Welfare effects

How transport investment can promote a more competitive and efficient economy

Key Summary

The grim result of decades of underinvestment is that over the last 12 months the cost of congestion to British business is £23.2 billion, a staggering rise of £5.7 billion over the year

The link between transport and economic efficiency

In the short term, there are two main ways in which transport networks can improve business competitiveness:

  • Better transport can directly reduce operating costs and increase the amount of time available for productive work. In the growing service sector, time spent travelling for business purposes can represent a significant proportion of total costs. Less time spent travelling means that individuals are able to spend more time on productive activities. In the freight sector ‘just in time’ delivery is at the core of modern economies, hence network speed and reliability can have a direct and significant impact on business costs (Fowkes et al., 2004, see also http://www.greenlogistics.org/).
  • Better transport can foster greater competition and promote a more efficient allocation of resources by bringing firms closer to a wider labour pool, to suppliers, to clients and to markets. Less time spent travelling effectively means firms and individuals are willing to pursue a broader range of economic opportunities.

For a more detailed analysis of how these benefits factor into the wider economic impact of transport projects see the 1999 SACTRA report and Mackie et al. (2001).

But what forms of investment have the greatest short term economic impact?

Transport networks are largely funded and provided by public owned not-for-profit enterprises with a significant degree of monopoly power. These organisations have therefore needed to develop criteria for deciding how available public funding should best be allocated between competing projects, modes and users to maximise their economic impact.

Welfare Economics has come to the rescue by postulating that an economically efficient allocation of resources (or Pareto optimum – that which we are all trying to achieve) is one that cannot be improved so as to make one individual or firm better off without making another worse of by the same amount.

So the answer is to fund those schemes, within existing financial constraints, which are forecast to produce the greatest net increase in the utility of producers and consumer (Glaister, 1981). This principle forms the basis of Cost Benefit Analysis (CBA), a concept originally formulated by Dupuit in the 19th century, subsequently developed by Marshall and applied in earnest to the transport sector in the UK following Michael Beesley’s seminal work in the ‘50s and ‘60s. In simple terms, CBA aims to identify those transport schemes which will deliver the greatest increase in available productive time and will extend existing markets the most.

"...capital projects with a good case on value for money grounds could and should be financed by borrowing, not by current taxpayers, because the benefits accrue to future taxpayers. This is the "golden rule". Failure to invest in worthwhile projects reduces future economic growth - it reduces debt, but also reduces GDP. Investing now, when there are spare resources in the economy and cost pressures are relatively subdued, makes very good economic sense. If the projects are demonstrably good value for money, it is very unlikely that more borrowing for this purpose would lead to a loss of confidence in financial markets."

Chris Riley (2010) of Oxera (formerly DfT Chief Economist).

How does CBA work?

CBA attempts to compare the economic benefits of a given investment to producers and consumers with the capital and operating costs over the life of the project, subject to a given discount rate (in the UK, this is 3.5% up to 30 years and 3% between 30 and 60 years). The economic worth of a project is normally expressed by its Net Present Value (NPV) or Benefit Cost Ratio (BCR).

A key issue in the application of CBA to transport is the measurement of benefits, the largest proportion of which typically come in the form of travel time savings. Work by the Department for Transport (DfT) quoted in the Eddington report suggests that travel time savings from investments in the strategic road network for example, represent close to 85% of total benefits. The proposed Northern Hub rail scheme is forecast to generate in excess of £10bn in journey time savings (2/3 of total benefits).

The Value of Time (VoT)

A key parameter in the measurement of user benefits is the Value of Time (VoT), which converts journey time savings into equivalent monetary benefits. A large body of empirical research has developed over the years in search of ever more accurate estimates of this parameter. TRL (2004) provides a comprehensive review and summary of key parameter estimates in the context of public transport. Abrantes and Wardman (2010) have produced arguably the most robust estimates to date based on an extensive analysis of UK studies going as far back as the 1960s.

Although there is a degree of variation between countries, it is standard practice to value time spent travelling in the course of work as a proportion of the wage rate (see Mackie et al. (2003) for a detailed discussion). Effectively, this implies that travel time is mostly unproductive and could be used more effectively for alternative purposes.

Commuting is typically seen as a sub-category of leisure time, which is valued based on consumers’ willingness to pay (WTP). The assumption is that WTP reflects the value consumers place on the alternative uses for which travel time could have otherwise been employed. Hence, it is reasonable to expect that a proportion of travel time savings would be used to undertake a greater amount of economically productive work or to expand their job search area, which would ultimately result in a more efficient allocation of the available labour pool.

Papers by Mackie et al. (2003) and Mackie et al. (2001) provide useful background information and the theoretical rationale for the approach to the estimation of the Value of Time.

Below we summarise some of the key standard parameters used in the UK as well as other characteristics commonly associated to the value of time:

Does CBA reflect the full economic value of transport investment?

