HS2 by Jonny Carr

This week Jonny Carr gave a presentation on his waynflete project. He spoken on the topic of “Is HS2 economically and socially worth it?”

In this dissertation I will decide whether high speed rail is a political stunt to earn votes or whether it is actually based on a true positive economic effect. I will look at the major positive effects of the scheme, the more narrow viewed benefits of an decrease in construction jobs and an increase in journey time to the wider effects of the benefits of agglomerating an economy, the multiplier effects associated with construction and others. I will weigh these against the reasons not to go forward with this project; this is primarily the capital cost of the scheme and the effects to the environment following a new train line.

Background of HS2

Many have heard of HS2, the acronym standing for “high speed 2,” the ambitious plan by the government to build a high speed rail link serving the midlands and the north of England. Currently the probable route proposed by the government is “Y” shaped, starting from London to Birmingham and then the two spurs. One of the spurs would go to Manchester and the other to Leeds via the east midlands. The new line would be built to the European GC loading gauge and would have a maximum design speed of 250 mph or 400kph but initially would run at a top speed of 225 mph or 362kph. Between some cities this new speed in the United Kingdom could reduce travelling time significantly. On deciding to make a decision such as this the government starting point is a cost-benefit analysis. A cost benefit analysis is a process of calculating the costs and benefits of a decision and those of its alternatives (within the same period), in order to have a single scale of comparison for unbiased evaluation. Thus providing evidence on whether the benefits outweigh the costs, and therefore whether the government should go through with building the railway. The government must also decide on the opportunity cost of their decision namely the value of the next best alternative foregone.

I decided to ask Matthew Trotter, an estate owner in the Chilterns, whose land according to one route, was at risk of being ploughed through for the train line, what he thought of the plan:

‘Gosh! Where to start? In truth I think this scheme to describe it simply, is preposterous. This is frankly a disturbance to the beautiful countryside, and although obviously I am biased, the train line cutting up the home I live in, the home that has been passed from generation to generation, bought my great grandfather in the 19 century. I, as you know have been protesting about this train line, since it was first proposed. At first this was for simply selfish reasons, not wanting to lose my heritage site, however having looked into the plan, it seems barbaric. The government has clearly not learned from their mistakes as HS1 in Kent has been a national disaster; there was nowhere near the demand that had been expected. HS1 cost £6bn to build and had to be sold for a quarter of that at £1.5bn. The government seems obstinate not to learn from their previous mistakes and it makes me angry that they run the bloody country!’

This view is obviously biased due to the fact he has such a personal agenda, he has also been part of an anti-HS2 group. However this does show you how even very well respected people feel very against this train-line. However what I must find out is whether they are hot-headed and angry about change, or whether they actually have a case.
Before looking at the cost benefit analysis, let’s look at whether the scheme is fair, and whether there are any political rather than economical imperatives for the scheme:

Fairness

The HS2 scheme brings up as much normative economics as positive economics. There are two main points of unfairness that opponents bring up.
The first is the fairly obvious one, people living in homes that will be affected by HS2, many do not believe they have received enough compensation in a valuation of the house before and after, on top of that there are all of the moving costs that are not taken into account. But most contentiously as with Mr Trotter the personal value of a house due to people’s attachment to their home means that many are enormously upset by HS2. Up to 300 thousand blighted households will be claiming compensation however far more will be affected, of these a survey by the telegraph suggested 89% said that they ‘are unhappy that high speed 2 is going ahead,’ this therefore suggests that the compensation may never be enough to eliminate a sense of unfairness.
The second point is that this train line will not be completed for a long time, with the Y network set to open by 2033, thus 20 years after the UK has to start paying for this therefore this scheme goes across at least two generations where many paying for the scheme (through taxes) will not reap the benefits.

Capital spend – Playing politics or real economic benefit

A cynical view of HS2 is the idea that large projects like HS2 are not economically sound, but instead shows the government throwing money around to create jobs and therefore make the economy seem better. ManMohan Sodhi, who teaches global manufacturing at the Indian School of Business, shares this sceptical idea:

“In every slump, in every recession, governments seek to invest in mega projects. This serves two purposes: One is to simply pump money and jobs into the economy to get it moving. The second, more important, is to let loose Keynesian animal spirits to lift sagging consumer confidence and thus revive the economy. Of course, these projects may or may not make sense economically, but, what price would one put on reviving animal spirits?…
“My own recommendation would be to spend £34bn on sending the first woman to the moon, instead of doing high-speed rail now. After all, it would satisfy the animal spirits argument. Furthermore, it would revive British space efforts – no need to make an economic argument there. And it would be an investment in British manufacturing and science, creating high quality jobs for British engineers and scientists rather than for less-threatened bankers and contractors.”

