A guest blog from Rail Operations and Planning Consultant William Barter looking at the costs of HS2 and examining a recent Channel 4 post on the matter.
Channel 4 News has posted a so-called “fact check” headed “Why the numbers don’t add up on HS2”, referring to a recent statement from Justine Greening:
“The capital cost at 2011 prices of building the complete Y network is £32.7 billion. At present values, it will generate benefits of up to £47 billion and fare revenues of up to £34 billion over a 60-year period.”
The problem is that it is Channel 4 themselves who have got the numbers wrong.
Justine Greening correctly quotes the cost of building the HS2 line (meaning the full Y network, not just London – Birmingham) as £32.7 billion at 2011 prices. Channel 4’s confusion arises when they take her statement of benefits in terms of “present values” as meaning that they are in 2012 (the present year) prices, as if she was trying to make the benefits look bigger to the tune of one year of inflation. But that is not what “present values” means in an investment analysis, and confusing “present values” with “2012 prices” is something that should make an economics undergraduate very red in the face, let alone the “fact checker” of a national news channel.
The concept of the present value (PV) reflects the common-sense concept that money in the future is not worth so much as money now. If I owe you £100, when would you rather I paid you? This year or next year? And if you owe me the £100? Thought so. So for a sum of money that is going to arise in a future year, for every year into the future it is “discounted”, that is, reduced by a small percentage for every year ahead that we look to make it comparable with money now. So discounting at 10% to make the sums easy, £100 next year might be worth just £90 now, and £100 the year after that just £81 now, as it is discounted twice. £81 is the PV of £100 in two years time, and the PV of £100 a year for two years is £90 + £ 81 = £171.
And that the difference between “at 2012 prices” and the PV is that at 2012 prices, £100 a year for the next two years would be £200. By quoting benefits that arise from a flow of income every year for 60 years as a PV instead of an arithmetic total, Greening is making the benefits look smaller, not bigger. And that is precisely what you want when looking ahead into the uncertain future.
But it still would not be valid to add up, as Channel 4 suggest, the £47 billion economic benefits and £34 billion fare revenues to make a present value of all benefits of £80 billion, deduct the £21.7 billion operating costs (which are also the PV of an annual cash flow over 60 years), and compare that with the £32.7 billion cost of building the line – for two reasons:
- As the Economic Appraisal documents make perfectly clear, £32.7 billion is the capital cost of building the line, not for the further capital cost of the trains that will run on it. They come to a further £8.15 billion all told.
- But these capital costs will not be incurred in one year but over a construction period between 5 and 15 years into the future for Phase 1 alone, and the rolling stock in particular will fall well towards the end of that period and indeed stretch to the completion of Phase 2. So the costs for both construction and rolling stock are both spread over a number of future years, and so have also been subject to discounting (but not nearly as much discounting as the benefits, which are being incurred much further into the future).
And that is what the £36.4 billion capital costs in the economic appraisal is, nothing to do with £32.7 billion adjusted for inflation as Channel 4 suggest, but the PV of the capital costs of both the line and the rolling stock that will run on it, put into comparable terms with the benefits and the operating costs. That is what should be compared with the PV of the benefits (net of operating costs) to give the Benefit : Cost ratio.
It won’t of course be what is paid, as that depends on inflation over the next 5 to 20 years, but the point about inflation is that it affects costs and benefits equally, so doesn’t change the ratio between them, which is what the economic appraisal sets out to assess.
So far from artificially overstating the HS2 case, Greening’s statement quotes the capital cost in a way that makes it look bigger than if quoted as a PV, and the benefits in a way that makes them look smaller than if quoted at 2011 or 2012 prices. In the economic appraisal, they are both counted as present values, specifically so as to compare apples with apples, which is what Channel 4 accuse her of not doing.
Who got it wrong? Channel 4 did.