiries). Why, if they really do systematically go off the rails, aren't we seeing infrastructure projects in the dock every other day?

And I'm not sure why the project paymasters would keep getting gulled - you'd think they'd wise up, and that there'd be a kind of arms race to build ever stronger protection against ever more blatant puffery. At one institution I know, for example, projects needed to meet an internal rate of return target of 19% and a payback period of two years - ruled designed to filter out all but the strongest cases (though people still tried brazen reverse-engineering of project numbers to fit the criteria). The NZ Treasury's required 8% real rate of return is arguably a similar device.

And even if project promoters are gaming the system over and over, you'd think the best projects would still be the ones most easy to manipulate to show supersized net benefits, and it could well be that even though they didn't live up to the hype, they were still well worth doing. The metric of success Flyvbjerg uses (actual versus expected usage) is only a partial view of overall value: what if a new road was underutilised relative to forecast, but was used enough to relieve a major bottleneck on a big highway? What if (like the Auckland Harbour Bridge) it unleashed a whole new avenue of development wholly outside the original cost-benefit calculus?

All that said, Flyvbjerg's general point must surely be right: people need to be realists about the often exaggerated anticipated benefits from infrastructure. But my point about unanticipated benefits in at least some cases must surely be right, too: who'd have thought, for example, that the Plain Old Telephone Service ('POTS') carrying voice over copper wires would end up supporting ADSL and VDSL speed broadband?

The reality is that every infrastructure investment, like any other investment, extinguishes some previous options, and creates new ones, and we may not even know what some of those options are, let alone their value, until after the event (maybe long after, as with the Harbour Bridge). As I said in the original post, "That doesn't mean that every social planner should have free rein to add on arbitrary benefits on a "build it and they will come" basis". Investment is an experiment, with uncertain results: there will be losers (and probably more losers than I previously thought), but if you make an over-cautious number of experiments, you'll also truncate your chances of the unanticipated payoffs.

The Aussies are winning the competition policy game

Yesterday the Australian government announced that it is going to follow the recommendations of the Harper review of competition policy, and change the bit of the Aussie competition law - section 46 - that aims to prevent anti-competitive abuse of market power. It's going to change to being based on an "effects" test - did the powerful firm's behaviour have the effect of damaging the competitive process? The current system, which focusses on the purpose of the powerful's firm's action, will be junked, and with it will go the whole legal palaver over whether a firm "took advantage" of its market power, and which has required going through a fanciful "counterfactual" exercise of whether a firm without market power would have done the same thing. Now, all that will matter is whether the opportunity to compete has been compromised - the effect. As it should be.

The Aussies have made exactly the right call. They're right when they say that

Australia’s current misuse of market power provision is not reliably enforceable and permits anti-competitive conduct. This slows the entry and expansion of new and innovative firms, delays the entry of new technologies into Australia and impedes economic growth in the long term

and right again when they say

this reform represents a commercially and legally robust law, preventing firms with market power engaging in behaviour that harms the competitive process. It places Australia’s competition law on the right footing to encourage economic growth and innovation

and I wouldn't mind if more governments came out and said

Protecting the competitive process is unashamedly pro-competition and allows everyone to have a go.

This has a variety of implications for New Zealand.

As I've argued before (here or here), I think the Aussie have got their act together on competition policy - commissioning a wide-ranging review, finishing it quickly, and adopting most of the decisions including (as we've just seen with their s46) some of the politically trickier ones. Earlier, the Aussie government had said it wasn't immediately going to change s46 as Harper had recommended, which was widely interpreted as fear of the big business lobby's reaction: the big end of the town was against the change, for a variety of principled and self-interested reasons. But the Turnbull government has correctly and (in defiance of the Sir Humphrey Applebys of Canberra) courageously faced down the political opposition. The Aussies are no shining angels on everything - they've been wusses about proper liberalisation of second-hand car imports, for example - but they've stolen a march on us here.

