There’s no surer sign of an imminent federal election than a fast-train promise. Labor is pledging that if it wins next year’s federal election, it will create a new High Speed Rail Authority and get cracking on building the 1750km railway from Brisbane through Sydney to Melbourne.
And who doesn’t love the idea of a bullet train zipping along Australia’s coastline? We like to imagine it would be nation-building, bring us in line with the rest of the world, and give a major economic boost to regional communities.
But this kind of project has little chance of passing any cost-benefit test under the current Australian government assessment framework, because that framework insists on artificially high discount rates.
Rather than cherry-picking a favourable discount rate for pet projects, the government – whether Coalition or Labor – should sort out how it deals with this key economic parameter so that decision-makers have some hope of understanding the merits, however limited, of east-coast high-speed rail, and how it compares with rival proposals.
In 2013, the then-Labor government commissioned a feasibility study of a high-speed rail line akin to those in Japan, Europe and, increasingly, China. It found the railway would take 45 years to complete and cost $130 billion in today’s dollars.
That 2013 study concluded that the benefits of a Melbourne-to-Brisbane high-speed railway would greatly outweigh its costs; it found that, for every dollar of costs, financial and non-financial, society would end up better off to the tune of $2.30. In other words, the benefit-to-cost ratio was estimated at 2.3 to 1.
But this favourable result was almost entirely due to a cherry-picked discount rate. The discount rate is the tool that puts costs and benefits occurring at different points in time on to a comparable footing. When a project’s benefits mostly come about in the more distant future, a high discount rate treats those benefits more sceptically than a low discount rate would.
The 2013 study discounted future costs and benefits at a rate of 4 per cent a year, giving the project a major leg up compared to rival projects – a leg up that would not be permitted under current policy. Without this leg up, the benefit-to-cost ratio was estimated to be just 1.1 to 1; in other words, only by the slenderest of margins would this project be judged worthwhile.
A 4 per cent discount rate wouldn’t salvage this project.
Discount rate policy in Australia leaves much to be desired, but that doesn’t mean project proponents should be able to cherry-pick a rate that suits their project.
It has long been Australian practice to use a discount rate of 7 per cent to appraise transport infrastructure projects. Sensitivity testing at 4 per cent and 10 per cent is usual. Project proponents do not get to choose what discount rate to use: Infrastructure Australia requires a 7 per cent rate for any project valued at $250 million or more where the proponent is seeking Commonwealth dollars. State governments mostly take the same approach.
The implication of using a 4 per cent rather than the usual 7 per cent discount rate is that it seeks to have the high-speed rail proposal appraised on a more favourable basis than other transport infrastructure proposals.
That’s because it discounts costs, and more pertinently benefits, that occur in the more distant future relatively lightly – and more of the high-speed rail proposal’s benefits are in this more distant realm.
Choosing a 4 per cent discount rate made a huge contribution to the favourable overall assessment of the project.
Low interest rates
Of course, Labor’s Catherine King may well argue that a discount rate of 7 per cent is far too high when the cost of money is at record lows, and she would be absolutely right. Since the late-1980s, when discount rates were first frozen at 7 per cent, real risk-free rates have plummeted from around 7 per cent to less than 1 per cent.
But nonetheless, this penalty remains in place for all projects, not just the east-coast high-speed railway. Any major infrastructure project should be assessed in accordance with established practice, and subject to the same constraints as rival projects with similar levels of risk.
A 4 per cent discount rate wouldn’t salvage this project. Since the 2013 business case, work has begun on Western Sydney Airport, a direct rival. The rail route assessed in 2013 would have limited value to regional areas, because key regional links, such as Newcastle to Sydney, were dropped due to cost. The main beneficiaries would be business travellers between Sydney, Melbourne and Brisbane, not regional communities.
All the same, whichever party forms government in 2022, the incoming infrastructure minister has much to gain from sorting out the problem of discount rates. In the short term, he or she should move toward lower and risk-reflective discount rates to appraise transport projects, and should establish an authoritative, evidence-based way to set and update discount rates to reflect real-world conditions.
Without puffed-up discount rates, the incoming minister would be able to see whether there are at least some good projects, with benefits in the more distant future, that currently don’t pass the cost-benefit test, but might actually be worth building.
Yes, Minister, they’re the nation-building ones.
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