How HS2 could be descoped to hide cost overruns

January 10, 2015 1 Comment

handcar204There are two main ways of dealing with cost overruns on big government projects without scrapping the scheme in question. The first is to ask the Treasury for more money – and this often works given the political embarrassment of half finished infrastructure.

The second method is ‘descoping’, which involves delivering less for the same budget. Examples include reducing the length of a route, making greater use of existing infrastructure, or lowering the quality of interconnections at stations. In recent years several schemes have been descoped to address rising budget estimates, including Crossrail, the Edinburgh tram and the planned high-speed line in California.

There is some tentative evidence that a similar approach has now been adopted for HS2, perhaps reflecting fears that further increases in the official budget would be politically disastrous at this stage of the project. (This may also explain why the budget is still quoted in 2011 prices in 2015). The HS1-HS2 link through Camden would appear to have been abandoned for the time being and there is now a major question mark over the £1 billion Warrington spur.

If the next government deployed economic logic it would scrap High Speed 2 entirely. However, the strength of the special interests backing HS2 raises the possibility of further descoping as a face-saving compromise.

Perhaps the least damaging ‘descoping’ option would be cancel current plans and speed up the existing West Coast main line instead, rebranding it as a high-speed route. One train operator has suggested London-Birmingham travel times could be cut to under one hour given improved signalling (and this would be to New Street, giving comparable overall travel times to HS2). At the same time various strategies could be undertaken to increase the capacity of the existing infrastructure (perhaps including the Chiltern Line to Birmingham).

Far less desirable, though still a big cost-saver and hugely preferable to current plans, would be to abandon Phase 2 entirely but keep elements of Phase 1. Now that Phase 1 is planned to reach Crewe, it could be argued by politicians that the line more or less reached the North of England. Northern cities could be bought off with (much cheaper) better links across the Pennines, together with improvements on the ECML.

Phase 1 could then be descoped by abandoning the Euston terminus and ending the line instead at Old Oak Common. This could reduce construction costs by roughly 25 per cent and would also undermine efforts by Transport for London and the Greater London Authority to ‘bully’ the Treasury into funding Crossrail 2 – now costed at an astounding £27 billion. Similarly the Birmingham spur could be scrapped with trains using existing tracks instead. Once again this could eliminate substantial ‘off balance sheet’ costs. Devious politicians might recycle some of these savings into longer tunnels in the Chilterns and better compensation to ‘buy-off’ opposition.

With the budget deficit stubbornly high and other spending priorities growing in political salience, cuts to the scope of HS2, and hopefully full cancellation, now seem increasingly likely. Observers should also watch out for hidden budget increases disguised by pushing elements of the project off-balance-sheet or delaying them until after the core scheme is completed.

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Scrap HS2 to ease government debt crisis

December 18, 2014

Hyperinflation 206x167The recent announcement that the projected cost of Crossrail 2 has risen to £27 billion should be cause for deep concern within the Treasury. Added to High Speed 2 and High Speed 3, this means the total budget of just three planned or proposed rail schemes could be close to £100 billion – or perhaps even higher, given the overruns so typical of big government projects.

Economic conditions amplify the financial risks. The deficit remains stubbornly high, while robust medium-term growth cannot be guaranteed given the ongoing crisis in the euro zone and the fragile condition of the banking sector. This implies that a large proportion of future transport investment may be funded by government borrowing, adding a not insignificant amount to a national debt that has already reached £1.5 trillion.

There are clear echoes of Japan in the 1990s: a heavily-indebted government viewing transport investment as a way to stimulate growth after a deep recession.

To be fair, there is some merit in this argument. Improved transport links tend to raise productivity and boost growth by lowering the costs of trade. Greater specialisation and economies of scale are facilitated. Workers find it easier to access jobs that make good use of their skills and talents.

But transport spending also has major downsides. The additional tax burden needed to fund schemes directly, or repay debt incurred, suppresses economic activity. Incentives for work and entrepreneurship are diminished, while resources are misallocated due to the distorting effects of taxation. The overall cost to the economy is substantially higher than the direct tax bill.

The negative effects may be particularly severe if transport spending pushes levels of government borrowing into dangerous territory, such that market confidence is undermined. This risks a ‘debt spiral’, with a larger and larger share of tax revenues used to pay back investors in government bonds.