His sarcastic view, with the idea of sending the first woman to the moon, shows how unconvinced he is of the HS2 economical position. However, he does make a valid point; the Keynesian idea of “animal spirits” is used to describe human emotion that creates consumer confidence. This can cause the multiplier effect. The multiplier effect is an increase in national spending producing an increase in national income and consumption greater than the initial amount spent. The multiplier effect is difficult to measure for HS2 although it is not as difficult to measure those who benefit directly it is far harder to measure those who benefit indirectly from the scheme, and then those who benefit indirectly from the people benefiting from the scheme. An example of the multiplier effect in the West Midlands is as follows: 22000 jobs are being created in the West Midlands, these people who take these jobs will have more money and this could lead to them spending more, therefore the places the consumers go will make more money, employers and shareholders of these companies will earn more, and therefore spend more. This is a continual cycle however each cycle less benefit is produced due to leakages (in the form of taxation, buying imports and saving). The multiplier therefore means in total more will be spent than the original money put in, this would potentially help the UK come out of the economic low due to the recession.
As we see later on, HS2 would never pay the government back for its investment so the multiplier and other benefits need to make up the shortfall.

Learning from the past

Some would say that HS1 was a huge success, they say it boosted tourism, and has connected the UK to the rest of Europe thus vastly helping trade. It helped the UK receive the bid for the Olympics,
HS1 has been a loss for the government in cash figures, it lost £4.8 billion due to as an MP report states ‘over-optimistic and unrealised forecasts for passenger demand on HS1,’ according to the report the actual passenger demand was just one third of the expected demand in the report in 1995 and two thirds of the report in 1998. This is a huge miscalculation as it is based on imperfect market knowledge; cynics would argue leaders of the project give overoptimistic forecasts to make the project work. Both reports failed to realise that the rivalling companies of the ferries and airlines in particular would respond to the competing train prices, as these companies put the prices down the demand for HS1 also reduced.

Cost Benefit Analysis

Cost
The government are expected to invest £32.7 billion into the project; the government claims they will reap £46.9 billion out of the scheme over 60 years. You would expect this to be a relatively obvious decision for the government, and is indeed the reason they are going forward with this decision at the moment.
However it is very difficult to measure the benefits of a scheme when so much could change in 60 years, similarly it is difficult to measure all of the costs, including those other transport networks affected by the loss of traffic to them due to HS2.Also by judging from history very few large government projects have been correct and most as with HS1 have gone over, HS1 went 18% over its original cost, thus I think that the cost above is likely to be an underestimate, we can see that the cost of the first section of the route has already increased significantly from £24 billion to £27.4 billion from February 2011 to January 2012. Furthermore the second section of the high speed 2 route has increased in price by over £2bn over the past year, many economists worry that it will keep increasing thus having a similar result to HS1.

Environmentally
From an environmental perspective, high speed railways are said to be much greener than other forms of transport. Certainly the carbon footprint of high speed rail can be lower, if it was available today,. High speed trains are also more energy efficient than other trains. But it will take a long time to recover the energy used in building all these new trains. As a result HS2 Ltd estimates an improvement in air quality of believes that phase 1 of HS2 will reduce carbon emission by 1.8 million tonnes of CO₂ equivalent over a 60 year period which offsets the 1.2 million tonnes of CO₂ equivalent therefore estimating that the scheme will reduce carbon emissions. However, this is a moderate saving of 0.6 million tonnes of CO₂ equivalent to put this in comparison the UK emits 520 1.2 million tonnes of CO₂ equivalent per year. Furthermore this is subject to debate, many would say that the demand for train travel is over exaggerated and thus the estimated CO₂ saved is exaggerated indeed stop HS2 believes that carbon emissions will increase due over the 60 year period due to the trains.
To get this savings, it’s not enough just to have high speed trains – you also have to persuade people to pay what could be very expensive train fares rather than go by car or even the budget airlines. Therefore there is a lot of uncertainty in the benefits and costs because there is imperfect market knowledge on how consumers will react.

