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Miracle cure that wastes tax dollars

By Henry Ergas - posted Friday, 10 October 2008

Like Baldrick in the television series Blackadder, Kevin Rudd has a plan, "as cunning as a fox who's just been appointed professor of cunning at Oxford University". It's cunning because it's so simple - throw billions of dollars of taxpayers' money at infrastructure - yet so versatile: six months ago, it was the answer to an overheating economy; now it's the miracle cure for one that faces a credit crunch. Trouble is, far from helping the Australian economy, it risks miring it in waste and inefficiency.

Of course, infrastructure-led recoveries are as old as the hills. Handing out shovels and getting the unemployed to lay sewers, extend roads and build bridges was once a sure-fire way of stimulating slowing economies. However, as country after country discovered in the 1980s, times have changed, and large-scale infrastructure programs are ineffective and inefficient as a response to slowdowns in economic growth.

They are ineffective because the days when building infrastructure was as simple as sending out a work team are long gone. Modern infrastructure programs require careful planning, have long lead times (including because of the need for environmental approvals) and are, in any event, highly skilled and capital intensive. As a result, by the time they come to implementation, the economy is typically picking up and all the programs do is increase any inflationary pressures the recovery creates.


What is far worse, however, is the inefficiency. Throughout the Organisation for Economic Co-operation and Development area, the salient feature of large-scale infrastructure programs has been how many poor quality projects, whose costs greatly exceeded their benefits, have been implemented. Far from making countries better off, these projects have made them only poorer.

That inefficiency is partly due to a crash-through or crash mentality. But it is aggravated by the frenzies of rent-seeking that important infrastructure projects unleash.

With individual projects involving multibillion-dollar outlays, the gains from being selected to operate a project are huge. The sheer magnitude of those gains encourages every form of manipulation and deception. It is therefore unsurprising that the track record of big infrastructure programs is dismal.

For example, although road construction is a relatively standardised activity, a study of a large number of road projects found that costs were routinely underestimated, with the average gap between estimate and actual expenditure being in the order of 15 per cent. Forecast error on big rail projects was even greater, with an average underestimate of costs in the order of 40 per cent, while demand was overestimated by an average of 105 per cent, so that actual use was typically less than half that initially estimated.

It is therefore unsurprising that 40 per cent of the large projects examined in one recent study were found to have performed very badly, with fewer than half the projects surveyed ultimately meeting most of their stated objectives.

These outcomes are the result of a political economy in which interest groups chasing large, highly concentrated benefits swamp the limited defences of the diffuse parties that will end up bearing the costs.


The trend to undertaking significant infrastructure projects through public-private partnerships has made that political economy only worse. By taking outlays off balance sheet, PPPs reduce the visibility of the costs forced on taxpayers and consumers, making it more difficult for those costs to be controlled. That most of those costs are shifted into the future further reduces their visibility, as do the opaque risk-sharing and cost-recovery arrangements built into many PPP contracts.

All of these deficiencies plague recent Australian PPPs. Sydney's Cross-City Tunnel project is often held up as the worst of a bad lot, but it faces stiff competition from projects in other states. For example, according to a recent report by PricewaterhouseCoopers, the construction cost of Victoria's Scoresby (Mitcham-Frankston) motorway was in the order of $2.5 billion; but the fares allowed the private operator amount to $7 billion, implying a rate of return that, even making the required adjustments, is as staggeringly high as it is inefficient.

Stringent safeguards are therefore needed if the Building Australia Fund is not merely to add to this farrago of waste, inefficiency and favouritism. Those safeguards need to include rigorous cost-benefit testing of all projects; full disclosure of the data, assumptions and models used in that testing, along with the results; complete transparency of any PPP contracts, along with estimates of their costs to the public; annual audit of outcomes compared with initial estimates; and stringent probity requirements around project selection and implementation.

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First published in The Australian on October 8, 2008.

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About the Author

Henry Ergas is chairman of Concept Economics. His new book is Wrong Number: Resolving Australia's Telecommunications Impasse (Allen & Unwin).

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Creative Commons LicenseThis work is licensed under a Creative Commons License.

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