At home, we have run a much less comprehensive 'targeted review of the Commerce Act' which, to be fair, did include a review of options for changing section 36 of our Commerce Act, our equivalent of the Aussies' s46 (and yes, I did make a submission saying we should go the way the Aussies have just gone). As for timeliness, the targeted review is still in the bowels of MBIE somewhere, and we don't know what it will recommend or when, or whether our government will go with whatever it comes up with.

You'd think our government would be daft to leave us as the only jurisdiction in the English-speaking world still hanging onto the economic and legal make-believe world of the "counterfactual", let alone - given that they're been banging the drum about harmonising trans-Tasman institutional arrangements - allowing a large gap to develop between our competition law and the Aussies'. But on the other hand I'm not fully sure our government is ready to take on potential big business opposition in the way the Aussies just have. Ours has, for example, flagged away criminalisation of cartels: yes, you can make a principled (though wrong) case for doing that, but it could as equally be symptomatic of paying close attention to whatever big business had been whispering in your shell-like. We'll see.

The only thing that slightly irks me about what the Aussies have done is the way they've represented it as a small business versus big business policy. It's been widely represented the same way in the media (here or here, for example). Now, I understand the politics of it - if you're going to brass off big business, then you'd better court the compensating small business vote, and anyway it plays to the long-standing "Aussie battler" meme. But it's not the best way to think about it: a better way is to recognise that anti-competitive rorts are as likely to rip off a big business as they are you or me. A business can be very big indeed, and still get ripped off when, for example, the fix is in (as it was) on the cardboard boxes it needs. Effective competition benefits us all - big and small.

Surprise! Surprise!

You've seen that the Reserve Bank has unexpectedly cut interest rates by 0.25% and has at least one more 0.25% cut in the pipeline.

For me, the most striking thing in the Monetary Policy Statement was this graph.

No matter how you slice it, it's now apparent that core inflation is, at best, systematically in the bottom half of the RBNZ's target 1-3% band, or, arguably, dropping out the bottom. And the trend, if anything, is that core inflation is still falling.

There are some who will argue that this is, in part, the RBNZ's own doing, with its interest rate increases in 2014 which (with hindsight) proved too tight a setting of monetary policy and hence subdued inflation more than desirably. Personally, I'm rather more inclined to another explanation, which is that our economy (and others) have changed in some still not fully understood way, so that the amount of inflation you get for any given degree of strength in the economy is less than it used to be (a "flattening of the Phillips curve", in the jargon).

Bernard Hickey of interest.co.nz asked Governor Wheeler a very good question at the post-Statement press conference, along the general lines that perhaps there have been structural changes in the global economy - technology? better supply chains? - that have made pursuit of 2% inflation targets a waste of space (I'm paraphrasing).

The Governor agreed that there had certainly been changes along those lines that could well be depressing inflation. But he said that no central bank had yet decided to flag away inflation targetting, and no central bank had lowered its target inflation rate. He also said that the traditional "output gap" analysis - if the economy is going gangbusters (a positive output gap) you'd expect higher inflation - is still very useful, and that the Bank isn't abandoning the traditional framework.

We'll see. For now, though, I'm rather attracted to the idea that inflation in the developed world has moved structurally lower. Throw in the additional fact that most of the major developed economies have their monetary policies set on super-easy, and you can readily get to the point of believing that there's actually no sensible setting of local monetary policy that will get inflation back up to 2%. In that light I'm not surprised that the Bank has now pushed  inflation being back at 2% out to March 2018.

A once in a generation opportunity

I'm going to be talking about infrastructure, but first let's detour back to August, 1968. President Johnson is waging the Vietnam War, the Warsaw Pact forces have invaded Czechoslovakia. In Dublin I have just turned 17, and I'm hoping that José Feliciano's Come on baby light my fire will encourage one of the prettier girls from St Louis Rathmines to have a slow dance with me (it won't).

