New discount rates could boost infrastructure investment

| February 26, 2018

Australia should revamp how it selects major transport projects, so that governments can better know which new roads and railways are worth building and avoid squandering billions of dollars of public money on the wrong projects, according to a new Grattan Institute report.

Unfreezing discount rates: transport infrastructure for tomorrow shows that the ‘discount rate’ Australian governments have applied to assess the value of proposed projects has been stuck at 7 per cent since at least 1989, even though the price of money has fallen from about 8 to 1 per cent since then.

The discount rate is a tool that puts present and future costs and benefits onto a comparable footing: it expresses how much we value the costs and benefits of a major project for young people and future generations relative to the costs and benefits for citizens today.

The report calls for the 7 per cent standard rate to be abandoned in favour of two lower rates: 3.5 per cent for low-risk transport projects such as trains, buses and urban roads, and 5 per cent for slightly higher-risk investments such as ferries and freight rail.

This new discount rate regime would cast fresh light on the value of some of Australia’s biggest transport projects. Under the present 7 per cent rate, the benefits of the $10 billion Melbourne Metro rail project and the Commonwealth Government’s $10 billion Inland Rail Freight project are both assessed to be only marginally higher than the costs, with Metro Rail ranked slightly better.

But under a lower discount rate, both projects would be assessed to deliver benefits about two-and-a-half times higher than the costs, and Inland Rail Freight could be ranked even higher.

On the other hand, the use of high discount rates may well have encouraged policy makers to turn a blind eye to rubbery figures elsewhere in the business cases for projects. Choosing a sensible discount rate should be part of broader reforms to make project assessment more rigorous.

This report builds on two 2016 Grattan Institute reports that exposed the need for changes to the evaluation and selection of major projects in Australia.

Cost overruns in transport projects found that governments spent $28 billion more on transport infrastructure between 2001 and 2015 than they told taxpayers they would. Roads to riches found that a big portion of the large sums governments allocated to transport projects between 2005 and 2015 was spent unwisely.

With our cities growing rapidly, smart investment in infrastructure is vital. Better project evaluation is needed so that we build the right transport projects in the right order. Better discounting could be a big step in that direction.

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