Economic Appraisal Methodology - Controversial Issues and Danish Choices



Economic Appraisal Methodology - Controversial Issues and Danish Choices

Authors

M Fosgerau, Danish Transport Research Institute; T Lund Jensen, Ministry of Transport, DK

Description

Abstract

The development and refinement of methodology for economic evaluation of infrastructure projects is an ongoing process in many countries. The paper reports on the revision of the project appraisal methodology of the Danish Ministry of Transport, which is about to result in the publication of a revised manual covering both road and rail projects.

The Danish Road Directorate and the Danish National Railway Agency each have a long established methodology for conducting project appraisal and more specifically for cost benefit analysis. However, the methodologies differed on important aspects, which raised doubts concerning the comparability of results from the two sectors. This led to the initiation of the current revision, supporting the shift towards a multimodal approach.

A recurrent theme during the revision process has been to balance between several objectives. The methodology should be broadly accepted such that the credibility of the analysis results is maximised and such that analysts will in fact adhere to the guidelines. High priority is given to practical applicability; however, without sacrificing the benefits of a consistent economic framework. These objectives have been pursued through the inclusion of both researchers and practitioners from different parts of the Ministry in the process.

A starting point for the project was an international comparison of the use of socio-economic cost benefit analysis for transport project appraisal comprising Finland, France, Germany, Netherlands, Norway, Sweden, and United Kingdom. This reviews five areas: the role of economic appraisal in the decision process, the theoretical framework, treatment of user benefits, treatment and valuation of external effects and presentation of results.

The paper focuses on a number of controversial issues where choices had to be made with quite substantial impact on results. The paper puts forward the discussion and the arguments that lead to the decisions embodied in the revised methodology. It is our hope that the paper will contribute to the clarification of the issues involved and perhaps even to furthering an international consensus concerning economic appraisal methodology within the EU.

The first decision was to use market prices, necessitating the use of an indirect tax correction factor (as labelled by GOMMS UK DfT). Convincing project analysts to use this factor ? seemingly raising project costs by 17 percent ? solely for theoretical reasons, was of course an important issue, which involved a prolonged discussion. The decisive argument for this methodological decision was the desire to treat equally projects undertaken by the private and the public sector.

Application of the indirect tax correction factor raises a number of complex issues concerning the calculation of the project impact on public finances. This concerns accounting for transport as an intermediate input, e.g. the value of working time and especially changes in revenues from fuel taxes, vehicle registration taxes and public transport revenues. (GOMMS is not entirely clear on this latter issue).

The impact on public finances does not only have distributional consequences; it also entails a cost, which is accounted for by a tax distortion factor applied to the net project impact on public finances. The factor takes account of distortionary costs such as the discouragement of work induced by income taxation. This factor has been set to 20 percent, which compares to 25 percent in the USA, 20 percent in Norway and 30 percent in Sweden (SIKA Report 2000:3). The remaining countries in the international comparison do not apply such a factor. Again, it was an important task for the project to provide an argumentation that was convincing to non-economists.

Regarding user benefits, the first main decision was to harmonise the various values of time used; currently with no distinction between transport modes. This may, however, be changed pending a value of time study under consideration. The second decision was to project the values of time using an elasticity of 1 with respect to GDP, which is in line with the British practice. This is a decision with substantial impact, as the value of travel time savings typically constitutes 80 percent of project benefits. With a discount rate of 6 percent and a projected GDP growth rate of, say, 2 percent this decision increases project benefits by up to 40 percent. Another decision subject to some debate was to apply the same value of time to small and large travel time savings.

A final both classical and controversial issue was the treatment of other nationalities and countries. Decisions had to be made concerning the treatment of user benefits falling to users of different nationalities, and similarly regarding revenues generated e.g. by users of tolled bridges. These issues are related to the treatment of EU subsidies in the cost-benefit analysis, and the analysis of cross-border projects like, notably, the Femer

Publisher

Association for European Transport