Economics

The Department for Transport is consulting on whether to extend the length of the appraisal period used to assess project benefits, typically 60 years at present. The argument is that many projects have the potential to deliver benefits well beyond this time horizon, but these benefits are not currently included in scheme appraisals. My response is set out below.

The standard approach to the appraisal of transport investments is based on the estimation of user benefits, mainly the saving of travel time. Clearly, uncertainty increases as more distant future benefits are considered. Factors that would need to be taken into account in estimating future demand include:

• Population growth. The Total Fertility Rate (the average number of children born to a woman over her lifetime) for the UK is 1.89, below the level of 2.1 needed for a stable population, and the lowest on record. Many developed countries have lower rates: Germany 1.45, Italy 1.44, Japan 1.41. So, we may experience future population decline, although decisions on immigration would affect the outcome.

• The relationship between income growth and travel demand. The average distance travelled by all surface modes has not increased this century (NTS data), suggesting an uncoupling of the relationship between GDP growth, income and travel demand. There is evidence for the saturation of demand for daily travel.

More generally, it is impossible to validate the performance of models far into the future. Lack of validation contributes to optimism bias in modelling generally. Models are complex and opaque, with the value of many parameters to be chosen based on expert judgement, such that outcomes can often reflect the preconceptions of those who commission the modelling. The Green Book and TAG provide uplift factors for costs to allow for optimism, but there is no equivalent for benefits.

There is evidence for optimism bias in demand estimation, particularly when competitive bidding is involved, as for rail franchises in the UK and toll road concessions in Australia. Some winning bids have been too optimistic in projecting future revenues, such that rail franchisees have withdrawn, and toll road investors disappointed and consultants successfully sued.

Given all the uncertainties, extension of the appraisal period beyond the current duration would be unwise. The possibilities of benefits beyond 60 years might be regarded as a bonus that could increase confidence in an investment that offers an acceptable BCR within that period, as well as to counter optimism bias in demand estimation.

I imagine the interest in extending the appraisal period arises from the HS2 Business Case, where extending to 100 years generates a small increase to the BCR that is otherwise in a low value for money category. Notwithstanding the arguments above, there could be a case for extending the appraisal period for HS2 on account of the expected changes in land use.

There has always been an inconsistency in supposing time savings to be the main user benefit of transport investment, given that average travel time as measured in the NTS has hardly changed over almost fifty years, despite huge investment justified by the saving of travel time. The explanation is that time savings are short run. In the long run users take advantage of faster travel to travel further, to gain more access to people, places, opportunities and choices. Increased access leads to changes in land use and in the built environment that are mainly long term.

Accordingly, it could be appropriate to appraise the long-term benefits of transport investment as part of consideration of its long-term impact on the wider built environment. In the case of HS2, this would involve assessing the prospects for business and residential property development at locations whose access is enhanced by the new rail route. That is not to say that changes in land use would continue over a long period. They may well take place fairly quickly, both before and after the rail route opens, although there would be long-term benefits from the improvements to real estate. There are many uncertainties about such developments, both planning and commercial, but these uncertainties are directly relevant to policy objectives and therefore worth addressing, unlike the uncertainties about long run travel time savings.

The underlying question concerns the nature of the long run economic benefits of transport investment. While an extensive methodology has been developed based on time savings as the main part of generalised costs, time and money are importantly different. Time acts as an independent influence on travel behaviour. The long run impact of investment is to increase access within a time constraint. Such increased access is the benefit to users and results in changes to the use and value of land made more accessible.

In conclusion, if appraisal focuses on time savings to users, then extension of the appraisal period is not justified. If, however, the focus is on increasing access to the built environment, then a longer timeframe might be warranted.

The National Infrastructure Commission (NIC) has published its final report on Rail Needs Assessment for the Midlands and the North. This had been commissioned by the government to support its intention to prepare an Integrated Rail Plan to identify the most effective scoping, phasing and sequencing of relevant investments and how to integrate HS2, Northern Powerhouse Rail, Midlands Rail Hub and other proposed rail investments.

The projection of benefits departs from the standard transport cost-benefit analysis in which the main economic benefit to users is the saving of travel time. As set out in the annex to the report, the Commission’s approach is to assess the potential for rail investments to support both economic growth and improved quality of life, as these arise through the increase in density in city centres. Such density increase generates the well-known boost to productivity from agglomeration, an approach which is innovatively extended to capture the consumption impacts of agglomeration through access to increased amenities. The latter replaces conventional time saving benefits.

