Tag: discounting

Did the benefits of the London Olympics outweigh the costs? The government’s UK Trade and Industry (part of the Department of Business, Innovation & Skills) has just published a report, London 2012, Delivering the economic legacy, which itemises the economic benefits of the games one year on. It claims that benefits to date are some £9.9 billion.

This compares with costs, estimated to be somewhere between £8.9 billion and £9.3 billion, although this figure does not include certain other costs, such as maintenance of the stadium. Nevertheless, according to the figures, even after just a year, it would seem that the Games had ‘made a profit’ – just.

The £9.9 billion of benefits consist of £5.9 billion of additional sales, £2.5 billion of additional inward investment and £1.5 billion of Olympic-related high value opportunities won overseas. Most of these can be seen as monetary external benefits: in other words, monetary benefits arising from spin-offs from the Games. The ‘internal’ monetary benefits would be largely the revenues from the ticket sales.

In a separate report for the Department of Culture, Media & Sport, Report 5: Post-Games Evaluation, it has been estimated that the total net benefits (net gross value added (GVA)) from 2004 to 2020 will be between £28 billion and £41 billion.

But benefits are not confined just to internal and external monetary benefits: there are also other externalities that are non-monetary. The Culture, Media & Sport report identified a number of these non-monetary externalities. The Summary Report itemises them. They include:

• The health and social benefits of more people participating in sport
• Inspiring a generation of children and young people
• A catalyst for improved elite sporting performance in the UK
• Setting new standards for sustainability
• Improved attitudes to disability and new opportunities for disabled people to participate in society
• Greater social cohesion as communities across the UK engaged with the Games
• Increased enthusiasm for volunteering
• Accelerated physical transformation of East London
• Beneficial socio-economic change in East London
• Important lessons learned for the co-ordination and delivery of other large-scale public and public/private projects

But with any cost–benefit analysis there are important caveats in interpreting the figures. First there may be monetary and non-monetary external costs. For example, will all the effects on social attitudes be positive? Might greater competitiveness in sport generate less tolerance towards non sporty people? Might people expect disabled people to do more than they are able (see)? Second, the costs generally precede the benefits. This then raises the question of what is the appropriate discount rate to reduce future benefits to a present value.

Perhaps the most serious question is that of the quantification of benefits. It is important that only benefits that can be attributed to the Games are counted and not benefits that would have occurred anyway, even if connected to the Games. For example, it is claimed in the UK Trade & Industry report that much of the Olympic park and stadium for the Winter Olympics in Russia was “designed and built by British businesses”. But was this the direct result of the London Olympics, or would this have happened anyway?

Another example is that any inward investment by any company that attended the London Olympics is counted in the £2.5 billion of additional inward investment (part of the £9.9 billion). As the London Evening Standard article below states:

In London, it credited the Games with helping seal the deal for the £1.2 billion investment in the Royal Albert Docks by Chinese developer ABP, the £1 billion investment in Croydon by Australian shopping centre developer Westfield with UK firm Hammerson and the £700 million investment in Battersea Nine Elms by Dalian Wander Group.

It is highly likely that some or all of these would have gone ahead anyway.

Then there are the £5.9 billion of additional sales. These are by companies which engaged with the Olympics. But again, many of these sales could have taken place anyway, or may have displaced other sales.

Many cost–benefit analyses (or simply ‘benefit analyses’) concern projects where there are strong vested interests in demonstrating that a project should or should not go ahead or, in this case, have gone ahead. The more powerful the vested interests, the less likely it is that the analysis can be seen as objective.

Webcasts and Podcasts

Have Olympics and Paralympics really boosted trade? Channel 4 News, Jackie Long (19/7/13)
Economy boosted by Olympics Sky Sports News, Amy Lewis (19/7/13)
Olympic investment boost to last decade – Cable BBC News (19/7/13)
Did the UK gain from the Olympics? BBC Today Programme (19/7/13)

Articles

Government announces almost £10bn economic boost from London 2012 Specification Online (19/7/13)
Olympic Legacy Boosted Economy By £10bn, Government Insists The Huffington Post (19/7/13)
Olympics are delivering economic gold but volunteering legacy is at risk The Telegraph, Tim Ross (19/7/13)
Vince Cable: Case for HS2 still being made The Telegraph, Christopher Hope and Tim Ross (19/7/13)
Olympic legacy ‘gave London a £4bn windfall’ London Evening Standard, Nicholas Cecil and Matthew Beard (19/7/13)
London 2012 Olympics ‘have boosted UK economy by £9.9bn’ BBC News (19/7/13)
The great Olympic stimulus BBC News, Stephanie Flanders (19/7/13)
London Olympics still costing the taxpayer one year on Sky Sports (19/7/13)
Mayor missed long-term London Olympic jobs targets, says report BBC News, Tim Donovan (19/7/13)
Olympics legacy: Have the London 2012 Games helped Team GB develop a winning habit? Independent, Robin Scott-Elliot (19/7/13)
London 2012 added up to more than pounds and pence The Guardian, Zoe Williams (19/7/13)