Heavily indebted governments should therefore exercise particular caution on transport investment. They must ensure that the economic benefits outweigh the full costs, taking proper account of the downside risks of budget overruns and the impact on public debt.

This didn’t happen in Japan. Vast sums were wasted on poor value schemes with low benefits – including the notorious ‘bridges to nowhere’. Government borrowing was pushed up, while taxpayers were also forced to pay ongoing maintenance and operating costs.

Unfortunately, a similar pattern is now emerging in the UK, as an ‘infrastructure craze’ grips our politicians. Rather than focusing on high-return, low-risk projects, the government is favouring low-return, high-risk schemes such as HS2. Once the negative effects on the wider economy of the additional taxation and borrowing are factored in, there is a significant chance that the costs of these projects will exceed their benefits.

The dangers are further exacerbated by rapidly changing technology. Developments such as advanced video-conferencing and driverless cars have the potential to completely transform transport markets by 2030. New technologies, for example in rail signalling or road pricing, also mean congestion and capacity problems can now be tackled at a tiny fraction of the cost of building brand new infrastructure.

Fortunately, there is still time for the UK to change course. One of the new government’s first priorities next year will be to instil confidence in its deficit reduction plan. Scrapping poor value transport projects would achieve this at minimal political cost.

City AM, December 2014

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Crossrail: On time and on budget, or delayed and descoped?

December 6, 2014

construction cranesMinisters and rail industry bosses frequently claim that Crossrail is being delivered ‘on time and on budget’, but is that really the case? A 2014 National Audit Office report suggests that, at best, these spokespeople may have been misinformed by their advisers.

The NAO analysis reveals that in 2009 ‘the anticipated cost of the programme had escalated to £17.8 billion’, taking the likely budget to about £19 billion once the rolling stock is included.

The report states that to reduce costs to an acceptable level, ‘the schedule for opening the railway has been extended’, with sponsors agreeing ‘to extend the timetable for full opening from May 2018 to December 2019’ (p. 22). Further economies were achieved by ‘simplifying integration works, re-sequencing work and reducing scope, saving £800 million’ (ibid.). In other words, the project seems to have been delayed and descoped and apparently will not be built to the specifications originally envisaged.

If an infrastructure project is already underway but heading over-budget, there are of course two main options to address this: increasing the budget by obtaining more money from funders, or building less infrastructure for the same money. In the case of Crossrail, the NAO analysis implies that if it had been built on time and to the original specification, the cost may have been approximately £20 billion (and it may have been far higher if the prolonged slump had not put downward pressure on construction rates).

It remains to be seen whether the scheme will actually meet the revised schedule and budget, since much of the construction work is yet to be completed. Whatever the outcome in five years’ time, claims that Crossrail is ‘on time and on budget’ risk misleading the public.

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Opportunity cost is the Achilles heel of High Speed 2

November 4, 2014

An economically rational transport investment policy would allocate scarce resources to those projects with the highest returns.

Yet even if one accepts the official estimates – and in reality there are major doubts as to whether the benefits will actually outweigh the costs – it is clear that High Speed 2 offers poor value for money compared with alternative transport schemes (data on rates of return on transport schemes here).

The issue of Opportunity Cost is therefore the Achilles Heel of HS2. Clearly the vast resources required would be far better deployed elsewhere.

If the aim is to cut journey times, then other schemes would deliver more valuable savings for less expenditure.

If the objective is to address overcrowding then there are far more cost-effective ways of increasing capacity and making more efficient use of existing links.

And if regeneration of the North is the priority, then greater gains would come from investing in local schemes that would deliver substantial agglomeration benefits.

In summary, High Speed 2 fails the test of economic logic. It is being driven by a mixture of politics and special-interest pressure rather than rational economic analysis.

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HS2 a classic example of special interests capturing policy

August 2, 2014

An excerpt from the Treasury Select Committee session on the costs and benefits of HS2, held on 5 November 2013:

 

 

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The railways are a classic example of a politically distorted market

July 6, 2014

In September 2012 I was invited to discuss rail policy with the Transport Select Committee. The session can be viewed here (@39 min). Some excerpts from the (uncorrected) transcript are provided below:

Chair: Do you support the Government’s overall strategy in HLOS [the government’s rail plan]? Have they got the right priorities?