The NIC analysis recognises increased wages for workers accessing better paid jobs through increased rail capacity. Improvements in rail connectivity between cities and towns are also estimated, which contribute to increased productivity.While changes in life cycle carbon emissions and in natural capital are estimated, changes in land use are not.

The NIC’s methodology is used to compare packages of investment, formulated according to both overall cost and emphasis on enhancing links, regional and long distance. Broadly, investment in regional links comes out as a bit more attractive than in long distance links, which implies less importance to building the eastern leg of HS2 to improve journey times to London than in reinforcing connections within the regions. However, in relation to the cost of investment, none of this additional rail capacity seems very attractive, although the Commission concludes that with some assumptions about the non-monetised benefits, its analysis suggests the full benefits should meet or outweigh the costs of the packages. In this respect it is similar to the conventional economic analysis of HS2.

Assessment

The NIC analysis is particularly interesting in that it is based on the recognition that travel time savings are not a satisfactory basis for estimating the benefits of transport investment, given that average travel time has not changed for at least half a century despite huge investment justified by the expectation of time savings. So the NIC focuses on the benefits of increased density of city centres that could be made possible by better rail connections. The established estimation of productivity benefits arising from higher density, the agglomeration effect, is extended to amenity benefits to consumers, a welcome innovation. Nevertheless, valuation of agglomeration effects is indirect, depending on econometric analysis, as opposed to changes in land use and value that are directly observable. So the omission of changes in land use from the NIC analysis is a pity.

The Department for Transport recently published a document outlining its approach to updating its Transport Analysis Guidance (TAG) ‘during uncertain times’. Two factors imply reduced travel demand: the long-term assumption about GDP growth has been reduced from 1.9% pa to 1.4%; and population growth from 0.3% to 0.15%, reflecting exit from the EU. New values for carbon emissions are also to be provided.

What was missing, I thought, was consideration of the need to update modelling, given the DfT’s intention to published a transport decarbonisation plan. Yet there are a number of shortcomings to existing modelling techniques, particularly in respect of estimating the impact of interventions aimed at reducing transport carbon emissions.

National models

The National Transport Model (NTM) is used to generate the Road Traffic Forecasts, most recently published in 2018. Scenario 7 addresses the consequences of a shift to zero emission vehicles and projects a 51% increase in road traffic 2015-2050, compared with 35% for the reference case, reflecting a reduction in fuel costs and assuming no changes to government policy on taxation.

There are, of course, sensitivities about making assumptions about future taxation. Yet mode share is influenced by levels of tax and subsidy. Arguably, both the growing proportion of SUVs and the decline in bus use have been facilitated by the freezing of road fuel duty since 2011. There is therefore a need for an approach to modelling that allows the full range of policy options to be explored, including changes in relative costs. One possibility might be to seek a remit analogous to that given by HMT to the National Infrastructure Commission, which must be able to demonstrate that its recommendations are consistent with gross public investment in infrastructure of between 1.0% and 1.2% of GDP in each year between 2020 and 2050.

Taxation aside, the growth of traffic projected in Scenario 7 is implausible. Travel time has been measured in the National Travel Survey (NTS) for the past 45 years and on average has remained close to an hour a day. This implies that the time available for travel is constrained. A reduction in fuel costs therefore would not lead straightforwardly to an increase in distance travelled, which would only arise if either higher speeds were possible (not to be expected from a switch to zero emission technology) or higher car ownership occurred (not assumed in the model).

More generally, the three key parameters of the NTS – average travel time, trip rate and distanced travelled per year – have not increased since 2000. I would expect any model to hold these per capita parameters unchanged on a central case projection, unless there were to be a clear causal explanation for a different trend. Population growth is then the main determinant of future traffic growth, but the relative mode share would depend on where the additional inhabitants live: to the extent they are housed on greenfield sites, car use would be important; to the extent they are located within existing urban areas, investment to support active travel and public transport would be relevant. My understanding is that the National Trip End Model (NTEM) provides a single national set of assumptions about demographic factors, and therefore does not allow consideration of policy options in respect of spatial location. If public transport and active travel are to be ‘the natural first choice for daily activities’, then the spatial location implications of population growth need to be incorporated into modelling.