Government Reports

London 2012 – Delivering the economic legacy UK Trade & Investment (19/7/13)
London 2012: Delivering the economic legacy UK Trade & Investment (19/7/13)
Report 5: Post-Games Evaluation: Summary Report Department for Culture, Media & Sport (July 2013)
Report 5: Post-Games Evaluation: Economy Evidence Base Department for Culture, Media & Sport (July 2013)

Questions

  1. Distinguish between gross and net benefits; monetary and non-monetary externalities; direct costs (or benefits) and external costs (or benefits).
  2. How should the discount rate be chosen for a cost–benefit analysis?
  3. Give some examples of monetary and non-monetary external costs of the Games.
  4. What are the arguments for and against including non-monetary externalities in a cost–benefit analysis?
  5. Why might the £9.9 billion figure for the monetary benefits of the Games up to the present time be questioned?

The UK government has just given the go-ahead for the building of two new nuclear reactors at Hinkley Point in Somerset. The contract to build and run the power station will go to EDF, the French energy company.

The power station is estimated to cost some £14 billion to build. It would produce around 7% of the UK’s electricity. Currently the 16 nuclear reactors in the UK produce around 19%. But all except for Sizewell B in Suffolk are due to close by 2023, although the lives of some could be extended. There is thus a considerable energy gap to fill in the coming years.

Several new nuclear power stations were being considered to help fill this gap, but with rising capital costs, especially following the Fukushima disaster in Japan, potential investors pulled out of other negotiations. Hinkley Point is the only proposal left. It’s not surprising that the government wants it to go ahead.

All that remains to agree is the price that EDF can charge for the electricity generated from the power station. This price, known as the ‘strike price’, is a government-guaranteed price over the long term. EDF is seeking a 40-year deal. Some low carbon power stations, such as nuclear and offshore wind and wave power stations, have high capital costs. The idea of the strike price is to reduce the risks of the investment and make it easier for energy companies to estimate the likely return on capital.

But the strike price, which will probably be agreed at around £95 per megawatt hour (MWh), is roughly double the current wholesale price of electricity. EDF want a price of around £100 per MWh, which is estimated to give a return on capital of around 10%. The government was hoping to agree on a price nearer to £80 per MWh. Either way, this will require a huge future subsidy on the electricity generated from the plant.

There are several questions being asked about the deal. Is the strike price worth paying? Are all the costs and benefits properly accounted for, including environmental costs and benefits and safety issues? Being an extremely long-term project, are uncertainties over costs, performance of the plant, future market prices for electricity and the costs of alternative forms of power generation sufficiently accounted for? Will the strike price contravene EU competition law? Is the timescale for construction realistic and what would be the consequences of delays? The articles consider these questions and raise a number of issues in planning very long-term capital projects.

Articles

Hinkley Point: Britain’s second nuclear age given green light as planning permission is approved for first of new generation atomic power stations Independent, Michael McCarthy (19/3/13)
Will they or won’t they? New nuclear hangs in the balance ITV News, Laura Kuenssberg (19/3/13)
Hinkley Point C: deal or no deal for UK nuclear? The Telegraph, Alistair Osborne (19/3/13)
New nuclear power plant at Hinkley Point C is approved BBC News (20/3/13)
Britain’s Plans for New Nuclear Plant Approach a Decisive Point, 4 Years Late New York Times, Stanley Reed and Stephen Castle (15/3/13)
Nuclear power plans threatened by European commission investigation The Guardian (14/3/13)
New Hinkley Point nuclear power plant approved by UK government Wired, Ian Steadman (19/3/13)
Renewable energy providers to help bear cost of new UK nuclear reactors The Guardian, Damian Carrington (27/3/13)
Europe backs Hinkley nuclear plant BBC News (8/10/14)

Information/Reports/Journal Articles
Environmental permitting of Hinkley Point C Environment Agency
NNB Generation Company Limited, Radioactive Substances Regulations, Environmental Permit Application for Hinkley Point C: Chapter 7, Demonstration of Environmental Optimisation EDF
Greenhouse Gas Emission of European Pressurized Reactor (EPR) Nuclear Power Plant Technology: A Life Cycle Approach Journal of Sustainable Energy & Environment 2, J. Kunakemakorn, P. Wongsuchoto, P. Pavasant, N. Laosiripojana (2011)

Questions

  1. Compare the relative benefits of a construction subsidy and a subsidised high strike price from the perspectives of (a) the government (b) EDF.
  2. What positive and negative externalities are involved in nuclear power generation?
  3. What difficulties are there in valuing these externalities?
  4. What is meant by catastrophic risk? Why is this difficult to take account of in any cost–benefit analysis?
  5. What is meant by a project’s return on capital? Explain how discounted cash flow techniques are used to estimate this return.
  6. What should be taken into account in deciding the rate of discount to use?
  7. How should the extra jobs during construction of the plant and then in the running of the plant be valued when making the decisions about whether to go ahead?