Dr Wellings: I would say no. The Government has not dealt with the fundamental problem that the rail industry is hugely distorted by subsidies and other distortions such as the planning system. Basically, the central planners in the DfT are groping about in the dark. They don’t have an idea of genuine levels of demand or genuine prices because we also have price controls. Before embarking on these absolutely huge investments at taxpayers’ expense, they ought to get the fundamentals right and remove these distortions and, in particular, the subsidy regime.

Chair: What would you like to see change?

Dr Wellings: I would like to see the subsidies phased out and a change in the planning laws that force developers into corridors around railway stations, for example. There needs to be a change in the tax regime as well so that there is a level playing field with other transport modes.

Mr Leech: Dr Wellings, you argue that there is no economic case for the improvements because of the cost to the taxpayer. You suggest that taxpayers are already paying about £5 billion a year in subsidy. As far as you are concerned, that is an unacceptable level of subsidy. What would be an acceptable level of subsidy?

Dr Wellings: Zero. I would like to see it phased out over a period of, say, 10 years to zero.

Mr Leech: What impact do you think that would have on fare prices on trains and the number of passengers who could afford to use them?

Dr Wellings: It would vary. I don’t think it would have much impact on, say, the London commuter market, which I think is probably fundamentally economically viable, particularly if we also liberalise the planning system so that rail companies could make money from property development as they do in Japan. At the other extreme, you have railways in places like rural Wales that are very poorly used. I think they should definitely close down. There is no economic case whatsoever to keep them going and there is also no social case.

Mr Leech: On the basis that there is a subsidy taking people out of cars and reducing carbon emissions, in your studies what impact would there be on carbon emissions and on the cost to congestion as far as the economy is concerned? Have you done any of that work?

Dr Wellings: It is a myth about carbon emissions. If you closed the entire rail network down overnight, the impact on carbon emissions would be barely measurable. There are two reasons for that. One is that it is quite a small share of overall transport use. The second reason, of course, is that we are talking about a different market from cars. A high proportion of journeys are into central London, for example. These would probably hypothetically go on to coaches and buses, which are more efficient than trains. It would actually be barely measurable.

There is also the effect of subsidising people to move further and further away from where they work through cheaper train fares. You end up, for example, with long-distance commuters through the season ticket system. Although the rail journey might be relatively efficient from an environmental perspective, in terms of the whole lifestyle they probably emit more than if they lived in inner London or close to work.

Steve Baker: Dr Wellings, in your article for City AM in July you were highly critical of the Government. You said that “cynical political calculation seems to be the driving force of policy”. You talked about the railways as a classic example of a politically distorted market. You have also said, without reading the whole article, that many of the projects are motivated by politics rather than economics. Could you give us some examples of where these things can be seen?

Dr Wellings: Yes. The most telling example from the recent plans was the plan to electrify the branch lines in south Wales. Of course the Welsh railways already have perhaps the highest operating subsidies per passenger mile in the whole network. We already have a false market, a rigged market, and yet we are going to invest good money after bad in this already hugely subsidised market. It seemed that the Government was allocating new schemes across the country to pay off various special interests. Few of them made any economic sense. For example, if you wanted a fast train up to Sheffield, it can already be done by the East Coast Main Line in an hour and three quarters. There just isn’t the demand for that kind of service. The idea to spend this money electrifying the Midland Mainline to make some very tiny time savings didn’t make any business sense to me.

Of course the worst example of all is High Speed 2, which has a very low benefit-cost ratio. We saw road schemes being cancelled in the Comprehensive Spending Review that had a benefit-cost ratio over three times High Speed 2. There is no economic logic at all behind current transport policies.

Chair: We are on rail today, though.

Steve Baker: I would follow it up by asking this question. Isn’t it true that all Government investment decisions, including right across transport, are influenced by politics to some degree?

Dr Wellings: What we have is basically a thinly veiled version of Soviet-style central planning here. It is hugely centralised with the DfT and politicians making the big decisions. This is in a morass of economic distortions from price controls, subsidies and distortionary tax treatments as well. These people just can’t make sensible investment decisions because, first, it is hugely politicised, and, secondly, because we don’t have genuine prices or genuine levels of demand.

