Written evidence from David Henderson
and David Sawers (HSR 200)
SUMMARY
(i) The HS2 proposal offers too low a prospective
return to deserve governmental support. On the government's best
estimate, the line to the West Midlands would produce discounted
benefits of £20.7 billion for costs of £24 billion.
The government would lose £10.3 billion on its investment.
These results must be uncertain; benefits may be over-stated,
and they are based on forecasts of traffic extending for 60 years,
though growth is capped at 2043.There will be a wide range of
possible outcomes. A project that would produce environmental
losses should produce a surplus of benefits over costs if it is
to be accepted.
(ii) There is no evidence that HS2 would help
to rebalance the economy. Most of the £4.1 billion of benefits
from wider economic impacts are attributed to increased efficiency
produced by attracting businesses to the areas around railway
stations. These estimates are questionable; £1 billion is
more plausible than £4.1 billion. Estimates of benefits to
more distant regions are trivial. The reasons for giving so large
a subsidy to the project are unclear. Subsidising this project
is inconsistent with the government's policy of reducing support
for the railways.
(iii) The method used by the government to present
the results is misleading. It treats the financial loss to the
government as the cost against which the benefits should be set;
it is usual to compare the total cost with the benefits. The government
thus claims that HS2 London-West Midlands provides a benefit-cost
ratio of 2.0, although a conventional approach gives a BCR of
0.86. The government's method was devised to allocate funds within
the Department for Transport's budget. HS2 might displace higher
yielding transport projects in that budget; in any case it would
compete with other government expenditure.
(iv) The government's claim that a high speed
network would produce greater benefits than any alternative is
not justified by the evidence. The alternatives to HS2 as ways
of increasing capacity on the West Coast Main Line have not been
studied with sufficient thoroughness to establish what would be
the best option. The methods used in the Strategic Alternatives
Study should have been more objective. The study may therefore
exaggerate the expenditure needed to increase the capacity of
the WCML. It suggests, however, that the forecast increase in
traffic on the West Coast Main Line could be met by incremental
improvements.
(v) We recommend that the high speed rail project
should be abandoned. Efforts should be concentrated on improving
the performance of the existing network, with more emphasis on
reducing the subsidy to the railways.
THE ECONOMIC
CASE
1. The most significant feature of the economic
case for the HS2 is that it relies on estimates of revenue extending
over 60 years. Although growth in traffic is capped in 2043, the
risk that basic assumptions like travel habits, available technologies,
and the rate of economic growth will change and affect revenue
becomes greater with the passage of time. If forecasts of traffic
are made for so long a period, a wide range of assumptions should
be employed, which implies that the results would have to be expressed
as a broad range of possible outcomes. Presenting the results
as a single figure, as the Department for Transport has done,
gives a false impression of certainty. A better approach would
be to calculate the results over a shorter period, perhaps 30
or 40 years.
2. Despite incorporating expected benefits for
so long a period, the forecast return on the HS2 is low. Employing
the government's discount rate of 3.5%, reducing to 3% after 30
years, the present value of costs is expected to exceed that of
benefits by £3.4 billion. The internal rate of return has
not been published, but is probably less than 3%. The government
should reveal this figure. The return on the longer Y route is
forecast to be higher, with benefits £0.6 billion less than
costs, but the costs of the longer route have not been studied
in enough detail for the estimates to be considered reliable.
A rate of return of less than 3% cannot be considered adequate
for a large industrial project like HS2. It would represent an
inefficient use of national resources.
3. The return on the project could well be even
less than the DfT's evaluation suggests. Apart from the uncertainty
created by the 60 year timespan of the revenue forecasts, traffic
is sensitive to the level of fares, and so to government policy
on subsidies to the railways. The main traffic forecast assumes
that fares rise by 1% a year in real terms; if they increased
by 2% a year, the sensitivity analysis in The Economic Case for
HS2 shows that traffic in 2043 would be 24% lower, and benefits
would also fall. What is more, the benefits to business travellers
from faster journeys may have been over-estimated. This class
of benefits, which provide 54% of all benefits, assumes that travel
is unproductive time; but many travellers work in a train. The
benefits of faster travel may therefore be smaller than predicted.
If benefits to business travellers were halved, the benefits
from HS2 would be £8.9 billion less than its costs.
4. The cost estimates for HS2 contain a large
contingency allowance, derived from experience of overruns on
previous projects, and should therefore be reasonably accurate.
The estimates do not, however, include costs that may be incurred
by London Underground. The introduction of HS2 is predicted to
lead to a near-doubling of peak hours traffic on the underground
at Euston by 2043. If so large an increase in traffic occurred,
the investment needed on the underground could run into billions.
