Wednesday, 9 March 2016

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.

2 comments:

  1. Could I commend to you the work of Bent Flyvbjerg at the Oxford Business School for an opposing view - that the costs of infrastructure projects are usually optimistically underestimated and their benefits overestimated, either innocently through natural optimism bias or deliberately so as to make sure they get built. He's got plenty of empirical evidence on his side. For example, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2229768

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  2. Thanks very much for that - I hadn't seen his work, but I'll follow it up once I've got a project I'm working on out the door. Much appreciated - I'll post again when I've read it

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