It could be that The Age has misrepresented Professor Currie but, on the face of it, this looks like the most foolish set of proposals I have yet seen put forward to address Melbourne’s congestion – and that is really saying something in Victoria! Many of the proposals –particularly  rationing road use to non-car users in the face of expanding travel demands – will worsen congestion dramatically not improve it – by constraining the times cars can make journeys and thereby creating bottlenecks.  Rationing plans do not allow high-valued journeys to be undertaken – they try to reduce car use by making congestion worse. 

How could a Government shell out hard-earned tax-payer dollars for such advice? My only hope is that The Age have misrepresented Professor Curries’ views.

The only way to manage excessive demands for something whose price of usage has been set at zero is to allow a positive price for road use to develop.  Road use needs to be priced as has been argued by countless commentators for more than 50 years.  This reduces the excessive demands for road space and allows journeys to be undertaken which do have high value.  To be specific suppose your wife is pregnant, her waters have broken and you urgently need to get her to hospital.  Under the Currie proposals you will face a more difficult task of getting her to the hospital since, with reduced effective supply, congestion will be worse – with congestion pricing you simply pay the toll and avoid the excesses of congestion.  With pricing people making marginal journeys defer or shift to another transport mode – about half of all journeys in a city are discretionary so it is quite easy to cut out 10-15% of demand to eliminate excessive congestion by pricing.

Parking spots shouldn’t be cut but priced properly so that, again, high-valued journeys can be taken.  Professor Currie is out of touch with the recent literature on parking  - much of this associated with Professor Donald Shoup – which again emphases using economics not heavy-handed prohibitions to manage scarcity.

Transport planning in Victoria is a black hole but this type of nonsense should be buried and a rational rethink of transport issues developed which is based on the science of scarcity – economics . Forget about daft engineering solutions that are usually ineffective – this proposed solution is worse than that since it will make things worse.

This article in the Sydney Morning Herald shows that local governments at least approve of road pricing of the type David Prentice and I have advocated.   Local government want the ability to levy road use charges to strengthen their revenue base.  Whether this should be given to them depends on the abilities of regulators to prevent local holdups of long-distance heavy vehicle transport – the ‘last kilometer’ problem – from emerging.  My guess is that many state and Commonwealth transport policy designers believe road pricing and supply decisions should reflect broader regional interests rather than those of local government.

But the general argument made me think about intergovernmental deals that might facilitate the pricing of roads by offering to local and state governments a secure additional revenue source or a revenue source that replaces other dumb charges.   Everyone agrees that stamp duty charges on such things as housing transfers are the dumbest sort of tax imaginable – they restrict labour market mobility and make it unnecessarily difficult for citizens to change their housing when their circumstances change.  Is there a better alternative?

One option would be to allow the states to retain most of the revenues from registration charges but to replace at least some of the $10b petrol excise that accrues to the government with user charges on congestion and heavy vehicle use that would accrue to the states and local government rather than to the Commonwealth.  The states and local government could plead that the user charges themselves were the result of Commonwealth Government attempts to improve efficiency (its not our fault!) and could minimise their own sense of political discomfit with such charges by looking at the piles of loot that they would collect from user charges.  I don’t think the Commonwealth would lose a lot of sleep by handing over $10b in revenues to fund about $10b in road construction and repair costs that would, in any event, mostly originate with the states and local government.

Transport economists would be happy since we would all end up with a more efficient transport sector with, if anything, an efficiency dividend passed on to drivers.  State governments acting alone might be reluctant to implement user charges but, if implemented on a coordinated basis across all three eastern states, might go for such a deal. Comments welcome.

Its a lovely result since it confirms – in a relatively minor way – the role of efficient pricing in limiting such paradoxes facilitates good road supply expansion decisions.  A simpler version of a similar insight is that, with efficient congestion pricing and with roads displaying constant returns, you know when to expand a road. Do so when with these efficient tolls the road makes a profit. In another lifetime I might spend my time studying the intriguing nature of road demands and supplies.  Beauty is in the eye of the beholder and, to me, this is aesthetic stuff.

There are serious issues in making road construction more efficient but I wonder if this lot are doing much more than airing their ideological priors.  I set out some of the difficulties of introducing commercial incentives into Australian road provision here. (The immediately preceding post).