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The bogus capacity arguments for High Speed 2

June 29, 2014

The government recently pumped c. £10 billion of taxpayers’ money into the West Coast Main Line (WCML), delivering major improvements in journey times. It is therefore unsurprising that passenger numbers increased significantly in the period immediately following the upgrade.

However, it is far from certain that strong growth will continue in the longer term. For various reasons the UK economy is likely to perform relatively poorly. In addition, new technology may reduce the need for face-to-face meetings. Driverless cars could cut the costs of road travel. Strained public finances may increase the pressure to lower the level of rail subsidies and end the generous tax breaks given to wealthy long-distance commuters.

There is currently significant spare capacity on the WCML, but if this were no longer the case in the future, it would be far cheaper to make relatively minor adjustments to the existing route than build a brand new high-speed link.

The first step should be to phase out the subsidies and tax breaks that artificially inflate demand on the line. This should include handouts for heavily supported feeder services to the WCML, including local public transport. For example, state support currently covers approximately 40 per cent of heavy rail industry costs.

Price regulations and franchising arrangements should also be reformed so that train operators can make better use of existing capacity. More flexible pricing would flatten the peaks and reduce overcrowding, while combining franchises or greater vertical integration would reduce the duplication of underused services, thereby freeing up paths. Low-cost enhancements could then be deployed, such as lengthening trains and reducing the number of first-class carriages.

If there were a commercial case, relatively minor infrastructure investment, such as modernising signalling and re-engineering junctions, could deliver further capacity gains at a small fraction of the cost of HS2. The 51m group (pdf) has provided examples of how this could be achieved.

The potential for market mechanisms to resolve capacity problems can be illustrated with regard to rail freight (the above point about subsidies also applies). Under market conditions congestion would push up access charges on the route in question, thereby encouraging operators to more fully utilise train paths (for example with longer trains) or to divert traffic to alternative routes. For example, higher prices on the southern WCML might push intermodal freight onto the Ipswich-Nuneaton route. It might also affect the choice of port and inland terminal. At the margin, containers could shift from London Gateway to, say, Felixstowe, Immingham or Hull.

It should also be noted that rail freight traffic is fairly trivial in terms of the capacity of the road network. If a larger share of forecast intermodal growth shifted onto the roads, the effect would barely be discernible in most locations. Any impact could be mitigated by deregulation measures such as raising HGV speed limits on single carriageway roads and increasing maximum weights and lengths. There may also be a case for peak-time pricing at the worst bottlenecks, combined with an equivalent reduction in fuel duty, thus strengthening the incentives for hauliers to operate off-peak and making better use of existing road capacity.

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HS2 regeneration claims are economic quackery

June 28, 2014

High Speed 2 is not the first transport project to have ambitious aims. Back in the 19th century the US government subsidised vast transcontinental railroads to bridge the east-west divide, rebalance the country’s economy and unify the nation.

But the situation on the ground presented challenges for this grand vision. Harsh conditions meant many construction workers fell ill or even died. This created a business opportunity. Entrepreneurs travelled to the railroads to sell ‘snake oil’ to the labourers. They claimed it would treat a whole range of conditions from infections to joint pain. The only problem was that it didn’t work. Customers were being misled.

HS2 is being sold as a modern-day elixir. At first it was promoted on the basis of faster journey times. Then it became an essential means to increase rail capacity. Politicians now argue the project will transform the North of England, bridge the North-South divide and turn northern cities into ‘world leaders’.

The scheme is therefore much more than a railway. It’s an economic cure-all that supposedly will rebalance the economy and create, depending on the lobby group, tens of thousands or hundreds of thousands of jobs.

It would be wonderful if HS2 really could make such an enormous impact. But in reality these assertions reflect a combination of blind faith and political spin. The economic evidence casts serious doubt on the ability of high-speed rail to deliver regeneration on a grand scale.

Take the example of East Kent. Back in the 1990s the government was pushing through the Channel Tunnel Rail Link, Britain’s first high-speed railway. The business case was very poor but regeneration claims were crucial in overcoming Treasury opposition. In particular, ministers said the line would transform the struggling old mining area along the Kent coast.

