Cars, congestion and costs: a new approach to evaluating government infrastructure investment.

Author:Dachis, Benjamin
 
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Current studies underestimate the costs of congestion in Canada's major cities, with a focus on time lost in traffic. Governments also need to include the wider economic benefits that are foregone because of urban congestion.

THE STUDY IN BRIEF

The existing debate about the cost of traffic congestion in Canadian cities has been limited to estimating the value of time lost by people sitting in traffic. However, there are broader costs of congestion that should be taken into account. This Commentary offers a decision-making framework for governments seeking to include these broader, social welfare costs in selecting which infrastructure investments merit public subsidy, and which ones should be handled by the private sector.

In general, the social returns from infrastructure can be substantial and governments are missing a large portion of the economic benefits of infrastructure when they do not estimate them. In particular, economic externalities--which arise when an individual's use of infrastructure affects someone else--can be quite large. Governments should assess the full range of social costs and benefits of externalities and include them in building a consistent economic case for investment.

With regard to transportation in particular, this report provides a new way of estimating the cost of congestion. To date, governments have made the case for transportation investment based on the estimated economic cost of time lost due to congestion. In the Greater Toronto and Hamilton Area, the commonly used estimate is that congestion costs the economy about $6 billion per year.

However, the existing studies provide underestimates of the costs of congestion. The reason: they ignore the positive effects of relationships among firms and people that are among the main benefits of urban living. These urban agglomeration benefits range from people accessing jobs that better match their skills, sharing knowledge face-to-face, and creating demand for more business, entertainment and cultural opportunities which, in turn, benefit other people. When congestion makes urban interactions too costly to pursue, these benefits are foregone, adding significantly to the net costs of congestion. For the Greater Toronto and Hamilton Area this report estimates the additional costs to be at least $1.5 billion and as much as $5 billion per year.

For Canadian governments, the framework for comparing the private and social returns of investments can apply to a wide range of investments, ranging from transportation to education to health and much more. In cases in which there is a substantial private return, the economically efficient option is for pure private provision. With such a framework in hand, Canadian governments can make better choices about their investment needs.

Governments of all levels across Canada are facing pressure to invest in the nation's infrastructure. However, they also have limited budgets with which to invest and conflicting demands for the money.

It is essential that they know which projects are most worthy of public funding and which ones should be left in private hands entirely. Transportation infrastructure to address traffic congestion is a prominent case in point where funding choices must be made. With the province of Ontario, for example, planning on spending $35 billion on infrastructure over the next three years, it is important that policymakers know how best to allocate that spending across many potential projects. To determine the investment projects that are most worthwhile, governments should determine which projects maximize social returns and pursue them.

Yet, governments often do not seek to account for all the social costs and benefits of infrastructure projects, partly because they are often difficult to quantify. This Commentary shows that the social returns from infrastructure can be substantial and that governments are missing a large portion of the economic benefits of infrastructure when they do not include them in their cos-benefit evaluations. In particular, economic externalities--which arise when an individual's use of infrastructure affects someone else--can be quite large. Governments should assess the full range of social costs and benefits of externalities and include them in building a consistent economic case for investment.

A New Way of Estimating the Cost of Congestion

To date, governments have made the case for transportation investment based on the estimated economic cost of congestion. In the Greater Toronto and Hamilton Area (GTHA), the commonly used estimate is that congestion costs the economy about $6 billion per year. Such estimates are based mainly on an assumption of the value of time people spend commuting on congested thoroughfares.

However, existing estimates of the economic cost of congestion are underestimates--and, furthermore, are potentially flawed estimates. The reason: they ignore the positive effects of relationships among firms and people--known as urban agglomeration externalities--that are among the main benefits of urban living. These range from accessing jobs that better match peoples' skills, sharing knowledge face-to-face, and creating demand for more business, entertainment and cultural opportunities which, in turn, benefit other people. When congestion makes urban interactions too costly to pursue, these benefits are foregone, adding significantly to the net costs of congestion. For the GTHA I estimate the additional costs to be at least $1.5 billion and as much as $5 billion per year in lost wages.

A New Approach to Government Investment Decisions

It is time that governments took a new approach to infrastructure investment by taking into account the broader economic impacts. For example, governments should estimate the benefits of the relationships between people and firms in an urban area. A person riding a subway or using a road creates the demand for infrastructure that enables the existence of that subway or road for other people in his city--a positive externality. At the same time, that person using the subway or road is crowding out a part of the infrastructure's potential use by others--a negative externality.

Canadian governments should select infrastructure investment on the basis of two overarching principles:

  1. Calculate the economic externalities of an investment, both positive and negative, and include measurable externality benefits in the cost-benefit analysis used in the initial decision to build; and

  2. Charge users of infrastructure the full social costs, to the extent possible. In the case of transportation infrastructure, governments should charge users for the full cost of congestion, but invest in more infrastructure than would be self-sufficient from fare or toll revenue alone, with a view to increasing quantifiable benefits from urban agglomeration.

    WHAT THEORY SAYS: THE OPTIMAL LEVEL OF INFRASTRUCTURE INVESTMENT

    Canadian governments of all levels face continuous pressure to build additional infrastructure, ranging from transportation to health and education infrastructure, and much more. How should governments prioritize their investments?

    The basic principle of identifying the ideal quantity of production of standard goods or services --those without any externalities--is that producers supply consumers up to the point where the price consumers are willing to pay for one more unit of a good equates with their benefit from doing so. That is, the marginal cost must match the marginal benefit. If the price a consumer is willing to pay is more than the cost of production, the producer will find a way to produce more. However, in the presence of externalities, the private benefit of consumption does not match the wider social benefit of consumption. The benefits of a new road, for example, can extend far beyond reduced congestion for drivers to include increased business activity. Hence, a framework for quantifying externalities can apply to a wide range of potential investment decisions by an income-constrained government.

    The best way to address externalities is for governments to make sure that people's private decisions to use infrastructure are influenced by pricing that takes into account the costs or benefits from a broader social and economic perspective. (1) When people do not take account of their effect on others, governments can step in to set pricing at levels that cover the social costs.

    Negative versus Positive Externalities

    Determining the optimal amount of government infrastructure investment and the appropriate price to charge for using that infrastructure hinges on externalities. Government policymakers should weigh the negative externalities, such as those caused by traffic congestion, against the positive externalities, such as those associated with enhanced urban access.

    To provide one example, traffic congestion is a negative externality in which one person's decision to drive harms others. When a driver enters a roadway, his decision is based on the private cost (such as his time and vehicle operating costs) to himself of using that road. He does not take into account that his choice may preclude others from using that road or slows down traffic. Likewise, other drivers on the road impose the same cost on him, sometimes resulting in congestion. The same principle applies to other infrastructure, such as transit, when a train, subway or bus user does not consider the effect on others of his riding at peak times. Congestion pricing, in general, imposes a cost on each user equal to the cost that user imposes on others. Commuters will choose to use the road or subway up to the point at which the last user's willingness to pay equals the cost to himself and to others.

    On the other hand, a positive externality is a benefit that accrues to others from an individual's decision. A classic example is the decision of a person to plant flowers in his lawn. The person who plants the flowers benefits from a nice-looking yard, but...

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