Road construction and road maintenance decisions are typically made by engineers and bureaucrats on the basis of cash budgets determined by a political bargaining process between the states and the Commonwealth.  A cash budget is provided and roads are designed on the basis of this.  The amounts of money involved are huge.

Moreover while motorists pay for the costs of roads the payments are not designed to provide accurate signals that help determine the appropriate use of particular roads.

There is a real case for reform that assigns a substantial role to economics. I addressed some of these issues here but in this post I emphasise institutional issues.

The Australian Transport Council (ATC, 2009) have been concerned with the implementing the first-phase of the COAG road reform agenda namely providing what is hope to be an effective and efficient transport marketplace for Australia.  This involves delivering improved road, rail and public transport networks to service the anticipated doubling of the Australian freight task over the next 20 years and greatly increased passenger movements.  The main issues are strategic network planning, infrastructure funding, investment decision-making and pricing for infrastructure services.  The idea is to impose market and commercial opportunities and disciplines particularly with respect to supplying road services. 

My view is that the supply-side issues associated with such reforms are very complex. Indeed my view is that few of the really intractable supply issues have been resolved.  

The demand side issues provide practical if not theoretical difficulties.  Eventually it should be possible to selectively price travel on the basis of congestion, axle loads and type of road – this is mass-distance-location charging  Therefore suppose the marginal social costs of using a road can be identified and billed to road users as an ‘attributable cost’.  The capital costs of roads not affected by the extent of usage (‘common costs’) can be collected by levying a fixed annual registration charge on road users. There are difficult issues here such as recouping specific costs of investing in road durability but these can be ignored here.  Suppose that a two-part tariff can be designed which recovers the capital and usage-related costs of each road.  Such charges will determine patterns of usage on roads and net revenues that can be attributed to roads.

Of course while such revenues can be identified ex post they can only be forecast ex ante.  Such forecasts will need to inform supply decisions both in regard to the upgrading or maintenance of existing roads and the construction of new roads.

It is not the suggestion here to suggest that difficult issues of user pricing do not arise but simply to suggest that they can be clearly articulated using well-known theory.  The practical issues are obvious in relation to assessing road damage costs. ATC (2009, p. 23) state:

‘Pavements across Australia vary widely in strength and quality with many sections which are fragile, particularly during wet periods.  Road pavement and bridge performance varies with construction specification, age, traffic and maintenance history, source of construction materials and climate, making engineering analysis and overall conclusions challenging. Road use/cost relationships are complex and not well understood. Empirical research to improve knowledge is necessarily long-term given road life and the number of axle passes needed for modelling impact’.

This claim seems incontrovertible although such issues can in principle be addressed.  What seems more problematic is to come up with institutional designs that encourage road supply agencies to optimise road construction on the basis of such empirical knowledge and to provide a regulatory environment that encourages agencies to levy user charges which reflect such marginal costs.

To simply suggest that road reform can follow the lead established by rail, electricity and telecommunications reforms is not helpful.  This does not seem obvious given the difficulties of assessing and monitoring highly-decentralised road use demands and in assigning charges.  Road commercialisation seems much more complex than commercialisation in these other industries.

Road supplies. What is sought is a road supply system which matches revenues received from roads with the costs of constructing and maintaining roads.  

A starting point is for a national agency, in coordination with other jurisdictions, to devise a strategy for land transport.  This would include short-run information on committed rail and road transport investments over the next 5 years and a medium to long-term plan that provides forecasts of various traffic volumes over a longer horizon. This would inform infrastructure road supply decisions in various jurisdictions, improve coordination across jurisdictions and facilitate forward planning.  

Then regional, state and perhaps national road supply agencies would then be set up to deliver efficiency by assigning them commercial incentives and accountabilities.  Incentives to respond to consumer demands would be created by linking revenues accruing to the supply agencies with road use charges levied on the specific roads they manage. The intention then is for roads to be constructed when capital and maintenance costs are covered. Then road agencies would not be constrained by current budgets but by the profitability of investments in roads.  Agencies could then issue equity of borrow in capital markets to fund road provision on the basis of expected revenues and costs. Road agencies would be subject to capital market disciplines.