Regional models

Beneath the NTM, there are a number of regional transport models. Those commissioned by Highways England are mainly (entirely?) based on the SATURN software first developed in 1980. Despite very considerable ex ante efforts to refine and update such models, there is a dearth of ex post analysis of modelling validity. A partial exception is the detailed monitoring of traffic for each of the three years after opening of the widened M25 between J23 and J27. Small time savings were found at year one, but these were lost by year two due to increased traffic volumes. The forecast traffic volumes derived from the model were less than observed and the forecast increase in traffic speed did not materialise, hence negating the economic case for the investment. The additional traffic generated externalities beyond forecast, including carbon emissions.

More generally, the whole area of regional modelling lacks transparency. Highways England does not appear to publish information on its models and their validation. It would be timely to review the validity of such models.

Assessment

Current UK transport modelling as a whole seems mainly concerned to update, refine and apply long established approaches. The bulk of modelling expertise is found within the consultancies, who are concerned to meet the needs of their clients using accepted methodologies, often to provide formal justification for a preferred investment. The Department is conservative in its requirements. Consultants therefore have little incentive to develop innovative approaches. Fresh thinking is needed, yet there is no academic centre of expertise in transport modelling where innovation could be expected.

Established models do not seem well suited to supporting a strategy aimed at achieving net zero transport carbon emissions by 2050. A related problem is the lack of data for model calibration in respect of the impact of the range of possible policy interventions. For instance, if the encouragement of active travel is successful, from which mode does the shift occur? The experience of the cycling city of Copenhagen is that car use is only slightly less than in London, but public transport mode share is half that of London. This suggest that we can get people off the buses onto bikes, but that it is more difficult to get them out of their cars, even in a city where all motorists are familiar with cycling.

Decarbonisation will be a long game, during which we should be able to gain understanding of the consequences of the various policy interventions, even though these will be difficult to model at the outset. It would be desirable to initiate the development of new models soon, ready for when calibration data becomes available.

The Full Business Case for HS2 Phase One has now been published. This  supports the Government’s decision to go ahead with the entire new rail route from London to the cities of the Midlands and the North, despite the dramatic escalation in construction costs, from £37.5bn in 2011, to £50bn in 2013, to £65bn in 2015, to £109m in the latest business case, and doubtless even more in eventual outturn.

It is noteworthy that the initial increases in the cost of HS2 did not change the supposed economic benefits, as measured by the benefit-to-cost ration (BCR), which held steady at close to 2.0, representing ‘high’ value-for-money according to the DfT’s Value for Money framework for economic appraisal. This was the result of substantial additional benefits being recognised by the promoters, even though nothing fundamental had changed in the business case. However, last year independent reviews by Douglas Oakervee and by the National Audit Office estimated higher capital costs that reduced the BCR to 1.5 or lower.

The new business case recognises these new capital costs but fails to identify any compensating additional benefits, such that Phase One (London to Birmingham) has a central-case BCR of 1.2, while the full “Y” network has a BCR of 1.5. Accordingly, Phase One has been assessed as ‘low’ value-for-money, while the full network would be ‘low to medium’. Any further increase in capital costs would reduce the outturn BCR, as would less demand than assumed for rail travel over the 60-year forecast period.

It is surely remarkable that the largest ever UK transport infrastructure investment is proceeding on the basis of such low returns, given the great number of more attractive potential such investments. Is this a case of politics trumping economics, or are the politicians right to see benefits not recognised by orthodox economic analysis?

The precedent of the Jubilee Line Extension (JLE) to London’s Docklands, with a BCR of less than one on the standard approach to appraisal, indicates the potential regeneration benefits that may be achieved. The increased real estate values, reflecting the economic benefits to businesses locating at Canary Wharf and beyond, were not taken into account since this would supposedly involve doubling counting benefits implicit in the value of travel time savings, the main element of economic benefit in the standard DfT WebTAG appraisal methodology. These time savings comprise small amounts of time saved by large numbers of commuters, valued by market research techniques that require respondents to trade time and money in the short run. Yet it is scarcely credible that the aggregate of such time savings could provide a measure of the long run cumulative real estate value uplift, whether for the JLE or for HS2.

Moreover, orthodox investment appraisal has no spatial content, no indication of the geographical distribution of economic benefits. This is a crucial issue for HS2, the strategic aim of which is to boost the economies of the cities of the Midlands and the North.