High Speed 1, as the line became known, did deliver impressive journey times. After fast services began in 2009, Central London could be reached in around an hour, compared with almost two hours previously.

Yet despite this major transport boost, East Kent is still economically depressed. Indeed in the period after the high-speed trains arrived, the region has performed worse on key economic indicators than the rest of Britain.

In the borough of Thanet, which includes Margate and Ramsgate, the employment rate has fallen to 61 per cent – 10 percentage points below the national average and similar to struggling old industrial cities like Liverpool. Median weekly pay for full-time workers is just £446, 14 per cent lower than the national figure.

East Kent has many advantages over the North of England. It’s just an hour’s drive from the M25 and close to prosperous areas in the South East. The Channel Tunnel gives the region easy access to the Continent and it is the closest part of the UK to Europe’s economic core. High-speed rail’s failure to transform the area augurs badly for the ability of HS2 to rejuvenate northern cities.

A second example is Doncaster. 125mph trains to London were introduced in the late 1970s, with electrification of the East Coast Main Line completed in 1991. The fastest trains to London take a little over 90 minutes to reach King’s Cross. Yet despite excellent transport links, Doncaster was ranked 42nd worst out of 318 boroughs in England in the 2010 Index of Deprivation. If the town itself were measured rather than the much wider area of the borough, it would be one of the very poorest places in the UK.

Big cities such as Leeds and Sheffield are of course different from smaller towns. High Speed 2 will make their journey times to London broadly similar to those enjoyed by the West Midlands today. Yet on most measures Birmingham performs far worse than Yorkshire’s major cities. Its employment rate is just 59 per cent, compared with 68 per cent in Leeds. Birmingham comes in the bottom ten districts in the Index of Deprivation.

Clearly improved rail links to London are no panacea. Other factors such as skills, education and entrepreneurship are more important determinants of economic success. But despite the evidence that HS2 won’t deliver the promised gains, it would be unfair to describe its promoters as snake oil salesmen.

For certain sectors and some localities there will indeed be benefits from the project, even if the enormous tax bill means they’re likely to be at the expense of other areas and the wider economy. However, assertions that high-speed rail will deliver a major transformation are far-fetched. HS2 is not an economic cure-all for the North of England and politicians that claim it is are indulging in economic quackery.

1st May 2014, Yorkshire Post (edited version)

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High Speed 2 is a deeply flawed project

February 23, 2013

HS2 534

Earlier this week, in a piece for ConservativeHome, Karen Lumley MP launched an astounding attack on our latest research paper, High Speed 2: the next government project disaster? Her article was astounding firstly because it failed to to address the detailed criticisms of HS2 set out in our analysis, and secondly because in places it parroted almost verbatim a briefing released by the ‘Yes to High Speed Rail’ campaign.

Contrary to the assertions of the high-speed rail lobby, our study shows that the economic case for the proposed scheme is very far from robust. Indeed, we conclude there is a high risk that HS2 will be the latest in a long line of government big-project disasters with higher-than-forecast costs and/or lower-than-forecast benefits.

The list of failed schemes includes the Channel Tunnel Rail Link (now known as High Speed 1), where passenger numbers after completion were only a third the level estimated at the planning stage. The line was uneconomic and most of the capital costs had to be written off – at huge expense to taxpayers.

HS2 is also uneconomic, of course. On a commercial basis it will be hugely loss-making, since the costs will far exceed the revenues – hence the need for such enormous subsidies. And the bulk of the financial risks will be borne by taxpayers, who will be forced to fund the scheme whether or not they use the train services. The main beneficiaries will be a fairly small number of relatively wealthy rail travellers, including long-distance commuters subsidised to make even longer trips, while the costs will be dispersed across the tax-paying population of the UK.

As with HS1, the case for HS2 is based on very high estimates of future passenger traffic. If passenger numbers are lower than expected, the bill for taxpayers will be even larger. And there are further flaws in the economic case.

One of the most ridiculous assumptions is that business travellers are unable to engage in any productive work on the train. In an age of laptops and mobile technology, this is clearly implausible. Yet it forms the basis of the time-savings estimates that are used to justify HS2.