To the landscape the costs are known more certainly, this is because a new train line created will ruin the natural landscape especially within the area of outstanding beauty in the Chilterns. There is an increasing scarcity for land, indeed there were 62.3 million people in 2010 this is set to increase to 73.2 million by 2035, more homes will be needed therefore as scarcity of land increases the value of undeveloped land increases. Furthermore the adverse effects include the devaluation of houses that HS2 goes through. The estimated cost to the landscape is £960 million, using analytical assumptions regarding land type and mitigation measures. However it is possible that this will be reduced as part of the ‘Review of Possible Refinements to the Proposed HS2 London to West Midlands Route’ a report by HS2 Ltd to the Government.

Travel Benefits
According to the Department for Transport the first phase of the route, the Birmingham-London journey will cut travel times from 1hr 24min to 45min. The second phase of the route will be more effective in terms of actual time cut, reducing Manchester-London journeys to an hour from 2hr 8 min and Birmingham-Leeds, the other spur of the ‘Y’ route, to 57 minutes from 2 hours. Both of these really change the journeys, from one that is an occasional route to one that is feasible as a commute, 2 hours there and back takes too much out of a day to make the trip viable for a commute whereas taking 2 hours from a day is manageable.
There are benefits for those who are not travelling on HS2. According to the government, HS2 will reduce numbers on other commuter train routes, many of which are overcrowded already. It is also hoped that 4.5 million journeys a year will be transferred from airlines to trains due to HS2 and nine million from the roads, thus helping reduce congestion, which will help everyone including those who will not use the train line. An added bonus is that it would provide relatively easy train transport from the continent to the UK connecting to HS1 and the channel tunnel. This potentially could increase trade and communication with the rest of Europe.

Problems with the Government Case
The business case for valuing the benefits of HS2 at £20.1billion relies on the assumption that time spent on trains is completely unproductive, however with the introduction of laptops and Wi-Fi on the trains a lot of business people work on the train. Indeed according to fieldwork done by the telegraph 82% of business people say they do work on the train, and 50% of time on the train by business people is spend doing work. Therefore the £20.1 billion is over exaggerated as it works on the figure that every hour saved by the train is £37, which is overstated as productive work would have been done on the hours saved. This is further lessened by the as according to the Department of Transport 60% of people who save time on the train will not do any extra work.

Economic Benefits

Creation of jobs
It is expected that the first stage of HS2 will deliver 45,000 jobs:
 9,000 construction jobs;
 1,500 permanent jobs;
 30,000 jobs in station redevelopment areas in Euston, Old Oak Common, Birmingham Interchange and Birmingham Eastside.
Phase Two is forecast to support the creation of a further 60,000 jobs, as well as 5,350 houses.
These are the direct jobs created by high-speed 2, however there are far more jobs created by the multiplier effect as (see page 2).

Agglomeration- Benefits of HS2 making cities ‘closer’ together
An agglomeration economy is primarily seen as an economy within an urban area which due to firms being located near one another gives a reduced cost of production for people in these areas. By building faster transport links between cities in the UK the UK becomes more agglomerated and therefore receives positive externalities from this connection. The benefits of this are seen in three different ways: labour market pooling, knowledge spillovers and connectivity between firms and their consumers and suppliers.

Labour Market Pooling: Companies will gain positive externalities by having an easy access to far more skilled professionals, who go there due to a large pool of employers. This means that as both employers and employees have more choice, agglomeration economies allow better productive matches between jobs and workers; this increases the production in an area. HS2 would help these labour market pooling externalities not within an urban community but between them, HS2 allows workers from Birmingham, Manchester and Leeds far better access to jobs in London for example. This would therefore increase the chances of these cities being part of the “London Bubble” by allowing faster access to London.

Knowledge spillovers: The exchange of ideas that leads to more efficient companies and to the production of new products, this is often from employee to employee. Knowledge spillover is partially due to companies copying rival firms to become more competitive, this means that industries are constantly improving; this is seen most in areas that are closely interlinked, as is the case within cities. This can improve firms and workers productivity. Knowledge spillovers is also due to the process of communication not necessarily between rivals but between companies becoming partners and sharing ideas, this leads to positive externalities and happens best where companies are close and so can easily share ideas.

Connectivity between firms and consumers and suppliers: A spatial concentration of firms allows lower costs of production because transport costs to move supplies or products are lower, which increases the efficiency.

These represent the major wider economic benefits of the train-line and explain why cities are far more productive.

