Articles



Economic Appraisal: New Thinking, New Ideas

As clients around the world, both in the public and private sectors, face increasing pressure to fund and procure transportation projects in an age of ever more pressing budgetary constraints, the need to develop innovative funding and scheme justification methods is becoming one of the most important issues facing the infrastructure sector. There are several developments in infrastructure appraisal and infrastructure procurement whereby new thinking is helping to resolve the conundrums of how projects are evaluated, appraised, and ranked against each other. Much attention is also being given to identifying various means of funding and project procurement.

This article reviews the latest thinking on these issues and gives some thoughts on providing a toolkit for public sector project decision-makers and private sector developers as they look to procure schemes. The issues and methodologies discussed are applicable globally, wherever infrastructure funding constraints are all too apparent.

What’s Typically Happened In The Past

The procurement of major infrastructure projects has traditionally depended on one of the three following strategies:

  • Direct funding from the central government (and/or regional government), with examples including the historical funding of major road and rail networks as well as other major transportation infrastructure;

  • Private funding (in whole or in part) of transportation infrastructure, which is typically associated with public-private partnership (P3 or PPP) schemes where, in return for its initial investment, the private sector is given the right to operate the asset and collect revenues (or availability payments) over a specified term; and
  • Innovative funding methods such as value capture and tax increment funding, whereby transportation projects are paid for out of funds collected from the increase in local land value (attributable to the project) as well as from hypothecated taxes levied on those who will benefit (local residential and local business taxation, etc.).

The ordering of these strategies is important as it broadly matches the ordering by which these procurement methods have taken place historically. To demonstrate, the great Interstate Highway System in the US was initiated by the public sector in the 1950s with the proposed funding accruing from taxation on fuel, cars, trucks, and tires.

The development of P3-procured infrastructure is a relatively modern phenomenon with various models, such as design, build, finance, and operate (DBFO), being used to get projects off the ground and operational. These types of projects can be seen globally in different forms and, in recent years, have also been introduced to modes of transport usually associated with more traditional public sector delivery methods.

Examples include the introduction of private finance into heavy rail operations, particularly passenger rail operations in the UK where franchises run by the private sector have been in operation for over 15 years. Similarly, the privatized rail sector in the UK has also featured privately financed rolling stock acquisition—something that was traditionally funded by the public sector.

 

As for the third type of funding and procurement method (value capture and tax increment funding), this is a more recent development and very much reflects the need to develop innovative funding mechanisms given the severe constraints placed on the availability of suitable levels of funding.

What’s Been Happening Recently?

The last five years have seen unprecedented change in the world economic order. The global recession has had an enormous impact on public and private sector infrastructure, especially in the transportation sector, and what had previously been a stable, accepted way of procuring major assets changed dramatically.

P3 deals, based on continued high economic growth and thus high traffic/usage growth, have had to be renegotiated as the original revenue growth forecasts could not be met. This has also generated what is, in effect, a new market whereby newly formed infrastructure funds have appeared during the last five years as investors typically seek to acquire under-performing assets (e.g., toll roads in Spain).

In addition to individual assets (such as a specific toll road in any part of the world), bundles of assets have also come to the market in recent years as their current owners seek to divest themselves of assets that have not performed as originally forecast. These bundles typically cover a wide array of assets over a large geographical area. Examples include packages of toll roads, regional airports, transportation hubs, and car parks located across countries as diverse as Spain, Ireland, Italy, and several countries in South America.

The key issue facing P3 bids that have taken place since 2008, especially those relating to traffic-based usage, is to produce short- to medium-term forecasts during a time of uncertainty surrounding the extent of any post-recession bounce back (in other words, if there will be higher-than-trend growth in the short to medium term as economies recover lost ground and close the output gap created as result of the recession).

These factors have introduced considerable uncertainty into the forecasting processes that underpin P3 deals and procurements. Some notable developments, however, have bucked the trend in terms of usage and patronage. In the UK, for example, the privatized passenger rail market has seen unprecedented growth in recent years despite the onset of the most severe recession in a generation. This somewhat counterintuitive outcome has been attributed to several factors, not least the dramatic rises in gasoline prices as well as a shift away from company car usage for business trips and increasing usage of passenger rail services by students.

New Funding Mechanisms and the Rise of Wider Economic Impacts

National and regional governments are facing increasing constraints in terms of the amount of funding they have available to procure essential infrastructure and transportation projects. This presents governments and public sector agencies with several questions: although infrastructure, especially new infrastructure, greatly facilitates economic growth, how can sufficient funding be secured so new projects can go ahead? When there are several planned infrastructure projects, including transportation projects, which projects will generate the most economic benefits? Once a series of projects have been prioritized, how are these to be funded and what are the best procurement methods?