More fundamentally, the importance attached to travel time savings is misconceived. The National Travel Survey has been measuring average travel time for 45 years, over which period it has hardly changed, despite many £billions of public investment in transport infrastructure justified by the value of supposed time savings. In reality, people take the benefit of such investment not in the form of more time for work or leisure, but as greater access to desired destinations yielding more opportunities and choices. The purpose of HS2 is to increase the access to London of those living in the Midlands and the North (and vice-versa). Increased access will lead to changed land use and enhanced real estate values, which are the market indicators of economic development.

It is possible that the real economic benefits of HS2 are substantially greater than calculated in the Full Business Case using the WebTAG methodology. It is therefore time to reconsider the basis of transport economic appraisal from first principles.

This blog post appeared as a Comment to a feature about the HS2 Business Case published in Local Transport Today 15 May 2020.

The Prime Minister has announced the Government’s decision to go ahead with High Speed 2 (HS2), the new rail route from London to the cities of the Midlands and the North, despite the dramatic escalation in construction costs, from £37.5bn in 2011, to £50bn in 2013, to £65bn in 2015, to excess of £100m in 2019 and probably in eventual outturn.

The value for money (VfM) of the investment has been computed according to the Department for Transport’s (DfT) standard approach to appraisal of proposed investments. This compares benefits with costs according to long-established principles of cost-benefit analysis as applied to public sector investments. The main benefit to users of a faster rail route is assumed to be journey time savings, which are supposed to allow us more productive work or enjoyable leisure. To these time savings are added lesser contributions from improved reliability and reduced overcrowding, as well as some wider economic impacts such as productivity gains and environmental impacts.

It was noteworthy that the initial increases in the cost of HS2 did not change the supposed economic benefit, as measured by the benefit-to-cost ration (BCR), which held steady at close to 2.0, or £2 of benefit for every £1 of cost. Substantial additional benefits were recognised by the promoters, even though nothing fundamental had changed in the business case. However, the independent review by Douglas Oakervee, commissioned by the Government and just published, puts the BCR at 1.1 to 1.5, reflecting the increase in costs. The National Audit Office’s recent report on HS2 estimated a BCR of 1.4.

The DfT is yet to issue a revised Business Case for HS2 that takes account of the latest plans and possible cost savings. When it does, I expect to see the usual tweaking and massaging of assumptions about an uncertain future state of the world that can be defended as a legitimate exercise of professional judgement by transport economists who wish to please their clients, in this case Ministers who have decided to press ahead. The objective will be to achieve a BCR of 2, which is the threshold for the DfT’s High Value for Money (VFM) category.

Apart from such malleability in analysis, there are two big problems with the standard approach to the economic appraisal of proposed transport investments. First, the time saving benefits arise from trips between cities and say nothing about economic development within cities. The strategic case for HS2 is to boost the economies of the cities of the Midlands and the North by improving their connectivity to London and the South East. But the impact on cities, as seen in the form of property development and increased real estate values from productivity enhancement and employment creation, does not enter into the cost-benefit calculus, which is silent on the geographical distribution of benefits. The Oakervee review concluded that the economic case does not currently fully align with the strategic case because economic rebalancing, one of the primary drivers in the strategic case for HS2, is not currently reflected in the economic case.

The second problem is that average travel time, as measured in the National Travel Survey, has hardly changed over the past 45 years, despite many £billions of public investments in the transport system justified by the value of journey time savings. What actually happens is that investments that result in increased speed of travel allows us to travel further, to gain access to more distant destinations, opportunities and choices, which are the real benefits experienced by users, not the hypothetical time savings assumed by the economists. Such transport investments lead to changes in land use as people and businesses take advantage of the improved access to land and property capable of better use.

The standard approach to economic appraisal of transport investments is quite narrowly focused and disregards the value implied by changed land use and the geographical distribution of economic activity. The DfT has not required or supported modelling of the land use impacts of transport investment, which has contributed to the failure to value the real benefits of HS2. These might turn out to be quite substantial if the linked cities can take advantage of the modern high-speed connection to London to boost their economies by local investment in property development near to new stations and in urban rail to enlarge the benefits to surrounding districts.

The purpose of HS2, as with any new railway, is to move more people through space, so spatial impacts are what are of interest. The focus of the transport economics profession on time savings has been quite misconceived.

This blog was also published in Transport Times on 13 February 2020