And on August 19 1968 this concrete power pole was manufactured: the date was inscribed in the concrete by someone at the (unidentified) factory. It's one of Vector's, and it's on Albany Heights Road in Auckland.

It's a fine example of how infrastructure can be a great, enabling investment. It's not just that this pole has been giving good service for 47 years already and, based on manufacturers' blurbs and various regulatory proceedings concerning expected asset lives, that it could well go on for another 40 years. But it's also because, when it was installed, Albany was still undeveloped farmland. Now, the same pole is helping supply power to a vastly larger population than was envisaged when it first went into the ground. Indeed, already installed power poles, and other infrastructure, were themselves instrumental in enabling the development that subsequently occurred. From the point of view of overall social return, and very likely from the investor's private rate of return, this has been an outstandingly successful investment.

There's an even bigger example - the Auckland Harbour Bridge. As Motu's Arthur Grimes pointed out in a fine paper

The benefit from building the Auckland Harbour Bridge did not arise primarily because it enabled 26,000 people to travel faster into Auckland; its primary benefit was that it enabled a tenfold population increase north of the harbour, greatly extending Auckland’s urban area.

Albany was once at the end of a windy road, well north of the end of the Northern Motorway; now it is a major commercial, educational, sporting and residential node within Auckland.

And Arthur went on to make the general policy point that "major strategic investments – whether in transport or broadband – sometimes cannot be analysed solely within a traditional cost-benefit analysis (CBA) framework. CBA does not cater adequately for the responses by private agents to the opportunities that may be created by gamechanging infrastructure initiatives".

It's not invariably the case that things will work out better than expected when infrastructure gets rolled out - as you'll see if you google "the bridge to nowhere" - but it's often the case that the total, social benefits of infrastructure investment will be greater than were able to be counted at the time of the investment. Go no-go decisions will as a result be unnecessarily conservative, and less infrastructure will get rolled out than would be best for the country's overall welfare. That doesn't mean that every social planner should have free rein to add on arbitrary benefits on a "build it and they will come" basis - that's the route to every politician's pet elephant getting painted white - but it's generally reasonable to suppose that the benefits may ultimately play out somewhere better than you might think day one.

Pulling things together, we've got three things going on. One, our existing infrastructure is inadequate, especially in Auckland, and there's a great deal of investment that we will need to do: the latest National Infrastructure Plan mentions "$50 billion of forecast infrastructure spend over the next ten years". Two, we can be reasonably sure that the total benefits of increasing the stock of infrastructure will often be more than the beancounters suppose. And three, we have a once-in-a-generation opportunity to borrow money for infrastructure at an exceptionally low cost.

The New Zealand government can currently issue 10 year debt at a tad over 3%. That's exceptionally low by our own historical standards - yet still highly attractive to foreign investors. The equivalent 10 year rates overseas are -0.41% in Switzerland (yes, you read that right, a negative 10 year bond yield, where lenders are paying the borrower), -0.06% in Japan (yup, negative again), 0.23% in Germany, 1.59% in the UK and 1.91% in the US. Currently the New Zealand government could fill its boots with all the infrastructure funding it could feasibly want, at exceptionally low cost.

I gather from media reports that the government is indeed thinking of bringing forward some infrastructure projects. My advice would be: let it rip.

How 'special' are Special Housing Areas?

Three months ago I went and had a look at a Special Housing Area (SHA) that had been set up not too far away from us in Browns Bay (if you're not au fait with the whole SHA thing and the Housing Accord, you'll find Auckland Council's guide handy).

As I said then, I came away thinking that calling it an "area" was pushing the ordinary meaning of the word: it was actually one site, at 4 Bute Road. I wasn't convinced there was much "special" about it, either. Lots of other mixed retail/residential blocks had already been developed along Bute Road, and giving accelerated planning permission to something that would likely have sailed through in any event didn't seem to me to be much of a nudge towards faster housing supply. In any event, 4 Bute Road didn't seem to have benefitted much: nothing was happening on site.

