The economics of road investment
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The Economics Of Road Investment. John Hine ETWTR. SE197. Questions and Decisions 1. Is the project justified ?- Are benefits greater than costs? Which is the best investment if we have a set of mutually exclusive alternatives? If funds are limited, how should different schemes be ranked?

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The economics of road investment l.jpg

The Economics Of Road Investment

John Hine



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Questions and Decisions 1.

  • Is the project justified ?- Are benefits greater than costs?

  • Which is the best investment if we have a set of mutually exclusive alternatives?

  • If funds are limited, how should different schemes be ranked?

  • When should the road be built?

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Questions and Decisions 2.

  • Are complementary investments required?

  • Should stage construction be used?

  • What standards should be applied ?

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Appraisal Framework

  • All appraisals need a framework or model for:

    a) Forecasting changes

    b) Evaluating those changes

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  • These include:

  • Supervision

  • Management

  • Manpower

  • Machinery

  • Materials

  • Land

  • Environmental Mitigation (e.g. Resettlement)

The Costs of Road Investment


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Primary Effects 1.

  • Reduced vehicle operating costs

    fuel and lubricants

    vehicle maintenance

    depreciation and interest


  • Reduced journey time

    drivers, passengers and


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Primary Effects 2.

  • Changes in road maintenance costs

  • Changes in accident rates

  • Increased travel

  • Environmental effects

  • Change in value of goods moved

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Secondary Effects

  • Changes in agricultural output

  • Changes in services

  • Changes in industrial output

  • Changes in consumers behaviour

  • Changes in land values

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Coverage and Double Counting

  • Any economic analysis should be designed to give maximum coverage of benefits.

  • But we must avoid double counting. Do not add primary and secondary benefits (e.g changes in land values added to changes in transport costs)

  • In a competitive economy the consumers’ surplus approach (used in HDM) should be adequate.

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The Economic Comparison

  • An economic analysis involves a comparison of “With” and “Without” cases.

  • Traffic forecasts are made for BOTH scenarios - The analysis should not be based on “before and after”.

  • An unrealistic “Without” case can give a false result.

  • A range of “with investment” cases should be analysed to find the best solution. A minimum investment approach often gives the best economic results and should be tested.

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Economic and Financial Prices

The cost to the economy of road rehabilitation and maintenance may differ from the financial cost because of :

  • taxes and duties

  • shortage of foreign exchange

  • under-employment

  • The Government will usually be concerned with ECONOMIC costs.

    Contractors will usually be concerned with FINANCIAL costs.


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    In an Economic Appraisal we use ECONOMIC (or SHADOW) prices NOT FINANCIAL prices

    Use of Economic Prices

    • Adjust financial prices as follows:

    • Exclude all taxes and duties and subsidies

    • Use the planning discount rate not the financial market rate

    • If overvalued exchange rate then value

    • imports and exports more highly

    • Use the opportunity cost of labour

    • Standard Conversion Factors are now widely used for

    • road construction costs


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    Benefits From Road Investment

    Changes in transport costs occur because of :

    • Lower road roughness

    • Shorter trip distance

    • Faster speeds

    • Reduced chance of impassability

    • Reduced traffickability problems

    • Change in mode

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    Traffic Categories

    • Normal traffic: Existing traffic and growth that would occur on the same road, with and without the investment

    • Diverted traffic: Traffic diverted from another road to the project road as a result of the investment

    • Generated traffic: New traffic induced by the investment

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    Transport cost savings for existing (or normal ) traffic

    = Traffic x Change in Transport Costs per

    km x distance

    Main changes in cost from:

    a) change in transport MODE

    b) reduced journey TIME

    c) reduced VOCs

    Benefits from Road Investment


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    Generated Traffic Benefits

    Traffic induced by the road investment are traditionally valued at:

    Half the difference in transport costs

    Hence total generated transport cost benefits

    = Generated traffic volume x change in costs per km x distance x 1/2

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    Estimating Benefits

    Normal traffic benefits:tripsN * d1 * (VOC1- VOC2)

    Diverted traffic benefits: tripsD * ((d1 * VOC1)-(d2*VOC2))

    Generated traffic benefits: tripsG * d2 * (VOC1- VOC2)/2

    d1 = existing road length d2 new road length

    VOC1 = vehicle operating costs per km “without”investment

    VOC2 = vehicle operating costs per km “with” investment

    VOC data relates to each road section and its condition at the time

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    The Consumers’ Surplus Approach

    Transport Cost Savings to existing

    traffic and normal growth






    Additional benefits from new

    traffic and production induced

    by new investment



    T1 T2 Traffic


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    Development Benefits

    • Development benefits arise from a combination of increased traffic and reduced transport costs.

