Last week’s and this week’s blog have moved away from the current state of the UK economy, Brexit, trade wars and other depressing areas and look instead at some of the techniques economists use when making comparisons between different projects.
When comparing alternatives, it is necessary to identify all the costs and benefits – monetary and non-monetary – and compare them. This involves finding a way of expressing them in money terms. Last week’s blog looked at how economists value a human life while this week’s considers the value of travel time (VTT), the amount of money a traveller is willing to pay to save time, measured in pounds per hour. This is important when considering whether to pursue major transport infrastructure projects since savings in travel time are an important benefit to be considered, as well as construction costs, savings in vehicle running costs from shorter or less congested journeys and reductions in accidents and fatalities.
When trying to value time saved by drivers and passengers, we first need to identify whether the journey is for work or non-work, (leisure and commuting) since the two are valued differently. A government paper in 2015 suggested commuting time saved should be valued at £11.21 per hour while leisure time is worth only £5.21. Time spent travelling for business is more complex with an average of £18.23 per hour, considerably more valuable than non-work time. This average contains considerable variations. For example, an hour saved on a business journey by car is worth £25.74 if the journey is more than 100 miles while, if it is less than 20 miles, the value is only £8.21 per hour. Time spent on rail travel, which might be expected to be less valuable because of the opportunity to work on the train, is actually more valuable, with an hour saved on a rail journey of more than 100 miles worth £28.99 per hour. This could be because the government paper takes into account the quality of the travel experience and considers such factors as whether the mode of transport is likely to be early or late and whether, on a train there are many, few or no seats free. Therefore, an hour spent in a car listening to the radio is far less of a cost to the employee than having to travel in a crowded train.
The final way in which time needs to be considered is in how we value costs and benefits accrued at different stages of a project. In a typical infrastructure project, the construction costs are front-loaded while the benefits, such as time saved and revenue generated occur over a longer period. If you were asked whether you preferred £100 today or the same sum in five years, you, along with the majority of the population, would prefer the former, not least because you could put the £100 in a savings account and it would be worth more than £100 in five years. Therefore economists “discount” the value of future costs and benefits and express the costs and benefits in terms of the “net present value” – the monetary value today of future costs and benefits. In a simple example, if the interest rate today were 5% and a project incurred costs of £100m today, the project would need at least £105m of revenue in a year’s time to be viable. In reality, one is not looking at one cost and one revenue figure but a series of figures over many years. The interest rate chosen is crucial since it would require revenue of £161 in five years to cover costs of £100 today at 10% but only £110 at 2% – a figure much closer to today’s borrowing rates. Hence the argument that now is an ideal time for our government to be improving the UK’s infrastructure.