5. The return on HS2 is all the more inadequate
when the construction of its track would cause substantial but
uncosted damage to the environment, as the result of building
its track through unspoilt and attractive countryside, and inflicting
noise on those living near the track. DfT states that 7,400 homes
would be within 100 metres of the line, but that only 4,700 would
experience a noticeable increase in noise. This assertion is somewhat
surprising. An effort should have been made to value the environmental
costs, and include them in the economic appraisal. If they could
not be valued, their description should have been incorporated
in the economic appraisal, and not hived off into the separate
Appraisal of Sustainability. A project that would cause significant
environmental damage could only be justified if it produced large
economic benefits to offset the losses. HS2 is not likely to produce
such benefits. Its construction is not therefore justifiable.
WIDER ECONOMIC
IMPACTS
6. The DfT forecasts that the HS2 will produce
wider economic impacts worth £4.1 billion over 60 years.
These benefits derive mainly from increases in the economic efficiency
of businesses which, it is predicted, would gather around the
new stations on the HS2 route and the existing stations on the
WCML as a result of the improved train service. The service to
intermediate stations on the WCML, such as Milton Keynes, is assumed
to improve after HS2 is opened, because there will then be spare
capacity on the WCML. It is assumed that these new or enlarged
collections of businesses will be closer to one another than they
would otherwise have been, and will therefore be more efficient
than they otherwise would have been. This effect is estimated
to produce benefits worth about £3 billion over 60 years.
It is also predicted that there will be further benefits, worth
about £1 billion over 60 years, from the effects of better
train services, which are expected to open up areas in London
and the West Midlands to the effects of wider competition and
wider markets.
7. These benefits are not very plausible. New
railway stations on a high speed line are likely to attract businesses,
but it is a bold step to assume that these businesses would be
more efficient than they would otherwise have been, because they
are closer to one another than they otherwise would have been.
This seems to be no more than an assumption. What is more, these
businesses will have moved to the HS2 station from some other
location, as the Sustainability Appraisal recognises; and there
could be losses from this move. The density of businesses in the
former locations may well decline, and so would the efficiency
of the remaining businesses there. This loss should be set against
any gain in efficiency among the businesses collected around the
HS2 stations. The £3 billion of benefits attributed to this
factor are best ignored: their generation is uncertain, and they
may be offset by losses elsewhere.
8. It is widely accepted that improvements to
transport services, especially of commuter services into urban
areas, can improve economic efficiency by producing "agglomeration"
effects - enlarging labour markets and increasing the interaction
between businesses in the area. The £1 billion of benefits
attributed to this effect are therefore more plausible; the improvements
in train services made possible by the construction of HS2, especially
any consequential improvement in commuter services on the WCML,
may produce benefits - especially in London.
9. The estimates of WEIs therefore appear excessive,
and much of the more probable benefit appears to arise in London.
There is no evidence, in the appraisal of HS2, to support the
assertions of Ministers that high speed rail would reduce inter-regional
economic differences and rebalance the economy. Indeed, HS2 Ltd
commissioned Daniel J Graham and Patricia Melo of Imperial College
to advise on the assessment of WEIs, and they concluded:
"Thus, while urban economic theory does not
preclude the existence of agglomeration benefits across inter-regional
distances, the empirical evidence suggests that these may be very
small indeed"[471]
10. Their illustrative examples were that an
increase of 25% in travel speeds that affected 25% of long distance
rail journeys might produce agglomeration benefits of £8
million, while a 50% increase in speeds might produce benefits
of £16 million. High speed rail cannot affect inter-regional
economic links and reduce inter-regional economic differences
unless these estimates are in error by a factor of one thousand
or so.
11. This conclusion should not surprise anyone.
It is evident that the UK is a small country, that it already
has a well-developed - if often congested - transport system,
and that journey times between major urban centres are already
short. The Eddington Transport Study of 2006 emphasised that the
UK is already well connected, and suggested that the key economic
challenge was to improve the performance of the existing network.
Investments which unblocked pinch points were expected to offer
the highest returns. But large projects, with speculative benefits
and relying on untested technology were not expected to generate
attractive returns.
THE APPRAISAL
METHOD
12. The government has presented the results
of the HS2 project in a misleading way. It treats the government's
loss on the project as the relevant cost, and so obtains a cost-benefit
ratio of 2.0. The normal method of presenting the results of an
investment appraisal is to compare the total costs with the benefits.
The costs of HS2 exceed the benefits, even on the government's
estimates, so a conventional appraisal would conclude that the
cost-benefit ratio was 0.86. The internal rate of return is also
commonly used to assess the merit of a project, and the return
it produces will be compared with the organisation's target return.
In the government's case, its target is 3.5%, falling to 3% after
30 years, and the return from HS2 is probably less than 3% on
the government's estimates. The government should publish the
internal rate of return earned by HS2, to clarify the position
about the return it might produce.