Such agencies would be ‘regulated’ to limit the abuse of local monopoly power and, subject to this, would develop road projects only if and only if ‘revenues’ from user charges and imputed community benefits exceeded costs.  The test would have to include alternative options such as public transport and would extend to regional groups supplying local roads.  The regulation would permit prices to be set to permit a ‘reasonable return on investment’.  

Several comments seem appropriate.

First, the taskforce report does not contain economic analysis.  This can be a useful adjunct towards considering what is an inherently difficult issue. As a minor issue it ignores the substantial literature on when optimally designed roads do self-fund on the basis of user charges.  Contributions on this highlight the role of road damage costs – see Mohring et al (1962), Small et al. (1989).  This literature discusses the self-funding issue when there are economies of scale and hence the need for ongoing road subsidies.  Small (1999) extends these results to allow for imperfections in input markets such as land markets.   This is important since, once transactions cost obstacles to user charging are resolved, it is important to understand the circumstances where such user charges will self-fund. Clearly if roads deliver community service obligations and other non-commercial objectives they will not self-fund.  But they may also not self-fund when certain returns-to-scale characteristics which are purely technical features of the roads arise.  This is a ‘loose end’ that is conceptually easy to tie down.  The main issue is to determine the returns to scale properties of different types of road constructions.

Second, and more substantively, the issue of ensuring economy-wide efficiency when decentralised road supply agencies make independent assessments of road investment needs is not addressed.  The independent agencies will have monopoly power and that will be regulated to yield a ambiguously defined ‘reasonable’ rate of return.  Even ignoring community service obligations (CSOs) this is a non-straightforward task. Regulators need to evaluate how pricing rules influence social surplus levels which include consumer benefits as well as supplier benefits. Interventions and supplementary public funding will also be necessary to meet CSOs that are not going to be self-financing. There is in fact no such thing as a ‘competitive national transport market’ and it is doubtful there ever will be.  Competitive markets might exist for road construction but they do not exist for road provision.

In part CSOs and capital costs of road construction that are not durability investments based on the needs of specific vehicle types would be funded from fixed charges that are currently collected as registration fees.    These would not necessarily disappear under a user-charges based system.  Mechanisms for transferring a component of such fixed charges to specific road projects need to be devised.

Generally it is not at all clear how commercialisation arrangements with respect to road provision can be made operational.  Major roads, such as interstate highways, would need to be centrally determined by a national highway agency which would account for the effects of expanding or upgrading certain parts of the network on traffic flows in other parts of the network.  If such roads are provided by decentralised jurisdictions but on a basis that is consistent with a national road transport strategy that amounts to the same thing as central provision. This is a difficult investment planning task in itself since, apart from complicated network effects, forecasts of traffic would need to be made on the basis of new and improved roads that are subject to charging. This would necessary draw on centrally provided forecasts of freight and passenger traffic demands as well as forecast impacts of new urban and lower tier road developments but, in addition, assumptions would need to be made about demand responses to charging.  Possible privatisations of the management of such efforts would be limited by the high upfront capital costs involved and the high uncertainty of demands for the final road demands.  Plausibly the lower capital costs enjoyed by government would favour public operation. Private operations would almost certainly result in contracts which guaranteed minimum rates of return thereby introducing moral hazard into road design behaviour. 

Given the plans for major national roads, lower level roads could be planned recursively by local agencies given central and decentralised information about local transport demands together with information about forecast provisions of major roads by the national authority.  The benefits of decentralisation here rest in the use of local knowledge.  Provision local plans need to be fed back into the planning mechanisms of the major roads provider.  Lower level road networks in urban areas would need to be able to user price to limit bottleneck ‘last kilometre’ features.  

This type of recursiveness which assists the design of a coherent road network is most applicable to links between national highways and urban settings. It is much less applicable to road planning issues in large cities which planning of major roads needs to occur in the context of broader planning issues which link optimal road hierarchy issues with land use planning.  Major arterials and ring roads in a metropolis need to be designed with the inclusion of smaller feeder roads in mind. There is not much recursiveness to simplify planning here. 

Generally the mechanisms by which comprehensive plans for high level roads can be linked to local planning are not secondary or simple issues and need to be set out.