My son Andrew Sloman (see also) is currently in Goa. My wife Alison and I went to visit him over half term – our first trip to India. Goa is a beautiful state, with wonderful beaches, fantastic food and perfect weather in February. But inland from this tourist haven lies an environmental disaster caused by the open-cast extraction of iron ore.

This tiny state by Indian standards produces more than 60% of India’s iron ore exports. Whilst, along with tourism, the iron ore industry has been one of the largest contributors to the Goan economy, its environmental footprint is massive. Deforestation and water and air pollution are just three of the environmental externalities.

So should a cap be placed on the amount of iron ore that is mined? Should the industry be taxed more heavily? Should tough environmental standards be imposed on the industry? Or should it simply be allowed to continue, given its large contribution to the Goan economy? Or, at the other extreme, should the industry be closed? The linked article looks at some of the issues. Try to identify, as an economist, what information you would require in order to come to a conclusion to these questions.

Greens’ shout for cap on iron ore mining falls on deaf ears Times of India, Paul Fernandes (28/2/12)

Questions

  1. What negative externalities are involved with the Goan iron ore industry? Are there any positive externalities?
  2. What difficulties are there in measuring the negative externalities?
  3. How would you set about doing a cost–benefit analysis of (a) expanding the Goan iron ore industry; (b) shutting it?
  4. Explain the following: “The net present value of the opportunity cost for 25 years at 12% social discount rate of giving it up is greater than its environmental cost by Rs 14,449 crore, the report states.” (A crore is 10 million and Rs is the symbol for an Indian Rupee, where £1 = approximately 78 rupees.)
  5. What difficulties are there in attempting to take distribution into account when doing a cost–benefit analysis?

On June 20, the Review of the Government’s case for a High Speed Rail programme was published. This was commissioned by the Transport Select Committee from the independent consultancy, Oxera.

The programme is initially for a high-speed rail link form London to Birmingham and then subsequently for two additonal routes from Birmingham to Manchester and from Birmingham to Leeds. The whole thing is known as the ‘HS2 Y programme’

Oxera’s brief was to ‘provide an independent review of the economic case for the programme and to provide a set of questions that the Committee could use to probe the evidence base put forward by witnesses during its inquiry.’ In considering the economic case, Oxera focused on the economic, social and environment impacts, both monetary and non-monetary.

The summary to the report states that:

Overall, the case for the High Speed Rail programme seems to depend on whether and when the capacity is needed, the selection of the best VfM [value-for-money] approach to delivering that capacity, the degree of uncertainty around the monetised benefits and costs of the preferred options, and judgements on the balance of evidence relating to non-monetised items, such as environment and regeneration impacts (which are likely to be substantive in their own right but not fully set out in the Government’s assessment).

On July 19, the Institute for Economic Affairs, the pro-free-market think-tank, published a highly critical disussion paper, challenging the case for HS2. The paper, High Speed 2: the next government project disaster? arges that:

There is a significant risk that High Speed 2 (HS2) will become the latest in a long series of government big-project disasters with higher-than-forecast costs and lower-than-forecast benefits. HS2 is not commercially viable and will require substantial and increasing levels of subsidy. Taxpayers will therefore bear a very high proportion of the financial risks, which are wholly under-represented in the Economic Case presented by the Department for Transport.

The publication of the report and the IEA discussion paper has fueled the debate between supporters and opponents of HS2, as the articles below demonstrate.

Update
In November 2011, the House of Commons Transport Select Committee came out in favour of the government’s HS2 plans. According to the committee’s chair, Louise Ellman:

A high speed rail network, beginning with a line between London and the West Midlands, would provide a step change in the capacity, quality, reliability and frequency of rail services between our major cities.

A high speed line offers potential economic and strategic benefits which a conventional line does not, including a dramatic improvement in connectivity between our major cities, Heathrow and other airports, and the rest of Europe.

However, she did raise some issues that would need addressing concerning the overall level of investment in the rail network and the encironmental impact of HS2.

Investment in HS2 must not lead to reduced investment in the ‘classic’ rail network. We are concerned that the Government is developing separate strategies for rail and aviation, with HS2 separate from both. We call again for the publication of a comprehensive transport strategy.

