The Economics Of Road
Investment
John Hine
ETWTR
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Questions and Decisions 1.
• Is the project justified ?- Are benefits
greater than costs?
• Which is the best investment if we have a
set of mutually exclusive alternatives?
• If funds are limited, how should different
schemes be ranked?
• When should the road be built?
Questions and Decisions 2.
• Are complementary investments required?
• Should stage construction be used?
• What standards should be applied ?
Appraisal Framework
• All appraisals need a framework or
model for:
a) Forecasting changes
b) Evaluating those changes
The Costs of Road Investment
These include:
• Supervision
•
•
•
•
•
•
Management
Manpower
Machinery
Materials
Land
Environmental Mitigation (e.g. Resettlement)
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Primary Effects 1.
• Reduced vehicle operating costs
fuel and lubricants
vehicle maintenance
depreciation and interest
overheads
• Reduced journey time
drivers, passengers and
goods
Primary Effects 2.
•
•
•
•
•
Changes in road maintenance costs
Changes in accident rates
Increased travel
Environmental effects
Change in value of goods moved
Secondary Effects
•
•
•
•
•
Changes in agricultural output
Changes in services
Changes in industrial output
Changes in consumers behaviour
Changes in land values
Coverage and Double Counting
• Any economic analysis should be designed
to give maximum coverage of benefits.
• But we must avoid double counting. Do not
add primary and secondary benefits (e.g
changes in land values added to changes in
transport costs)
• In a competitive economy the consumers’
surplus approach (used in HDM) should be
adequate.
The Economic Comparison
• An economic analysis involves a comparison of “With”
and “Without” cases.
• Traffic forecasts are made for BOTH scenarios - The
analysis should not be based on “before and after”.
• An unrealistic “Without” case can give a false result.
• A range of “with investment” cases should be analysed to
find the best solution. A minimum investment approach
often gives the best economic results and should be
tested.
Economic and Financial Prices
The cost to the economy of road
rehabilitation and maintenance may differ
from the financial cost because of :
• taxes and duties
• shortage of foreign exchange
• under-employment
The Government will usually be concerned with
ECONOMIC costs.
Contractors will usually be concerned with
FINANCIAL costs.
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Use of Economic Prices
In an Economic Appraisal we use ECONOMIC
(or SHADOW) prices NOT FINANCIAL prices
Adjust financial prices as follows:
• Exclude all taxes and duties and subsidies
• Use the planning discount rate not the
financial market rate
• If overvalued exchange rate then value
imports and exports more highly
• Use the opportunity cost of labour
• Standard Conversion Factors are now widely used for
road construction costs
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Benefits From Road Investment
Changes in transport costs occur
because of :
• Lower road roughness
• Shorter trip distance
• Faster speeds
• Reduced chance of impassability
• Reduced traffickability problems
• Change in mode
Traffic Categories
• Normal traffic: Existing traffic and growth that
would occur on the same road, with and
without the investment
• Diverted traffic: Traffic diverted from another
road to the project road as a result of the
investment
• Generated traffic: New traffic induced by the
investment
Benefits from Road Investment
Transport cost savings for existing (or
normal ) traffic
= Traffic x Change in Transport Costs per
km x distance
Main changes in cost from:
a) change in transport MODE
b) reduced journey TIME
c) reduced VOCs
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Generated Traffic Benefits
Traffic induced by the road investment are traditionally
valued at:
Half the difference in transport costs
Hence total generated transport cost benefits
= Generated traffic volume x change in costs per km
x distance x 1/2
Estimating Benefits
Normal traffic benefits:
tripsN * d1 * (VOC1- VOC2)
Diverted traffic benefits: tripsD * ((d1 * VOC1)-(d2*VOC2))
Generated traffic benefits: tripsG * d2 * (VOC1- VOC2)/2
d1
= existing road length d2 new road length
VOC1 = vehicle operating costs per km “without”investment
VOC2 = vehicle operating costs per km “with” investment
VOC data relates to each road section and its condition at
the time
The Consumers’ Surplus
Approach
Total
Benefits
Transport Cost Savings to existing
traffic and normal growth
=
Cost
+
Additional benefits from new
traffic and production induced
by new investment
C1
C2
T1
T2
Traffic
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Development Benefits
Development benefits arise from a
combination of increased traffic and
reduced transport costs.
Benefits may also include :
• Increased agricultural production
• Increased service provision
• Increased industrial activity
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Tariff, Birr per qt.
