Thursday, April 21, 2011

Opportunity Cost, CBA and the CRC

Opportunity cost is one of the most important concepts in economics.  It is the measure of the next best alternative that could be done with the time/money/resources dedicated to a given activity. It is part of what economists think of as the true cost of any activity and its essence is its ability to focus attention on forgone opportunities whenever one action is taken.

People use the concept naturally all the time, but there are also many situations in which opportunity costs are forgotten.  A good example of opportunity cost as used by average people is with frequent flier programs.  You may have accrued enough miles to qualify for a 'free' ticket on an airline.  You may also know that you have to go to Seattle in a couple of weeks and consider whether you should use the miles and fly 'free' and save yourself the three hour drive.  But you know intuitively that it is not 'free' in the sense that if you use it for a trip to Seattle you will not be able to use the tickets for a trip to NYC or Miami or wherever and that the cost of such a ticket is probably a lot more than buying a ticket for Seattle.

This is opportunity cost in a nutshell, by using the ticket for a trip to Seattle, you are foregoing the use of the miles on a ticket to another destination you might like to visit.  Thus the 'cost' of the Seattle ticket is the forgone ticket to Miami.

Perhaps no where is the concept of opportunity cost more important to focus on than in Cost-Benefit Analysis (CBA).  I tell my students, who are often frustrated at their inability to come up with good numbers, that the very act of identifying the relevant costs (accounting and opportunity) is incredibly valuable exercise in its own right.  It is valuable because the relevant question on public works projects is never "do we have enough money to build it and does the benefit of the project justify the amount we are going to spend?"  Rather it is "is this the best use of the resources we need to devote to the project?"  Answering this second question is built into CBA because a good CBA accounts for opportunity cost as well.

Which is all to say that we need to take a good look at what critics of the Columbia River Crossing (CRC) project, like Joe Cortright, are saying about the true costs and benefits of the project and how divergent they are from the CRCs own CBA.

I have not studied the topic in any great detail (and, in fact, can find no evidence of the CRCs actual CBA on their website) but there some very compelling points that Cortright makes about the project's CBA that raise serious questions about the quality of the CBA and the assumptions contained therein.

One of the first things that worries me is the obvious and fundamental error in counting the benefits of the project: the double counting of the benefits from reduced travel times.  Though I cannot find the CBA itself, there are tables from it reproduced in this document.  Here are two:

Oops.  This is such a fundamental error, I used it as an example in my own class.  In fact, this is precisely the double counting mistake that Gruber uses as a hypothetical in his public economics text.  The expected increase in property values in Clark county are due to the decreased drive times.  So the travel time savings and the property value increase are measuring the same thing.  The increase in market values of homes are the market outcome of the fact that the travel time savings make potential buyers willing to pay more.  If this kind of mistake can be in the CBA, what else in it is suspect?

In fact, I have seen testimony by the author of the CBA who was asked about this and his response was that he understood that there was some controversy about including both benefits in CBAs but his personal belief was that both should be included.  But this is simply wrong and disingenuous, there is no controversy at all and the only reason both are in there is to seriously, and wrongly, inflate the benefits of the project.

Now I don't claim to be any sort of arbiter about projections, but given this, I begin to wonder about other things pointed out by Cortright in this document.  [Keep in mind that this is an analysis being funded by an opponent of the project, but equally, I suppose it is fair to mention that Cortright's concerns predate this commission]

Here are two striking graphs that raise concerns about the forecasts for traffic levels (and thus the necessity for a new bigger bridge):

Now, part of this decline may be due to the recession, but note that the peak and subsequent decline started prior to the recession.  Perhaps it is due to gas prices then? And in fact gas prices did rise preceding the recession (this is a chart of DOE national retail gas prices for regular grade gas):

They did move up to the 2 to 3 dollar range in 2005 but didn't peak to $4 until 2008 and gas is notoriously price inelastic, meaning people do not adjust to much to increases in gas prices (at least not in the short run).  Besides, $4 gas is probably the new reality not a temporary spike give the huge increases in demand from the rapidly developing middle income countries.

In addition, Cortright also shows the overall peak and decline of vehicle miles traveled in Oregon which clearly precedes and seems unrelated to the current recession:  

ODOT responded to the Cortright report and a fair hearing includes both their response (here) and Cortright's response to their response (here).