    • Benefits may also include :

    • Increased agricultural production

    • Increased service provision

    • Increased industrial activity


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    Illustration of Benefits













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    Different Types of Benefit

    • Normal traffic benefits

      = traffic x change in transport costs

    • Development benefits

      - A function of (change in transport costs)2

    • Social benefits

      - A function of population x change in transport costs

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    Consumer’s Surplus Approach:

    • Advantages: Simple, cost based, traffic approach dependent on predicting changes in traffic

    • Disadvantages: May not address critical factors promoting either rural development or social access

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    Producers Surplus Approach

    • Advantages: Draws attention to changes in agricultural output (key economic activity in rural areas)

    • Disadvantages: No reliable way of predicting response

      - impact studies give widely different answers

      –it could be based on agricultural supply price

      elasticities but this is almost never done; it requires

      very careful examination to use.

      • For most projects benefits are just invented !

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    Producers’ Surplus

    Price & Costs per unit

    Of output


    farmgate price


    lower input costs

    O1 O2


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    Indicies and Ranking

    • Widely used for feeder road planning; there are many different approaches

      e.g. i) cost of improvement / population

      ii) estimated trips / cost

      Adavantages: Speed , simplicity, transparency, many factors can be incorporated

      Disadvantages: How do we value widely different factors ? (adding up apples and pears); weightings are not stable ; cannot easily address questions of road standards, timing etc, ; possible double counting

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    Community Priorities

    • Community priorities now often form an important part of feeder road appraisal. It is possible just to ask communities to rank the investments they prefer- both within the road sector or between roads and other investments.

    • Advantages: Community acceptability, use of community knowledge

    • Disadvantages: Sectional interest groups may dominate voting, community knowledge of area or road impact may be poor

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    1. Net Present Value:NPV = (B1- C1) + (B2- C2) + ….. (Bn- Cn) (1 + r) (1 + r)2 (1 + r )n2. Internal Rate of Return : solve for i, (IRR) 0 = (B1- C1) + (B2- C2) + ….. (Bn- Cn) (1 + i) (1 + i)2 (1 + i )n B1, B2 … Bn : Benefits in years 1, 2 … n C1 C2 Cn : Costs in years 1, 2 …. n r : Planning discount rate , n : planning time horizon

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    3. Net Present Value/ Investment Cost

    NPV/ C = NPV/Ci

    4. First Year Rate of Return

    FYRR = (B1- C1)


    B1, C1 : Benefits and Costs in year 1.

    Ci : Road investment costs

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    Economic Comparison of Alternatives

    • When comparing project-alternatives, the Net Present Value (NPV) is used to select the optimal project-alternative (alternative with highest NPV)

    • The Internal Rate of Return (IRR) or the B/C ratio are not recommended to compare alternatives of a given project

    Alternatives NPV0.

    Optimal Alternative:Highest NPV


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    Ranking Projects by Economic Priority

    • When comparing the economic priority of different projects, a recommended economic indicator is the NPV per Investment ratio


    Selected Alternative OverlayReseal


    NPV/Investment 8.45.2



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    Economic Decision Criteria


    Economic validity v. good v. good v. good poor

    Mutually exclusive v. good poor good# poor


    Project timing fair## poor poor good

    Project screening poor v. good good poor


    Use with budget fair ## poor v. good poor


    # Need incremental analysis

    ## Needs continuous recalculations

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    Appraisals & Post Evaluations 1.

    • An Appraisal is carried out before an investment is made. Everything is uncertain.

    • A Post evaluation may be made say 5 years after the investment. The investment is known and 5yrs of with case are known.

      The without case is unknown as is the remainder of the with case.

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    Appraisals & Post Evaluations 2

    • In Both Cases forecasting and evaluation models are required to come to an answer.

    • Hence we can never be certain about the viability of an investment !