Ethiopian Statistical Analysis
Transport Tariffs (Derived from
Regression Analysis)
60
50
40
30
20
10
0
0
50
100
Distance, km
main road
rough road
animal transport
Illustration of Benefits
Headloading
C1
Track
Costs
Improved
road
C2
C3
T1
Traffic
T2
T3
Different Types of Benefit
• Normal traffic benefits
= traffic x change in transport costs
• Development benefits
- A function of (change in transport costs)2
• Social benefits
- A function of population x change in
transport costs
Consumer’s Surplus Approach:
• Advantages: Simple, cost based, traffic
approach dependent on predicting
changes in traffic
• Disadvantages: May not address critical
factors promoting either rural development
or social access
Producers Surplus Approach
• Advantages: Draws attention to changes in agricultural
output (key economic activity in rural areas)
• Disadvantages: No reliable way of predicting response
- impact studies give widely different answers
–it could be based on agricultural supply price
elasticities but this is almost never done; it requires
very careful examination to use.
– For most projects benefits are just invented !
Producers’ Surplus
Price & Costs per unit
Of output
p2
Increased
farmgate price
p1
lower input costs
O1
Output
O2
Indicies and Ranking
• Widely used for feeder road planning; there are many
different approaches
e.g. i) cost of improvement / population
ii) estimated trips / cost
Adavantages: Speed , simplicity, transparency, many
factors can be incorporated
Disadvantages: How do we value widely different
factors ? (adding up apples and pears); weightings are
not stable ; cannot easily address questions of road
standards, timing etc, ; possible double counting
Community Priorities
• Community priorities now often form an important
part of feeder road appraisal. It is possible just to
ask communities to rank the investments they
prefer- both within the road sector or between roads
and other investments.
• Advantages: Community acceptability, use of
community knowledge
• Disadvantages: Sectional interest groups may
dominate voting, community knowledge of area or
road impact may be poor
Economic Decision Criteria 1.
1. Net Present Value:
NPV =
(B1- C1) + (B2- C2) + ….. (Bn- Cn)
(1 + r)
(1 + r)2
(1 + r )n
2. Internal Rate of Return : solve for i, (IRR)
0 =
(B1- C1) + (B2- C2) + ….. (Bn- Cn)
(1 + i)
(1 + i)2
(1 + i )n
B1, B2 … Bn : Benefits in years 1, 2 … n
C1 C2 Cn : Costs in years 1, 2 …. n
r : Planning discount rate , n : planning time horizon
Economic Decision Criteria 2.
3. Net Present Value/ Investment Cost
NPV/ C = NPV/Ci
4. First Year Rate of Return
FYRR = (B1- C1)
Ci
B1, C1 : Benefits and Costs in year 1.
Ci : Road investment costs
Internal Rate of Return
8000
NPV at 12%
Discount Rate
Net Present Value (M$)
6000
4000
Internal Rate
of Reurn
2000
0
0.0%
10.0%
20.0%
30.0%
-2000
-4000
Discount Rate (%)
40.0%
50.0%
60.0%
Economic Comparison of Alternatives
• When comparing project-alternatives,
the Net Present Value (NPV) is used to
select the optimal project-alternative
(alternative with highest NPV)
• The Internal Rate of Return (IRR) or the
B/C ratio are not recommended to
compare alternatives of a given project
Project
Alternatives NPV
0.0
3.7
6.7
5.5
Optimal Alternative:
Highest NPV
Ranking Projects by Economic Priority
• When comparing the economic priority
of different projects, a recommended
economic indicator is the NPV per
Investment ratio
Projects
Selected Alternative
NPV/Investment
Overlay
8.4
Reseal
5.2
Overlay
2.1
P
R
I
O
R
I
T
Y
Economic Decision Criteria
NPV
v. good
IRR
v. good
NPV/C
v. good
FYRR
poor
v. good
poor
good#
poor
Project timing
fair##
poor
poor
good
Project screening
/robustness
poor
v. good
good
poor
Economic validity
Mutually exclusive
projects
Use with budget
fair ##
poor
constraint
# Need incremental analysis
## Needs continuous recalculations
v. good
poor
Appraisals & Post Evaluations 1.
• An Appraisal is carried out before an
investment is made. Everything is
uncertain.
• A Post evaluation may be made say 5
years after the investment. The
investment is known and 5yrs of with
case are known.
The without case is unknown as is the
remainder of the with case.
Appraisals & Post Evaluations 2
• In Both Cases forecasting and
evaluation models are required to come
to an answer.
• Hence we can never be certain about
the viability of an investment !