The impact of competition on passenger numbers has also been neglected. When HS2 opens there will be spare capacity on the existing West Coast Main Line (WCML). Indeed, existing stations on the WCML – such as Birmingham New Street – are likely to be more convenient for many travellers than the new HS2 stations. Competition from alternative routes is likely to put downward pressure on both passenger numbers and fare revenues on HS2. Taxpayers will once again be on the hook for any shortfall.

There will also be serious cost implications from the decision to terminate the proposed line at Euston. Just under a quarter of the construction costs of the London-Birmingham route will be spent on the five miles from Euston to Old Oak Common, a total of about £4 billion. Worse still, the Underground station is already overcrowded at peak times, while the Northern Line and the Victoria Line are among the most congested on the entire Tube network. Realistically, the problem of passenger dispersal at Euston will require further investment in expensive infrastructure, whether a new Underground line or a Crossrail 2 link. The Treasury should be extremely concerned about the wider implications of HS2 for public expenditure, particularly in the context of extremely high levels of government debt.

Policymakers should also be highly sceptical about the wider economic benefits claimed for high-speed rail. While certain areas will undoubtedly benefit from a large injection of taxpayers’ money, there will be wider economic losses from the additional taxes needed to fund the scheme. It is well known that higher taxes destroy wealth – by reducing work incentives and hampering investment, for example – yet this has not been factored into the government’s assessment of the wider economic impact of HS2. Lower taxes and less regulation would do far more to regenerate the North of England than a hugely expensive rail line.

Before even considering spending £34 billion on high-speed rail, the government should be addressing the enormous burden already imposed on taxpayers by existing rail subsidies, which totalled at least £5 billion in 2010. Unless these subsidies are phased out, together with price controls and other distortions, the real level of demand on the railways cannot be determined and, accordingly, resources are likely to be misallocated. If HS2 goes ahead, taxpayers will be punished for the government’s failure to expunge socialist economics from Britain’s transport sector.

27 July 2011, ConservativeHome

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Politicians should get out of the transport market – starting with High Speed 2

February 23, 2013

Britain’s transport sector is cursed by endless intervention by politicians. Investment has tended to be driven by political priorities rather than consumer demand. The emphasis has been on satisfying concentrated special interests rather than the wider populations of taxpayers and transport users. The latest example is High Speed 2 (HS2) – critiqued in a new IEA paper released today.

HS2 exemplifies the government’s flawed approach to transport policy. It is a centrally-planned, highly political project with all the deficiencies that implies. In particular, central planners struggle to allocate resources efficiently because they cannot access the dispersed and subjective information held by individuals. This problem is exacerbated on the railways since policymakers are operating in the absence of genuine market prices. Indeed, a wide range of economic distortions, including price controls, large state subsidies and an artificial industry structure, make it very difficult to make efficient investment decisions.

The incentive structures facing politicians and transport planners also lead to the misallocation of resources. Financial risks are offloaded on to taxpayers, often many years in the future, while in the short-term politicians and senior civil servants can gain prestige from their ‘grand designs’.

Accordingly, it is unsurprising that the government’s economic case for HS2 is deeply flawed. The passenger and revenue projections are hugely optimistic compared with other, independent,estimates. There are also several unrealistic assumptions – perhaps the most ridiculous is that business people can’t do any productive work on trains. It is also clear that the route of HS2 has been ‘gold-plated’ with little regard to the costs imposed on taxpayers and property-owners: it will be hugely expensive to tunnel the line to Euston and the implications for overcrowding on London Underground may lead to billions more in infrastructure expenditure (funded largely, once again, by taxpayers rather than passengers).

An alternative to the politicisation of the transport sector is provided in Chapter 10 of Sharper Axes, Lower Taxes. Clearly cancelling big, uneconomic projects such as HS2 is a first step. But reform must go much further. Genuine privatisation is needed, not just on the railways but also on the roads. This means more than transferring nominal ownership. Subsidies to public transport should also be phased out, the tax treatment of different modes should be harmonised and the sector should be deregulated. The chapter identifies £15 billion of annual savings to taxpayers in 2015 from such a policy, plus considerable privatisation receipts that could be used to cut fuel taxes. Getting the government out of transport will also ensure that investment serves the needs of consumers rather than inflating the egos of politicians.

19 July 2011, IEA Blog

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