Monday, May 11, 2020

Its not the shovels that count: its what they're shovelling

Is boosting infrastructure the best road to economic recovery for New Zealand?
If we do not get investment for recovery right we will undermine productivity and economic progress for generations to come. Indiscriminate infrastructure development at this time risks limiting options by absorbing and concentrating resources in an area in which performance has been demonstrably deficient.

New Zealand's recovery from Covid19 requires short-term job gains and long-term income growth if we are to throw off the shackles of public debt. Committing substantial resources to “shovel-ready” projects without rigorous assessment risks excessive spending to meet uncertain demand. The result of over-investment will be lower foreign reserves, a diminished credit rating, and a prolonged productivity deficit.

Get the economics right first
Economic justification is essential to establish whether the benefits generated by infrastructure justify the resources consumed in its development. Projects that do not stack up have a negative fiscal impact, requiring ongoing tax- or rate-payer subsidy. While otherwise uneconomic projects may provide non-market benefits (to the environment, social equity, or public health for example), if we do not first consider their economic efficiency, we cannot know whether they are the best means of achieving those benefits. 

We do know, however, that the wrong projects can set our economy back: the Think Big projects contributed substantially to a run on foreign exchange reserves in the early 1980s.

Current failures
The damage from uneconomic projects tends to increase if they are large scale. The literature on cost blowouts for major infrastructure projects – especially in transport – is extensive. Auckland's Central Rail Link , for which the case was flawed from the outset, and Transmission Gully are text book cases.  Consider the following:
  • Under-specification at the outset, with inadequate technical assessment or design myopia leading to re-specification and add-on costs in the course of development;
  • Under-costing from relying on precedent and current (or historical) costs for estimation, failure to consider the effect of competing demand for resources, and the optimism-bias of project protagonists leading to unwarranted approvals and subsequent cost blow-outs;
  • Contract failures from accepting low tenders and engaging at-risk contractors to meet tight project budgets, leading to higher costs when contractors fail and re-tendering is necessary;
  • Project delays from under-specification and under-costing compounded by resource shortages (including labour and skills), tying up capital and delaying benefits.
The failures threatening the CRL are such that economist Tim Hazeldine’s view is that it is time to stop pouring good money after bad. The contingencies facing such large scale projects should double down the call for rationality in today’s perilous economic environment. 

Unproven Demand
Because large-scale investments take time to finish, demand at completion may be quite different from what was projected at inception. Along with the impact of unexpected disruptions, extended pay-back periods add to uncertainty over what demand a project may eventually have to meet. 

As of today, the Infrastructure Commission’s pipeline of major public capital works , although incomplete, outlines around $16b or more of spending. Approximately 60% of this is for transport. (These figures are based on the cost ranges provided).  Yet major transport projects today face substantial shifts in demand, such as:
  • Revised working conditions lowering building occupancy and increasing the appeal of large footplate, low-rise, suburban workspaces with natural light and airflow;
  • Changed working arrangements (staggered hours, home-based working);
  • Newly suppressed demand for and lower passenger densities on public transport;
  • An increased preference for medium/low density suburban living environments;
  • A shift from large scale venue-based recreation;
  • Reduced international travel and tourism;
  • Reduced demand for mall-based retailing in favour of local services and centres;
  • More on-line retailing and in-home services.
We can add to this market uncertainty the impact of changing technologies, including prospects for:
  • Enhanced face-to-face telecommunications;
  • Gains in vehicle autonomy increasing capacity on existing highways;
  • Falling electric vehicle costs boosting private transport and demand-responsive public transport;
  • Aircraft operations favouring smaller aircraft on point-to-point rather than hub-and-spoke networks;
  • Continuing logistics gains integrating production and distribution with direct delivery;
  • Artificial Intelligence, product printing, design refinement, innovation, and changing consumption preferences jointly supporting local production of specialised goods;
  • Distributed specialist services (law, health, medicine) supported by AI, gains in computing power, seamless tele-conferencing, and advanced instrumentation;
  • Decentralised settlement with modern, localised infrastructure, decentralised employment, and efficient inter-regional and international information and transport connections.
A Shortage of Resources
Supply chains are over-stretched in the development sector.  This flows through to delays, costs, and failures all-too-often overlooked by local politicians and their consultants in the haste to justify economically suspect projects. 

Shovel-ready projects track straight into this quagmire of unrealistic supply chain and labour market expectations.  Yet, Infrastructure New Zealand has effectively lobbied the civil engineering/development complex to the top of the national economic agenda. It is supported by a network of professional players (engineering, consulting, planning, design, and legal) and the vested interests of operators. Because of its visibility, infrastructure building also plays to political monumentalism. 

What are the alternatives?
A shovel ready recovery locks us into projects based on the economy and labour market of the past. Uneconomic or marginally economic projects limit our ability to do other things. It would be better to focus on initiatives that lift adaptability (the ability to change what we are doing), and flexibility (the ability to vary how we are doing it). 

Here are some ideas that might contribute: 
  • Vet and prioritise infrastructure projects, ditching those like Auckland light rail plans with costs bound to blow out and which face uncertain demand; 
  • Pursue best practice in the assessment, design, specification, and management of any projects that may be justified (most likely in public health, water quality, and the like); 
  • Prioritise social infrastructure (education, health, and housing) for  short- and long-term benefits. 
  • Promote innovation and entrepreneurship with vocational education to increase career mobility and deepen domestic skills and experience. 
  • Pursue an open business environment to facilitate enterprise, mobilise capital, ensure productive resources and feedstocks can be widely accessed, and streamline regulation; 
  • Address business support to future-oriented capacities, rather than propping up existing structures and practices; 
  • Review approaches to trade facilitation, support for innovation and technology, and business taxation. 
  • Maintain household incomes: increasing local consumer spending, especially among low income households, will have the highest immediate impacts on employment while providing breathing space as the country and the world adjust to the economic shock of Covid 19.

Quite simply, an infrastructure-dominated programme that imposes new and potentially open-ended fiscal demands on currently constrained incomes is more likely to undermine than boost economic activity.

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