Budget account

The government is almost certainly going to have to fund this project because of its scale by borrowing money from the private sector. There are many different ways for this to occur. One could be via a pension fund, as pension fund look for long term and low risk returns, both from overseas and within the UK, the HS2 project does offer this. Another way the government could approach this is through banks as they did with HA1 (although a far smaller project). However this investment is fairly low returns (as low risk) therefore deterring banks it is also very illiquid and by the Basel III rules banks are reduced in their ability to invest in illiquid projects. The final way is using the bond market, such as with the £44 billion high speed rail project in California, the problem with this is that if that as the bond’s value and coupon rate are determined before construction starts meaning that if the project goes over budget it can become very expensive for the government. However all of these methods involve the government borrowing money, this increases there already large budget deficit and at some point has to be paid back. The problem with borrowing is that the more you become in debt the more you have to pay back in interest rates (in the form of coupons), this often leads to more borrowing which can lead to borrowing spiraling out of control, in the cases of Ireland and Greece.

At the moment the government will likely lose money by this scheme, the government has calculated that the total operating and capital costs of £59bn over the 67-year time frame would surpass the predicted revenues of £33bn from the line, this would leave £26bn to be funded by the taxpayer. It is important however to note that this is not the money the government will lose as the economic benefits derived from the scheme should mean that the governemtn earns more tax revenue, indeed from second part of the project Y network as stated by Richard Threlfall, Head of Infrastructure, Building and Construction at KPMG,

A final way that the government could try to recover some of the cost is by a levy system. This could be a passenger levy however this promotes the idea of the train as a ‘rich man’s railway’, whereas the government is trying to present it as a train for the people. A more effective method would be a tax on businesses in the areas that would most benefit from the agglomeration effects of the train line. Although this has worked well with London’s Cross rail, business levies paying for one third of the cost of construction, this is fairly controversial for HS2 as businesses will benefit by greatly varying degrees and indeed the cities will have different benefits. This imperfect market knowledge makes it difficult for this scheme to work as the councils of London, Leeds, Birmingham and Manchester could all argue over how much they are willing to pay.
“The funding and financing of HS2 infrastructure will come in large part from central government funds. While our base assumption is that Government is likely to have a central role in driving forward investment in the vital infrastructure project for the country, we will examine the potential for private financing to reduce the up-front capital demand on the taxpayer and offer value for money.”

Currently the UK has a budget account deficit, successive budget deficits result in a national debt, currently this is manageable for the UK, however it is the highest it has been for 40 years as shown in the graph:

debt

This can be very dangerous because it seems that the deficit is unsustainable, the national debt in 2011 was $0.91 trillion and it is expected to grow to $1.03 trillion for the 2012 figures. This is very dangerous as this is around 60% of our GDP, most of this is financed by high levels of lending from abroad, the problem is, especially following the crash of Greece, to finance this debt is becoming more expensive. A good example of this in the UK is the downgrading of the credit rating of the UK from its triple A rating to AA1 by Moody’s. This will make government bonds more expensive and therefore the coupon rate of the government bonds are becoming larger, thus making it harder for the UK to pay back its debt as they also have to pay back interest. As the graph shows it is going to be relatively difficult to pay back this debt because the UK has been in deficit for so many years (from 2002 the UK has had a large budget deficit), this means it will be difficult for the UK to have a surplus to pay the loans back. However this is not unsustainable as it is agreed that a debt only becomes unsustainable when the interest rate payments are greater than 12% and in 2012 of the planned expenditure only 5.4% is on interest repayments, however this is still very large as this is larger than all budgets of Whitehall excluding 3 which will be difficult to pay back.

Therefore, one massive problem for many with HS2 is that contrary to the government aims of reducing the deficit, after the downgrade by Moodies David Cameron stressed how important it was for the government to keep reducing the deficit:

“It demonstrates that we have to go further and faster on reducing the deficit. It is this government who have cut the deficit by a quarter, who have a million extra private sector jobs and who have low interest rates that are vital for the future of the economy. The decision of the ratings agency is a reminder of the debt and the deficit problem that this country faces and, frankly, it is a warning to anyone who thinks we can walk away from it. It is absolutely vital that we continue with the work of this government that has cut the deficit by a quarter that has a million extra private sector jobs and has interest rates at record low levels.”
Therefore this asks the question whether this scheme completely goes against the policy and the philosophy of this conservative government.

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