Missing: Morality and flexibility in economics

spoke last week at the EDO LawJam about missing elements in the economic analysis of major projects in Queensland, and across Australia.

Assessments of the merits of such projects typically require some kind of cost-benefit analysis. This analysis is intended to take into consideration the vast array of externalities and second round effects of major mines, ports, rail, and other projects, like casinos, subdivisions, and so forth.

One major problem with these assessments is the sheer ambiguity of the requirements, and hence the quite extreme level of discretion in how to undertake the assessment. Project proponents employ economic guns-for-hire who use whichever method of assessment gives the desired answer. Not surprisingly, benefits alway greatly exceed costs.

My fellow speakers in the night – Rod Campbell and Sean Ryan – shared examples of mining companies sourcing bogus economic reports to massively overstate the social benefits of their proposed operations, only to find them thrown out of court during appeal cases. This has lead to some projects having multiple economic reports; the first commissioned to give an outrageous answer, the next to give an answer that might stand up in court.

There is clearly a problem of outrageous flexibility in the regulations when the same company can commission two economic assessments and get two totally different answers to the social costs and benefits of the same project. In one case the net job creation estimate was inflated by 1,000% compared to their second round report, while the value of State royalties was inflated by 1,800% ($22billion compared to $1.2billion).

But this is not an accident. Major mining and property development projects are the playground of politically connected insiders. Take this example of a mine neighbouring NSW Minister for Primary Industries, Lands and Water Niall Blair’s property, which has “this remarkable dogleg around the minister’s property by the mine site”.

Political connections get outcomes in this game, and to keep the game going requires considerable flexibility in the assessment regulations.

Apart from this political element, I spoke about two main points.

  1. The neglected moral foundation of economic analysis
  2. Ignoring the value of flexibility

My point about neglected morality is that any estimate of costs and benefit necessarily makes moral judgements about whose costs and benefits are worth considering. Why only humans? Why only Australians? Also, there are hidden moral judgements about the dollar-for-dollar equivalence of cost and benefits affecting different groups of people in different ways. Undertaking economic assessment without acknowledging these foundations is deceptive.

My second point is that major developments, particularly open cut mines, are irreversible commitments. If at some future point in time it turns out that the site is more profitably and socially beneficial for use in agriculture, or some other use (say a solar electricity generation plant), then we cannot change the use from open cut coal mine back to these alternatives.

But if we stick with agriculture, we keep open the option for alternative high-value uses at future points in time. Thus, when comparing the social costs and benefits of a project like a mine, with a baseline alternative of agriculture, we must value the inherent flexibility of agricultural uses to allow for alternative future uses of the site.

My presentation can be viewed and downloaded from here.

Comments

  1. This piece has to be a wind up, doesn’t it?! I mean even every law school student is taught on day one “Never ask a question unless you know what the answer is going to be”. In The Law there are at least some real ground rules to be adhered to. But in Economics? None….

  2. “Project proponents employ economic guns-for-hire who use whichever method of assessment gives the desired answer. Not surprisingly, benefits alway greatly exceed costs.”

    Bit like the MRRT or the NDIS or Gonski.

    • Empire Investing

      You really didn’t respond to the content of Cam’s article there, did you 3D? More like a politically driven deflection…

      • Mine is a direct response. Cameron uses entertaining graphics and a farming v mining analogy. I use three recent policy initiatives, each of which promised much, none of which will deliver mooted benefits, two of which place a great and continuing burden on taxpayers present and future.

        And it’s all political. And it is a moral dilemma, placing debt burden on future generations to satisify demands of current generation.

      • Indeed, Cam’s point is almost completely political! Using the bogeyman of mining and Arcadia of agriculture. Agriculture uses more than 50% of Australia’s total water consumption, a valuable resource. Cam should avoid associating with Rod 😉

    • 3d, that is disingenuous.

      MRRT was the bastard child of the resources industry and Gillard ambition – you’ve admitted this – so of course the c-b only resulted in the desired outcome of effectively zero cost to resource companies and the personal benefit of a person securing power.

      NDIS had c-b by the pc.

      I don’t know about Gonski as a package but there is a plethora of c-b information on the components.

      • Everything 3D says is disingenuous. All it does is lie and obfuscate. The blog comments would become a lot better if it were banned completely. It’s here to obfuscate and cause trouble; the mods finally realised that on climate change, but it’s true for all topics it comments on.

  3. Empire Investing

    Cam – given the variables, the qualitative nature of said variables and the timeframes involved (who the hell knows what will happen in 5 years let alone 20), can quantitative NPV’s or cost benefit analysis really give us any sensible data for these large projects? If not, what the hell would we use to make the call?

    • No. That’s why I say these are not really economic but moral questions.

      I said in the presentation that the value of doing the analysis is not the number. The value is the process of seeking out views, opinions, impacts, concerns or support, etc amongst the community to put this into the public domain. There is no magic formula for balancing competition interests, even if economists think they can get close. By highlighting the question of irreversibility of some projects I point out that for all the effort of these reports to convert these values/views to a number, they still miss a huge part of the core economic story (let alone the peripheral unquantifiable stories).

