WP 1 Economics of European infrastructure funds: methodology

FUNDING - SP -Dec 8+9

WP 1 Economics of European infrastructure funds: methodology

Funding

SP Dec 2005


Objectives of this WP: Methodology of a European infrastructure fund:

– How to spend the money:– Selection of projects– Loan or subsidy– Other conditions (tolling, guarantees,…)– Individual accountability of projects

– How to finance the working of the fund– Loans (what type?)– Subsidies (what type?)

– How to operate the fund– Decision making on selection of projects– Decision making on total capacity of fund– Political feasibility– Membership issues– Termination rules for the fund

• Conclude with concrete proposals to study


Tasks WP1

1. Economics of federal infra funds 1. What has economic theory to contribute?2. Questions for survey about EU and US experience

2. Survey of experience in EU 3. Survey of experience in US 4. Mark up rules for funding investments5. Risk taking, financial constraints, multi-

government levels, network effects6. Conclusion: proposals


Survey of Theory with a Graphical example 1

• Consider a bridge or a railway line used by local users and foreign users

• The bridge requires a lump sum investment X and we will analyse whether a local govt (member country) makes the right investment and pricing decisions

• Public good economics focuses on two motives for federal aid:– Spillovers (use of the good by foreigners)– Insufficient financial capacity (not relevant for member

states)


Survey of Theory with a Graphical example 2

• The bridge requires a lump sum investment X and we will analyse whether a local govt (member country) makes the right investment decisions

• This is a simplification where we have only the 0/1 decision on investment, not the optimal choice of capacity

• The bridge or railway will be used by locals and foreigners• We analyse the following cases:

– No congestion, no pricing of infrastructure use– Congestion, optimal pricing – Congestion, locally optimal pricing– Corridor effects (or complementarity of investments)– Political economy issues

• Two issues are of interest to us:– Does the local government take the right investment decision: will it make the

investment when it is worthwhile?– Will it take the right pricing decision?– How can federal government correct this?


Economics of infrastructure projects – if unpriced and no congestion

price

trips

MWPlocal

MWPlocal+foreign

Local govt:Total benefit local (blue)> total cost XInstead of Total benefit local + foreign > total cost X

Federal intervention: subsidy rate s1Total benefit local (blue)> total cost (1-s1)


Economics of infrastructure projects – if unpriced and no congestion

• Economics of grants:– Mostly Conditional and open– Asymmetric information: Federal government

does not know cost of project or precise share of foreign user

– Optimise Subsidy contract = working rule of fund


Economics of infrastructure projects – if unpriced and congestion

price

trips

MWPlocal

MWPlocal+foreign

Local govt:Total benefit local (blue)> total cost XInstead of Total benefit local + foreign > total cost X

Federal intervention: subsidy rate s2Total benefit local (blue)> total cost (1-s2)

AverageUser Cost

Loss of surplus due to foreign users


Economics of infrastructure projects – if priced at SMC and congestion

price

trips

MWPlocal

MWPlocal+foreign

Local govt:Total benefit local + tax revenue > total cost XThis means green area extra Instead of Total benefit local + foreign benefit + tax revenue > total cost X

So grey area is still missingFederal intervention?: subsidy rate s3Total benefit local (blue)> total cost (1-s3)

AverageUser Cost

SMC

Optimal toll


Economics of infrastructure projects – if priced above SMC and congestion

price

trips

MWPlocal

MWPlocal+foreign

Local govt:Total benefit local + tax revenue > total cost X

Compared to SMC pricing, larger chance that project is realised BUT smaller total surplus (mainly for the foreign users)

Federal intervention:Pricing contract + investment subsidy ?

AverageUser Cost

SMC

Local toll


Economics of infrastructure projects – if priced, congestion and corridor effects

• In a corridor, infrastructure use by foreigners (transit) in one country will depend on capacity and pricing in the other country

• De Borger, Proost, Van Dender (2005) and De Borger, Dunkerley,Proost (2005) analysed this issue in more detail


TOLLING Corridors– 2 cases

Country A

Country B

Country A Country B

TRANSITLOCAL

LOCAL

TRANSIT

LOCAL LOCAL

PARALLELTOLL COMPETITION

SERIAL TOLL COMPETITION

TRANSIT

TRANSIT


Relative efficiency of tolls in corridors(Nash equilibrium - illustration)

50% local,50% transit – welfare gain w.r.t no tolling

Parallel

Network

(2 links)

Serial

Network

(2 links)

1st Best 100% 100%

Competition + toll discrimination

93% -1087%

Competition+ uniform toll

89% - 665%

Toll on locals only 22% 37%


Relative efficiency of tolls (Nash equilibrium - illustration)

50% (90) local, 50% (10) transit – welfare gain w.r.t no tolling

Parallel

Network

(2 links)

Serial

Network

(2 links)

1st Best 100% 100%

Competition + toll discrimination

93% (99.9%) -1087%(-126%)

Competition+ uniform toll

89% (99%) - 665%(+63%)

Toll on locals only 22% (63%) 37% (+89%)


Endogeneous investments in serial corridor

• 2 stage game with 2 countries, – First stage: decide on capacity– Second stage: pricing game (Nash)

• First results for “roads” (constant returns to scale in capacity extension) and symmetrical countries

• We start with an equilibrium with no pricing of the use of the road and 50% of roads is used by transit

• Examine what capacity choices are made in function of pricing regimes – Introducing pricing leads to lower capacity with uniform pricing

and a welfare loss !


Variable UnitNash Equilibrium

differentiationNash Equilibrium

uniformNash Equilibrium

local tolls only

Local demand (1300 in no toll equil) Trips 1192.3 716 1187

Transit demand (1300 in no toll equil) Trips 387 716 1281

Trip volume, country level Trips 1579 1433 2468

Generalised price, local Euro/Trip 83.5 163.4 84.5

Generalised price, transit Euro/Trip 437.4 326.7 137.2

Capacity (2000 in no toll equilibrium) 1538 1425 1724

Inverse capacity 0.00065 0.00070 0.00058

Local Toll Euro/Trip 24.6 105.2 15.9

Transit Toll Euro/Trip 159.8 105.2 0.0

Local MEC Euro/Trip 14.2 8.6 14.2

Global MEC Euro/Trip 18.8 17.2 29.6

Local CS Euro 119270 43047 118117

Tax revenue, country level Euro 91070 150664 18810

Cost of capacity Euro 34940 32652 39158

Welfare, country level Euro 175400 161059 97768

Transit welfare (CS) Euro 25065 86093 275350

Overall welfare Euro 375865 408211 470886

Change compared to Non toll equil % -21.06 -14.27 -1.11


POLITICAL ECONOMY of infrastructure projects –if unpriced, no congestion

price

trips

MWPlocal

MWPlocal+foreign

Local govt: lobby for projects that give a local benefit if paid federally

Benefit will be larger when use is unpriced or when revenues go to locals

WP 1 Economics of European infrastructure funds: methodology

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