13. The government's method of calculating the
cost-benefit ratio for HS2 was originally chosen to help allocate
the budget of the DfT, because the department's criterion for
selecting investment projects was the amount of transport benefits
they would produce for each pound of government expenditure. Even
at this level, the criterion is defective; a government department
should be concerned with the efficiency with which national resources
are used. At the level of the HS2, the criterion has no merit
at all. There is no DfT budget for so large a project, so far
into the future. If it was to be built, the DfT budget would have
to be greatly increased. The cost of HS2 would be competing with
other possible government expenditure a decade from now.
14. Further, the DfT already has a large portfolio
of projects that have been appraised, so their expected returns
are known. It is relevant to compare the expected returns to
HS2 with those from the other projects in that portfolio, which
it could displace or preclude. Without knowing whether these alternative
projects are expected to yield more or less than HS2, it is impossible
to judge whether HS2 would represent a good use of limited DfT
funds.
15. The government in fact needs to consider
whether it should provide any finance at all for a project like
HS2. When the railway system was run by a nationally owned corporation,
it was told that investment in long-distance travel should be
judged by a purely financial criterion. Now the railways have
been privatised, it is ironic that such investment should be judged
by cost-benefit appraisal, and that of an idiosyncratic kind.
We believe that the best test for investments like HS2 is whether
the public is expected to be willing to pay enough for the new
service to make it profitable. Faced with the results of the government's
present appraisal, decision-takers should compare total costs
with benefits, and recognise the uncertainty of the forecasts.
THE STRATEGIC
ALTERNATIVE
16. The government has published a report, the
Strategic Alternatives Study, which shows how the expected need
for additional capacity on the WCML could be met by upgrading
the existing track, to show what investment might be needed if
HS2 was not built. Its authors, Atkins, state that the proposed
works would make the WCML four track throughout and grade separated
as far north as Crewe, and would provide extra terminal capacity
at Euston and Manchester.
17. The Study provides for more work on the WCML
north of the junction with HS2 than does the HS2 proposal, which
assumes that high speed trains would run to Manchester. It therefore
plans to increase the capacity of the WCML to permit just as much
traffic as would be carried by conventional trains in the alternative
case. Surprisingly, it considers that fewer improvements are needed
than Atkins does in the alternative case. The HS2 proposal allows
for some work on infrastructure and signalling in the Stafford
area, but no work in the Manchester area because improvements
there are already planned. The Strategic Alternatives Study proposes
three extra platforms at Manchester Piccadilly station and grade
separation at Ardwick, costing £395 million. At Stafford,
it proposes spending £1,111 million on three grade separated
junctions and a stretch of new line to bypass two stations.
18. South of Stafford, the larger proposals in
the Alternatives Study are providing four tracks for nine miles
between Coventry and Birmingham at a cost of £903 million,
to allow fast trains to overtake slower trains, and providing
a grade separated junction south of Leighton Buzzard at a cost
of £243 million, so that trains can switch between fast and
slow lines at 100mph.
19. It is not self-evident that it is necessary
to provide nine miles of four track, rather than one mile, or
just to provide additional tracks in some stations, to permit
fast trains to overtake slow trains, nor that it is worth spending
£243 million to permit trains to change tracks at 100mph.
Combined with the heavy expenditure proposed around Stafford and
Manchester, one wonders whether the proposals represent good value
for money.
20. The defect in this study lies in its methods:
it does not try to establish whether the proposed improvements
represent the best value for money. The scale of the increases
in capacity on the WCML that are worth undertaking can only be
established by calculating the return that each increment in capacity
will produce. This methodical approach is essential if the scale
of the desirable investment is to be established. The Alternative
Study relied on expert opinion to establish what investment was
worth undertaking, not methodical analysis, but such an approach
is unlikely to produce the optimal answer. Our subjective judgment
of the exercise is that it suggested more expenditure than is
likely to be proposed by the rational analysis we recommend.
21. For all its limitations, the Alternatives
Study gives an initial impression of the scale of improvements
needed on the WCML to accommodate the anticipated growth in traffic;
and this impression is that the scale is small. The Study identifies
only three projects between London and Birmingham that it considers
worth undertaking, and the biggest of them - four tracking nine
miles between Coventry and Birmingham - is one of the more questionable
of the proposals. This small number of infrastructure schemes
comes despite the failure to incorporate longer trains as a means
of increasing capacity; it appears technically feasible to increase
the length of trains from 11 to 12 coaches, but this option was
ignored.
22. The deficiencies of the Alternatives Study
imply that the government cannot claim that HS2 offers the greatest
benefits of all possible means of increasing capacity on the WCML.
A rationally-conducted Alternatives Study might well produce a
means of increasing capacity that gave a better return than the
HS2. The ability to phase any increases in capacity to match increases
in demand - which the builder of a new line does not possess -
also increases the potential return from investments that increase
the capacity of an existing line. Incremental improvements therefore
seem a better policy than large scale investment. They would also
fit better with a policy of improving the financial performance
of the railways.
23 August 2011
471 Advice on the Assessment of Wider Economic Impacts:
A report for HS2. Daniel J Graham and Patricia Melo 2010. P. 37. Back
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