Tuesday, February 21, 2006

Sydney's tunnel - confused controversy

The Tunnel controversy aired on Four Corners last night is becoming confused with a sort of low-level, anti-business leftism. This is a problem because road pricing is useful in dealing with congestion. That said, the NSW Government's handling of the Tunnel operation has been very poor. What are the core difficulties with this project?

Apart from traffic engineering design issues there are three basic problems:

  • Pricing vehicle use of the tunnel at a pricey $3-56.
  • Closure of adjacent roads to force traffic into using the tunnel to avoid 'rat-running'.
  • Limiting potential competition from technologies such as light rail or requiring compensation to the consortium should such competition be introduced.
These issues are problems and stem from the NSW Government's decision to sell the right to operate the tunnel to the private CrossCity motorway consortium. They are not problems associated with the greed of CrossCity itself which has undertaken a high-risk project and rightfully insists on protection of its substantial investment.

Pricing for road use to limit congestion is a good idea. Economists have advocated such policies for at least 40 years: the best recent survey by far is Lau here. But the price of using a road should reflect the marginal social cost of using it not the average cost plus a profit margin. Moreover, it is the averaging process that is at fault here not the margin. These projects have large fixed costs but such costs are irrelevant to pricing as shown over 150 years ago by A. Cournot in relation to his 'bridge problem'.

Pricing the tunnel at marginal cost will result in tolls much lower than $3-56. During off-peak periods where traffic using the tunnel is light access should, on this basis, be free.

In lieu of comprehensive electronic pricing of all roads in a city (this will become increasingly feasible with GPS-based satellite technology) policy makers can only choose to price certain key roads. This creates incentives to divert around the priced roads to avoid tolls. This incentive is particularly strong if the road is overpriced as the Cross City Tunnel clearly is. Without such limitations the eficiency arguments for tolling can vaporise because you get severe 'rat-running' external costs (Max Corden would call such things in trade theory 'byproduct distortions') along the boundary of the priced road.

The need to protect the CrossCity operators from competition stems from the privatised structure that has been set in place. As John Quiggin pointed out in the Four Corners show, the public sector has a lower cost of capital than the private sector so it can incur lower capital costs. But more importantly the public sector can internalise ther prospects of competition from other transport operations and does not need to be protected against such risks so it, for this reason alone, has a lower cost of capital.

It would have been better for the tunnel to have been publicly-funded but built and perhaps even managed by private operator. This would have given the private sector efficiencies sought, would have left the Government to marginal cost price which would have reduced the need to restrict 'rat-running' and would have left government free to introduce new competitive transport technologies such as light rail based on a social cost-benefit analysis reflecting the public interest.

The argument that the NSW Government could not afford to borrow to pay for the project is nonsense since its debt is low. The notion that it is more costly for the community if the government borrows at a low rate to fund the project rather than for the community to pay a much higher rate of return on the same amount borrowed is patently silly.

The report by a bipartisan parliamentary committee slamming the tunnel project is discussed here and here.


Bring Back EP at LP said...

I am outraged the group cannot go broke if their business decisions go pear-shaped.

more of captialising the profits and socialising the losses!

PPP's are fine by me but if they go broke give it back to the taxpayer.

hc said...

Its not their bad business decisions, its dumb contracting by the government.

David said...

This is very much about dumb contracting by the government.

One way this kind of thing can be discouraged is by greater scrutiny of these contracts. Claims of 'commercial in confidence' are often bandied about but a lot of the contents of these contracts are not truly commercially sensitive for operators and it is the government that is just as keen or more keen to make sure the contracts remain secret - to avoid the public seeing how much flexibility in future policy the government has traded away to save some money up-front.

Bring Back EP at LP said...

Any contract that does not allow poor businesses to go broke is a very poor contract

FXH said...

If I remember correctly Bob Officer always insisted that Government DID NOT have a lower cost of money.

hc said...

Francis, There is no equity premium and they can guard against unforeseen transport risks better than the private sector. Bob Officer is a bright guy but I don't know wht he would say this.

I also like Tony Abbott but his sense of humour and his directness. Not his music. I also wish I was as fit as he is.