It is a well established result (Jara-Diaz, 1986) that, in perfectly competitive markets operating close to full employment, the direct producer and consumer benefits derived from transport investment lead to equivalent short term gains in economic efficiency.

However, at times of high unemployment, traditional welfare analysis may overstate short term benefits as greater productivity may not be readily converted into increased output. On the other hand, analysis by the DWP suggests that transport can make a contribution towards tacking unemployment by increasing labour flexibility amongst the unemployed.

“Time spent travelling during the working day is a cost to the employer's business. It is assumed that savings in travel time convert non-productive time to productive use and that, in a free labour market, the value of an individual's working time to the economy is reflected in the wage rate paid. This benefit is assumed to be passed into the wider economy and to accrue in some proportion to the producer, the consumer and the employee, depending on market conditions”.

DfT WebTAG guidance.

It is also now widely accepted (1999 SACTRA report; Eddington Study), that there are a number of circumstances under which conventional cost benefit analysis and welfare economics do not necessarily reflect the full long term value of transport investment:

  • Additional economic impacts may arise due to market imperfections such as the existence of agglomeration economies, the presence of natural monopolies and network economies in transport markets and the occurrence of externalities (congestion, accidents and environmental costs).
  • At a more fundamental level, transport investment can also help support long term structural change, which cannot be easily factored into standard transport analysis. 

Empirical evidence on the link between travel time savings and economic efficiency

It is difficult to unpick the direct effect of transport investment on GDP via its impact on producers and consumers. However, some evidence is available.

Mackie and Simon (1986) state that three quarters of local firms surveyed after the construction of the Humber bridge claimed they were able to utilise their time savings productively through improved vehicle routing and utilisation, greater market penetration, an extended catchment area and internal rationalisation (quoted in SACTRA 1999).

Cleary and Thomas (1973) found that the opening of the Severn bridge had made the area a more attractive location for manufacturing investment, market catchment areas had extended across the estuary and firms had strengthened operational links between units split across the two regions. A survey by the Welsh Office (1980) found that 47% of large manufacturers, 84% of small manufacturers and 85% of freight businesses considered that the transport link had “helped to increase business” (quoted in OECD, 2002).

A survey by Ernst & Young (1996) found that businesses consider congestion and unreliability to add to business costs, particularly for companies in the service sector and those serving urban areas. Of the firms surveyed, 20% reported that travel time savings had allowed them to access wider markets, wider labour catchment areas and reduced their inventory costs. (quoted in McQuaid et al., 2004 and SACTRA 1999).

The British Chambers of Commerce have recently called on the UK government to spend £30bn on strategic transport projects, which are estimated to generate in excess of £80bn worth of economic returns, largely arising from travel time savings. Their 2008 transport survey estimated congestion to be costing every UK business, on average, more than £17k per year due to higher operating costs and loss of productive work time. Of those businesses surveyed, 78% would actually support the principle of road pricing subject to public transport improvements and increased investment.

The European Cities Monitor has consistently found easy access to markets, customers and clients, alongside availability of qualified staff, to rank as the top two essential factors influencing business location. Although ease of travelling around and within a city and quality of life for employees come much lower down the list of essential factors (cited as essential factors, respectively, by 25% and 20% of surveyed firms) they are clearly related to the top two factors.

 

Key Reads

  1. Mackie et al (2003) Values of Travel Time Savings in the UK

    This paper analyses the values of travel time savings (VTTS) in the UK context. It looks at VTTS for employers' business travel, the relationship between VTTS and the size of time savings and suggests a preferred approach for the value of non-work time savings for car and public transport users. It also makes the case for the standard value of non-working time in evaluation and for variations in the VTTS by journey length and mode of travel.

  2. DfT WebTAG Guidance documents - Expert, TAG Unit 3.5: The Economy Objective

    Provides detailed guidance on appraising transport projects against economy objectives.

  3. McQuaid et al (2004) The importance of transport in business' location decisions

    Reviews evidence on the issues considered by businesses in choosing where they locate / relocate and in particular, the extent to which transport is a factor within that decision-making process.

  4. Green logistics

    A hub for research into the sustainability of logistics systems and supply chains, providing an insight into how network speed and reliability can have a direct and significant impact on business costs.

  5. OECD (2002) Impact of transport infrastructure investment on regional development

    This report summarises a comprehensive study on current evaluation studies in OECD Member countries, aiming to find empirical evidence on wider impacts of transport infrastructure investment on regional development and to develop guidance for governments and transport administrations on how to identify such impacts and include them in appraisal methodologies.

Further Reading

  1. Alonso (1964) Location and land use: toward a general theory of land rent

  2. Cleary and Thomas (1973) The Economic Consequences of the Severn Bridge and its Associated Motorways

  3. Welsh Office (1980) M4/A55 Study: The Effects of Major Road Investment Schemes in Wales

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