Over the weekend I went back to have a look and see how things have progressed since then. And the answer is, they haven't. The big tree next door has had a good summer, but that's it.

All of which is a bit odd, as the supposedly fast-tracked SHA site is still sitting there, while further along Bute Road, non-SHA developments are coming along fine. Here's a big new five-storey one, for example, at 1/23 Bute Road.

So I went to have a look at another local SHA, at 586 and 588 East Coast Road. This is an earlier one: it was part of a batch that were designated SHAs in September 2014, whereas 4 Bute Road got the nod in August 2015. Here's what it looks like: it's the bungalow with the grey roof in the centre of the picture, plus the house with the orange roof behind the pine tree.

Again, this is stretching "area" a bit, but I suppose two average-sized sections make an "area" of some sort. Whether it needed or benefitted from "special" designation is anyone's guess. It's true that there aren't other apartment blocks in the immediate vicinity, so maybe the developer would have been attracted by faster-track consent (under the SHA process) for a 39-apartment development, instead of some more protracted bunfight. But on the other hand there's already a 2-storey business park thingie next door (you can see the edge of it in the left hand side of the photo), so putting in a smallish apartment block wouldn't be that much of a planning consent hill to climb.

In any event, nothing's happened on this site, either, though to be fair the original SHA announcement in September 2014 talked of a timeframe of "the next 24 to 36 months", and said "There is an intention to have the residential housing project completed in the early part of 2017".

Where all this leaves me is this. I'd like to believe that "Special Housing Areas" greased the wheels of the housing planning process, and either accelerated or increased new construction, or both. That would  be a great outcome on one of our largest national infrastructural challenges: skyrocketting Auckland house prices, as we know, have had ramifications all over the place.

But how will anyone definitively know? At one level, it's not that hard to create an anecdotal trail (as I've just done) of slow SHA development and as-fast or faster non-SHA development, and to convince yourself that they've had no impact on supply at all, or even held it up. It's possible, for example, that the central quid pro quo of, broadly, faster planning consent in exchange for inclusion of some "affordable" units within the development, never took off enough to make any difference.

But for a policy this important, I'd like to think there'll be some more sophisticated analysis of whether it's working. Granted, MBIE and Auckland Council have, between them, come up with a series of informative monitoring reports: you'll find the latest one, covering the period October 2104 to September 2015, the second year of the Housing Accord, here. It's got lots of useful data, such as this graph (on p15) of what's happened to housing consents since the Housing Accord kicked in.

The problem, for me, is that the data, while useful, don't really answer the question, did the SHAs make a difference? We don't know how much of this recent consenting and development would have happened in any event - in fact, while consenting has picked up substantially in the Housing Accord era, it hasn't yet consistently reached the levels that Auckland managed without Accords and SHAs in 2002-04 (and in a smaller Auckland back then, too). So I'm hoping that someone - an economic consultant with an interest in housing, maybe? - will be asked to turn their minds to a proper 'with and without' exercise: matching a bunch of otherwise similar SHA and non-SHA areas, and checking to see if the SHA ones outperformed in speed or quantity.

Incidentally, the monitoring report mentioned, in passing, a couple of truly appalling facts about the slowness of the normal planning process. It was giving some case study examples (on pp6-9) of where SHA planning processes have got things moving faster: it said, for example (p9) that "Within two years of the start of the Accord, homes are being delivered in SHAs like Weymouth and Northern Tamaki and sections delivered in special housing areas like Whenuapai Village".

Jolly good: but the report also noted that these were "processes that would normally have taken 4 or more years", and earlier (p6) it said that "Under the Resource Management Act 1991...the rezoning of brownfield sites to enable more intensive development can take between 2 and 6 years".The Second World War took six years. I don't think a planning consent needs to.