      What’s the alternative you say? There is no simple solution because there is a political-economy environment that needs considering when any change are made. Maybe I should write a post about alternatives some time.

      • A counter-example reinforcing your PoV is that when you miss some key stakeholders, the decisions can be *very* wrong.

        For example, the NSW Govt decided to dig up George St for a light rail without consulting Ausgrid. They were mistakenly left off the list of stakeholders (no conspiracies, genuine mistake). It turns out that George St is a major conduit for the electricity distribution network in the CBD, and it’s going to cost a bomb to reconfigure it.

      • The light rail decision was a shocker.

        Having reconfigured the bus routes around George Street (which proved no great drama) they could have easily created a set of bus only lanes along the entire proposed route and started running long buses. That would have allowed the concept of a dedicated public transport corridor to be tested without any of the expense associated with the light rail capital works.

        Then if they found that the capacity of the buses was not sufficient they could think about laying tracks.

        Worth keeping in mind that outside of peak periods that light rail route could be serviced with a few buses.

        Check out all the CB documentation and the most serious alternative – outlined above – is dismissed without any substantive discussion. Classical example of hundreds of pages to divert discussion of an alternative that was practical, cost effective and could easily transition to the expensive option.

        The catch? None of the fat fees associated with major capital works and the associated financing.

        The fact the LNP were red hot for $2B worth of light rail – 12 km – should have been warning enough.

        http://pfh007.com/2015/11/19/lnp-nsw-sell-off-more-assets-flogged-off-by-mr-baird/

  4. interesting timing for me given the article in todays SMH re the redevelopment of Circular Quay. Whilst I am sure it will make it an even more beautiful place but surely there is no was a cost benefit analysis could ever justify this.

  5. Great stuff. Cutting through the BS. I remember listening to a discussion between Henry Ergas and a ‘lefty’ economist (forget who) about the modelling for an answer issue, and both agreed that a key improvement to this aspect of project assessment was to be transparent about assumptions and model methodology. At least that would be a start, and allow discussions around valuations, and allow everyone to see through some of the morally bankrupt assumptions used.

    • “Cutting through the BS”

      It is easy to say than do. After all, there are still some people on this site who believe that negative gearing has been costing the government coffers!!

  6. This is where the true tragedy of the Royal Commission into trade unions is illustrated.

    To get the outcomes you are after in bc analysis, you at least need to start with ethical actors inputting data.

    If you have corrupt unions, corrupt employers and corrupt governments undertaking billions of dollars worth of infrastructure, be that mining, power, transport, buildings, you will never get an ethically based bc analysis.

    A Royal Commission into Unions Employers, Governments and the interwoven corruption and legal-but-dodgy practices rife in the infrastructure industry would have saved billions and had a direct effect on productivity in this country.

    Instead, we got a political RC which, even if successful in cleaning out union corruption, won’t deal with employer or government corruption, and so within a couple of years unions will be reinfected, and nothing to see from $80m. Sad.

  7. Cameron, I think you are wasting your time, talent, energy and good will in economics. Economics (and main stream political economy) has lost it’s connection with morality (if ever had one) long time ago. At present it has only one purpose – to justify political decisions made by the will of the powerful. It turned into pure pseudo science propaganda.

    You will probably have more change of changing this world as moral philosopher than economist who thinks about morality. It’s still not too late to get out and save your life.

  8. Morality in Economics? Never was, never will be:

    Economists simply don’t know what to do about it. An economic system is not supposed to undertake a slow motion collapse…..but despite all the complexity, jargon and counter-intuitive concepts of wholesale finance, in general terms this is nothing that we haven’t seen before. It is fractional lending being practised globally only without anything specific at its core…. a bank run without the traditional bank; a money squeeze without any money; a popular wave of irrationality without any people to do it, only institutions themselves. In short, it is a run with all the dirty and disastrous economic consequences of it. The fact that you cannot pin down exactly what is being run …. only makes it unnervingly difficult to suggest how to stop it; the unmistakable character of it, by contrast, leaves little to the imagination about how it ends.

    http://www.alhambrapartners.com/2015/11/20/looking-to-the-future/

  9. Economists continue to demonstrate lack of morality every time they write/speak favourably on rates at/below 300bp.

  10. Good posts here.

    My point to add is on systems theory.

    If you truly want to make things ‘better’. Start from scratch and understand that systems tend to form themselves.. and many vested interests get caught along the way.. heck… approval gates are scattered as well.

    Wicked problems require wicked reflection. Before you introduce the cane toad… have a good think.

    Take a walk in nature. Meditate. Swim in a nice swimming pool. We will be gone before these wicked problems can be understood.

    When you run an excel model and you run into a circular loop.. you can workaround by iterating… but if the problem is big enough youll only have one option.. that is to restructure the model so that it flows with logic or just reset and start again. By default that is where we are headed.

    If all else fails… create infrastructure australia… oh… create the united nations… oh… i m shit out of luck