Tuesday, 6 September 2011

BBC Scotland can't do economics

2 stories over the past month have been noticeable for the economically uninformed reporting on BBC Scotland:

The first was the call from Scottish Government for a change in approach towards more Keynesian counter-cyclical capital spending. When such calls are made by Ed Balls we get Stephanie Flanders at the "Big BBC" discussing it from an economics perspective. However, when "Wee" BBC Scotland reports on this it's always, frustratingly, framed as a Holyrood versus Westminster "spat".

The second story was of course the trams fiasco, on which there were two aspects that were badly reported. The first was the constant repetition that the costs of the St Andrews Square option would be more than £1B because interest payments are added to the contracted costs. This ignores the fact that the costs of cancellation cannot be met with borrowing because there is no asset against which to secure any new borrowing. Reporting it in this way is effectively saying that the ability to borrow is a disadvantage - a cost that should be reported. The huge difficulties that would be caused by not being able to borrow to meet the cancellation costs are just glossed over. It's also inconsistent with how any purchase is normally reported: nobody claims that their house costs double what it actually cost just because they had to take a mortgage out and they are including all the interest payments on the mortgage.

The other badly reported aspect was allowing the sunk cost fallacy to be willfully misrepresented. The sunk cost fallacy describes the situation where you have a project with, say, projected benefits of £40M and projected costs of £35M. The project goes ahead on this basis but when £10M has been spent, the remaining costs are reassessed as now being £45M (i.e. £55M total cost). The rational calculation to do at this point is to compare the value of doing nothing (costs to pay = 0, benefits received = 0, i.e. value = 0) against the value of proceeding (costs to pay = £45M, benefits received = £40M, i.e. value = -£5M) and so decide to cancel the project without taking the £10M already spent into consideration. However, those promoting the sunk cost fallacy as being a reason to cancel the trams were only mentioned the bit about not thinking we have to get something for the money already spent.

A very conservative calculation would give the benefits of the full (18.5km) airport to Newhaven tram line as £545M (since this was the original cost of the full line, which was approved and so we have to imagine that the benefits are at least this large) and the benefits of the truncated (13km) airport to St Andrews Sq line as £383M (=545*13km/18.5km). The options now are to cancel the project, which has a value of 0 (no asset gained and assuming total cost of ~ £600M = £440 already spent + £160M cancellation fees, is sunk) or continue, which has a value of £153M (asset worth £383M gained and differential costs of £230M (£830M cost of which £600M is sunk)). Clearly we should proceed.

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