One bone of contention which is a point on which reasonable people can disagree is how the CRC and the Rose Quarter bottleneck should be related.  The CRC says it is not within the scope of their project to include the Rose Quarter and Cortright contends that any benefit that comes form the CRC is only realized if the Rose Quarter bottleneck is fixed.  I imagine that most daily trips that originate in Clark county do not end before the Rose Quarter and it is hard for me to imagine that you will get significant travel time savings without fixing the Rose Quarter save for local travel times in Clark County.  If CRC benefits that are being counted are contingent on the solution to the Rose Quarter than I agree wholeheartedly with Cortright on the need to include the cost of fixing the Rose Quarter in the CBA.

In the end I do not wish to take sides, but I do wish that I could come to a conclusion about how worthwhile a project is the CRC and to do so requires good information and a good CBA.  I am convinced that we currently have neither.  

Which gets us back to the start of the post.  Is the CRC the best way to spend $3.6 (or $8 or $10) billion dollars in the region?  Sure some of it is federal money that would not come without the CRC, but a ton is local and we are currently dealing with a pathetic excuse for a public education system and a collapsing public service infrastructure.  I do believe that transportation and infrastructure are important to economic growth, but we do have a perfectly good bridge in place and congestion serves the purpose of increased density, reliance on transit and the like.

A good discussion then of the opportunity cost of the CRC project is a necessary first step before we divert billions of public dollars that is desperately needed elsewhere. I hope that the legislature will stop and attempt to have this discussion before committing to the project.


MPPBrian said...

I disagree with your assertion that the existing bridge is "perfectly good." My understanding is there are several safety issues with the existing bridge, which is not expected to do well in a major earthquake. A bridge of a different design would perform better, be anchored in the bedrock, not have a tall tower with a counterweight, etc. Additionally, the drawbridge component and lack of shoulders has made the bridge a frequent source of rear-end and sideswipe collisions. So it seems like a thorough CBA would consider these safety issues as well and the economic benefits of fewer accidents, lives saved, potential disruption to the economy if there is a major quake that knocks the link out, and so forth.

Also, I think it is worth considering the source of funds along with opportunity costs. While it is theoretically possible that we could toll the existing bridge and use the funds for projects elsewhere, it is unlikely that there would be political support for tolling for any project other than improvements to the bridge and CRC project area. So it seems like this would in some ways limit the practical relevance of opportunity cost to project alternatives within the area.

On another note, thanks for writing about the new Student Legacy Park yesterday. I and many others spent a lot of time collecting signatures and getting out the vote for it!

Joe Cortright said...

One small addendum on the federal funding: There is a widespread belief--propagated by CRC proponents--that there are essentially no opportunity costs associated with federal funding for the CRC. They claim -- inaccurately in my view -- that the CRC is a special project that would somehow qualify for federal funding in a way that no other project in Oregon might not.

But I think this is belied by the political realities. Project proponents also claim that Oregon and Washington's clout (Patty Murray, Earl Blumenauer, Peter DeFazio, all sit on key committees) could help Oregon and Washington win an earmark for this project. But these three leaders could equally easily use this same clout for other projects.

In reality, when Congress allocates funds, every legislator argues for projects in their home district, and just like your frequent flier miles example, using our federal "chit" for CRC means that we can't use it for something else--like say the Sellwood.

The key lesson here is that pretending that there are no opportunity costs is a central part of the "selling" of the CRC.

One other comment on CBA. The CBA conducted for CRC is a kind of global take-it-or-leave-it excercise. The CRC didn't look at the CBA of any of the alternatives to the CRC (aside from a contrived do-nothing scenario). It could well be that other projects (seismic retrofit of the existing bridge, bus-rapid transit, tolling only, commuter rail or a third bridge) would have a higher B/C ratio. Saying that B>C for a single alternative at the end of the process is using CBA as a sales tool, not an analytical one.

In addition, a really useful CBA would attempt to disaggregate the major components of the project to see which pieces have the highest ratio of B to C. While I doubt it, the overall B/C ratio may exceed 1 for the grand total. But a thoughtful analyst would ask, "which pieces of the project generate the greatest benefits". According to the Independent Review Panel, the project will likely have to be broken up into phases. A disaggregated CBA might lead you to prioritize different elements of the project, and focus on doing the most valuable ones first.

Xerographica said...

"Is this the best use of the resources we need to devote to the project?"

I really get this question...but what I don't get is how planners could ever answer "yes" to this question. Planners are a few puzzle pieces short of a perfect picture.

How many puzzle pieces are planners missing? Well...they are missing each and every taxpayers' individual opportunity cost decisions. That's 99.99% of the puzzle.

But you already knew that. Yet, despite missing nearly all of the puzzle, you seem to be under the impression that it's possible for planners to have enough pieces to accurately describe the picture.

If you really want to know whether a project is truly the best use of limited public resources then you'll support donations to government organizations being 100% tax deductible...aka pragmatarianism.