The Great Infrastructure Debate

Several governments across the world have put forward major infrastructure schemes and plans as a way to stimulate and restart economic growth. In the UK, for example, the coalition government is promoting the new HS2 high-speed rail line as a means of generating significant employment opportunities in the construction sector when the line is being built, and generating long-term economic benefits, including those associated with improved connectivity between major centers of population.

The opposing issues facing policy and decision makers at the moment are the need for big-ticket items of infrastructure, and the realization that funding for these projects is scarce whilst the general public need to be convinced of the merits of these plans.

Methods of Ranking Projects

So that policy and decision makers can make informed decisions about which projects to pursue in a climate of budget constraints, a new array of methods and tools has been developed to help inform these decisions. In addition to traditional transport economics, which measures monetized journey time savings, accident reduction benefits, and decongestion benefits, these new methods appraise:

  • The connectivity a transportation project provides a workforce to places of employment. In other words, the benefits associated with reducing travel times to and from areas of employment (in UK appraisal guidance, this is termed “agglomeration”);
  • The welfare impact on economic output associated with transportation projects and whether this is valued more highly by consumers compared to the cost of the project—technically termed as “output change in imperfectly competitive markets.” In a transportation context, this includes the benefits that business travelers experience when a transportation intervention takes place (note that the impact would be positive where business user benefits are positive overall, and negative where business user benefits associated with the transport scheme are negative); and
  • A labor supply impact whereby a reduction in transport costs (costs in this context can include monetized journey time savings, etc.) can have a positive impact on economic activity, measured through GDP increases; higher GDP provides a means to allow for higher consumption levels, again therefore impacting on welfare or wellbeing. (Guidance currently used in the UK provides a methodology for estimating the impact of transport on the total amount of labor supplied and the resulting impact on welfare. This is termed “economic welfare impacts from labor market changes.”)

All three elements are referred to as “wider impacts” and are closely related to the outputs from traditional traffic and transport modeling exercises. In addition, the following methods are also used to assess the impacts of projects:

  • Regeneration: how a proposed scheme will impact the local economy by showing the processes that link transport to economic vitality, and how the scheme can be expected to reduce unemployment, either by generating new jobs or by improving access to existing jobs. (In the UK, for example, this approach has been used to assess the impact of regional road schemes such as the A303 and the A30 in the south west of the country. Compared to the wider impacts previously mentioned, the key differentiator here is that these schemes have dispersed, regional impacts and are not as suited to the transport modeling-based wider impacts measures that are more commonly found in densely populated urban areas); and
  • Economic impact assessment: using more conventional methods to quantify the employment impacts of infrastructure projects; for example, direct on- and off-site employment, indirect on- and off-site employment, induced employment, and employment attributed to the connectivity offered by major transportation hubs. (As an example of the last item, several major businesses located near to London’s Heathrow Airport cite the airport’s hub status as being a major reason why they are based in the area.)

 

Innovative Funding

In recent years, there has been a concerted effort to develop innovative funding mechanisms for major infrastructure projects. Some of these build upon existing mechanisms, such as the community infrastructure levy (CIL) in the UK, whereby developers contribute to the financial cost of new infrastructure. Other mechanisms are relatively new (especially outside the US) and include tax increment financing (TIF), whereby an increase in site value and private investment generates an increase in tax revenues. Parsons Brinckerhoff has been at the forefront of value capture in recent years and this remains another important funding mechanism for transport infrastructure. These developments are likely to continue to come to prominence in the near future as infrastructure promoters and developers increasingly seek innovative ways to finance projects.

Next Steps/The Way Forward

Although what was summarized in this article appears to be a diverse range of project appraisal and delivery methods, there are various unifying themes that run through all of these topics and this points to the following:

  • Before projects are commissioned—or indeed ranked against each other—new methods of demonstrating wider economic benefits are going to come to the fore as various authorities seek to demonstrate how infrastructure is so essential to economic development;
  • An ever-discerning populace will want to understand how these big ticket projects contribute to economic activity, and thus understand the rationale for investing such large sums of money;
  • Once projects have been justified, evaluation of the most appropriate delivery mechanism will take place;
  • Although P3 delivery is likely to continue, the use of innovative funding mechanisms will come to the fore, especially for those projects that can generate revenue streams via processes that have so far gone largely untapped; and
  • In the future, infrastructure developers are likely to use innovative means to demonstrate the benefits of various projects and devise appropriate procurement/funding mechanisms.

Parsons Brinckerhoff’s broad spectrum of specialist skills in all of these areas places us in a unique position to advise our clients globally on infrastructure appraisal and delivery. We also remain at the forefront of the latest thinking in these areas and combine excellence in traditional appraisal methods with in-depth understanding and appreciation of the latest developments.

 

Image Header Source: M. Peinado (Creative Commons)