Re: HSR Urbanists: “We Are All O’Tooles Now”

OldUrbanism — Wed, 02 Sep 2009 20:43:16 -0000

After reading this post, I once again notice the suggestion of an alternative formulation of the "full cost" of roads (and other infrastructure). I have encountered this argument in several posts on this blog. Some of the ideas I don't think are correct, and so would like to discuss here.

The first is the issue of opportunity cost, which you give great prominence to in this post. I think it would be important to first mention in each case whether you are referring to private finance of infrastructure (e.g. roads) or social benefit-cost analysis for public provision, which is much more common. In both cases interest rates figure prominently, but are treated slightly different. The opportunity cost of investment capital is explicit in the case of private finance, it is simply factored into the interest rate. It is more difficult for social BCA. since the objective is to determine the appropriate opportunity cost. Most recent textbooks I've seen on the subject do not assume a priori that public projects simply displace private capital investment, but rather some combination of private capital and private consumption, the latter having a lower marginal rate of time preference (and hence discount rate). Since this issue is not 100% settled, the best course of action in the case of social BCA is to use sensitivity analysis for a range of values, assuming different types of discount rates.

In the case of private finance, two other factors that you mention, risk of cost overruns/uncertainty and demand uncertainty/bias can also be appropriately factored into an interest rate. In principle, the same could be done for the discount rate in social BCA, but in practice is rarely employed.

The last two factors, legal costs associated with eminent domain and opportunity costs of land, are in fact often included in typical project cost estimates for both public and private projects. The former is fairly straightforward, as it is a project-related cost. The latter, opportunity cost of land, is simply the purchase price of land (assuming it is bought at market rates through an arms-length transaction -- this doesn't always happen). I have also heard some argue that the cost of existing roads should reflect the land it occupies. To me, this raises at least three questions:

1) What value would that land (presumably urban) have were it not made accessible by the provision of infrastructure. Would it have any value at all (above an agricultural use)?

2) The land typically occupied by urban infrastructure (especially roads) is not well-suited for development, and hence would have a low opportunity cost. This land often appears in long, narrow parcels, upon which little could be profitably built, especially if confronted with modern land use regulations (e.g. maximum impervious surface requirements).

3) Who is the residual claimant for the payment of the supposed opportunity cost? Local government? How would this enhance social efficiency?

Lastly, how do you arrive at an interest rate of 15 percent? This just sounds absurd. Most of the privately financed roads and other infrastructure projects I've seen recently have not faced interest rates remotely close to this level, even the risky ones. Heck, even the Channel Tunnel project did not face rates this high. As a real estate developer, have you ever been charged a rate this high for long-term debt?

There are probably a laundry list of issues one could discuss on this matter, and I've just touched on a few that caught my eye. My final point would be this: there are things we could do to better discipline infrastructure investment, but they must be tempered with realism. Even if it were possible to calculate a socially optimal cost for road users (hint: it isn't), could we actually do it? I haven't even touched on transaction costs, which become an important matter when talking about things like externality pricing or toll collection. Politically and practically, we cannot achieve social optimality. It's just not a Pareto efficient world. We should probably content ourselves with doing things that push us in the right direction and that we know will work.

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Re: HSR Urbanists: “We Are All O’Tooles Now”