Finally, the issues of shifting toward a system based on user charges and productive efficiency is not only an issue of implementing charges.  These concerns are important but there is also the issue of how charges should be directed toward the existing network of Australian roads which may not be optimally designed with respect to features such as durability.  Here it might not be efficient to pursue cost-recovery on the basis of user charges if, for example, roads have sub-optimal durability.

These comments should not be taken to imply a rejection of the COAG reform process but rather suggest directions for refining it or assisting its development. The importance of some type of reform itself is undeniable. This was highlighted by announcements on 27 April, 2009 when state and Federal governments announced a $37b package mainly devoted to building roads in the eastern Australian states (AFR, 2009).   Although linked to longer term productivity issues the main stated motivation for such a road building program was to stimulate employment over the next 5 years.  Apart from this there seemed no explicit motivation for a package which costs around 3 per cent of Australian GDP. The Business Council of Australia’s President Greg Gailey is quoted in the AFR report as stating:

‘Our infrastructure problems are not only driven by poor planning and unclear objectives, but also by inappropriate infrastructure pricing, the absence of effective national infrastructure markets and poor regulation.’

Almost any market-based planning scheme would outperform current approaches to road  policy-making.

 References

Australian Transport Council, COAG Road Reform Plan Phase 1 Report,  Australian Transport Council Report to The Council of Australian Governments, March 2009.

A. Hepworth, L. Dodson & M. Dunckley,  ‘States Agree $32bn boost for transport’, Australian Financial Review (AFR), 27^th April 2009, p1, p6.

H. Mohring & M. Harwitz, Highway Benefits: An Analytical Framework, Evanston, Illinois, Northwestern University Press, 1962, 70-87.

D. Newbery, ‘Pricing and Congestion: Economic Principles Relevant to Pricing Roads’, Oxford Review of Economic Policy, 6, 2, 1990, 22-38.

K.A. Small, ‘Economies of Scale and Self-Financing Rules with Non-Competitive Markets’, Journal of Public Economics, 74, 1999, 431-450.

K.A. Small, C. Winston & C.A. Evans, Road Work: A New Highway Pricing and Investment Policy, Brookings Institution, Washington DC, 1989.

The Government will fork out $4.7b for this project and borrow enough from the private sector to take its stake to about 50%.   My guess is that, if this project goes ahead, that 100% of the funding will be public – we will all pay directly for this one.

The AFR today sets out the financial actions since last October – $10.4b in cash payments and home-owner grants, $6.2b in subsidies for the car industry, $15b deal with the states, $4.7 b for road, rail and small business,  $30b guarantee for Ruddbank, $42.5b for bonuses, pink bats and schools, $1b in repackaged work programs and, today, $31.7b in what are mainly road projects.

The cost of all these projects and handouts – every dollar – will eventually need to be repaid in full as taxes.  In the long-run we are not all dead. Already we face large public sector deficits in the next few years due to revenue shortfalls.

I want to focus on this last class of spending – boring old roads.  It was mainly promoted today as a way of generating jobs rather than a long-term measure to improve our road infrastructure – it will stimulate the economy over the next 5 years says Minister Albanese.  It was also promoted simply on the basis that spending would occur faster than under the previous government.  Moronic I know but the Opposition’s response was equally stupid in denying this! We spent faster!

Of the $32b NSW gets $8.6b, Victoria $4.4b, Queensland $6.6b, WA $2.8 billion and the rest being smaller bits.  Partly the huge outlays to NSW are an attempt to boost the re-election prospects of the worst state Labor Government in Australia.  Partly too, the large outlays in that state reflect the crucial role NSW plays in facilitating transport on the eastern seaboard. It is the ‘centre’ state.

It is a lot of money and rivals the broadband plan in its overall financial impacts even if it will gain less publicity.  Absolutely no justification for this expenditure is provided.  There is no overall plan and no attempt to relate road provision to road demands.  Among conventional economists this does not surprise since broadband to them is a commercial product whereas roads – well they are just ’infrastructure’.

Yet there is a COAG agenda to reform the process basis of building and maintaining our stock of roads. Those governing in Canberra today should remind themselves of this.  We don’t want road spending to continue to be a political football.  The supply of roads should meet the commercial criteria that are applied to any large scale investment projects and, if there are community service obligations, these should be brought into the open and made explicit.