Investment in high speed rail has potential to boost growth but may have a substantial negative impact on the countryside, communities and people along the route. This must be better reflected in the business case for HS2 and future phases of the project. We would encourage the Government to follow existing transport corridors wherever possible.

Further update
In January 2012, the government approved HS2. The Transport Secretary, Justine Greening, said:

I have decided Britain should embark upon the most significant transport infrastructure project since the building of the motorways by supporting the development and delivery of a new national high speed rail network.

The ‘articles for further update’ below give reactions to the announcement.

Articles
Is the UK’s high speed rail project a waste of money? BBC News, Rory Cellan-Jones (21/7/11)
On a collision path The Economist blogs, Blighty (21/7/11)
High speed rail dismissed as ‘vanity project’ by right-wing think tank The Telegraph, David Millward (19/7/11)
HS2 high-speed rail plans ‘a recipe for disaster’ Guardian, Dan Milmo (19/7/11)
High speed rail report shows ‘uncertainty’ over benefits Rail.co, A. Samuel (21/7/11)
Our high speed rail future BBC News, Rory Cellan-Jones (21/7/11)
Anger as high-speed rail link to London branded ‘vanity project’ Yorkshire Post (20/7/11)

Articles for update
MPs support plans for a high speed rail network BBC News, Richard Lister (8/11/11)
High-speed rail project will boost economy, say MPs Guardian, Dan Milmo (8/11/11)
High speed rail report ‘raises questions’ say opponents BBC News (8/11/11)
MPs back controversial high-speed rail link Yahoo News, Sebastien Bozon (8/11/11)
HS2 project: ‘Wrong to castigate locals’ BBC Today Programme (8/11/11)

Articles for further update
HS2 go-ahead sees mixed reaction BBC News (10/1/12)
HS2 – What’s in it for you? Channel 4 News (10/1/12)
Ready to depart: But will the HS2 express be derailed before it arrives? Independent, Nigel Morris (11/1/12)
HS2 go-ahead sees mixed reaction BBC News (10/1/12)
HS2 go-ahead sees mixed reaction BBC News (10/1/12)

Reports and discussion paper
Review of the Government’s case for a High Speed Rail programme Oxera Publishing (20/6/11)
High Speed 2: the next government project disaster? IEA Discussion Paper No. 36 (19/7/11)
Good case for high speed rail to run to Birmingham and beyond, say MPs House of Commons Transport Select Committee News (8/11/11)
Transport Committee – Tenth Report: High Speed Rail House of Commons Transport Select Committee (8/11/11)

Questions

  1. Itemise (a) the monetary costs and benefits and (b) the non-monetary costs and benefits of HS2 that were identified by Oxera. Try to identify other costs and benefits that were not included by Oxera.
  2. Why are the costs and benefits subject to great uncertainty?
  3. How should this uncertainty be taken into account by decision-makers?
  4. Explain the process of discounting in cost–benefit analysis. How should the rate of discount be chosen?
  5. What are the main criticisms of the report made by the IEA discussion paper?
  6. Assess these criticisms.

Are consumers ‘rational’ is the sense of trying to maximise consumer surplus? In some circumstances the answer is yes. When we go shopping we do generally try to get best value for money, where value is defined in terms of utility. With limited incomes, we don’t want to waste money. If we were offered two baskets of goods costing the same amount, we would generally choose basket A if its contents gave us more utility than basket B.

So why do we frequently buy things that are bad for us? Take the case of food. Why do we consume junk food if we know fresh produce is better for us? To answer this we need to look a little closer at the concept of utility and what motivates us when we consumer things. The following article does just that. It reports on writings of Michael Pollan. Pollan looks at our motivation when choosing what and how much to eat. For much of the time our choices are governed by our subconscious and by habit.

“Millions of humans, while believing they govern their actions with conscious intelligence, clean every morsel from their dinner plates, mainly because their parents told them to. And we do this even if we don’t particularly like the food on the plate and even if we know we should be eating less of it. Unthinkingly, we follow a habit we would condemn if we looked at it clearly.”

You mar what you eat and the politics of Michael Pollan National Post (Canada), Robert Fulford (18/1/10)

Questions

  1. What is meant by ‘rational behaviour’? Is it reasonable to assume that people are rational in most circumstances?
  2. Is eating junk food consistent with the attempt to maximise consumer surplus?
  3. How relevant is the principle of diminishing marginal utility in explaining the amount of junk food we eat?
  4. To what extent are the problems that Pollan identifies examples of (a) imperfect information; (b) irrationality?
  5. What does people’s eating behaviour reveal about their preferences for the present over the future and hence their personal discount rate?
  6. What are the policy implications of Pollan’s analysis for governments trying to get people to eat more healthily?