In my first post today, I posed some questions around the plausibility of the assumed increase in international travel into and out of New Zealand if the proposed Wellington airport runway extension was to proceed.

In this post, I want to focus mainly on how the consultants have calculated the net national benefits from the runway extension.

The Sapere cost-benefit analysis estimates net benefits to New Zealand from proceeding with the runway extension now of $2090 million (2015/16 dollars).  These results are summarised in Table 30 of the report.  Of these gains, just under half accrue to New Zealand users of the airport (in respect of both passenger and freight traffic) and just over half accrue to “other sections of the community”.

Even if the passenger number assumptions are correct, the benefits to New Zealand users appear to be somewhat overstated, and the benefits to the rest of the community are largely non-existent.

Take  the users first.    The main benefit to New Zealand users is the lower cost of travel.   Much of that is the cost of time.  The consultants have valued the time of New Zealand travellers using some standard values from an Australian Civil Aviation Safety Authority document, but don’t appear to have allowed for the fact that New Zealand earnings  (and hence the appropriate value of time) are materially lower than those in Australia.  In PPP terms, real GDP per hour worked in New Zealand is only around 75 per cent of that in Australia.  That suggests the consultants have overstated the value of the time savings, and that the actual number would be lower by perhaps 25 per cent.

Concepts of consumer and producer surplus are very important in evaluating the welfare implications of proposals such as this.   The basic idea is illustrated in this chart.

Consumer surplus is the value from consuming a product or service over and above what the consumer had to pay for it.  For some consumers, the surplus will be large (think of the first refreshing drink on a very hot day), but for the last additional consumer (the marginal) consumer, that surplus should be zero.  People will purchase additional products or services up to the point where the marginal cost to them is just equal to the marginal value of that additional consumption.  We’ll come back to producer surplus shortly.

Sapere have allowed for an estimate of the consumer surplus  that arises from the additional use of air travel services by outbound New Zealand residents ($73 million of the benefits). I’m not totally clear how they derived that benefit estimate   But they consciously do not to attempt to put a value on the additional consumer surplus New Zealand residents gain from the additional goods and services consumed on their additional overseas holidays.  It is hard to estimate such a value, but (as they pointed out to me) this omission does somewhat understate the benefits to New Zealanders of a runway extension that leads to the sort of increased outbound New Zealand traffic the calculations are based on.  However, while this is an omission, the magnitude seems likely to be quite small.  Recall that these are the marginal travellers, for whom a holiday abroad is only attractive because of the option of travelling directly through Wellington.   It is also worth stressing that while these gains are real, they accrue directly to users of the airport, and provide an additional basis on which the airport could recoup the considerable cost of providing the longer runway.

The bigger questions arise around the estimates of the benefits to the rest of the community.

The first of these is the value of the additional GST on sales of goods and services to the 200000 more (by 2060) annual foreign visitors to New Zealand as a result of the runway extension.    That GST is mostly a net real gain to New Zealand (foreigners funding our government spending).    In the Sapere estimates, it would be worth a discounted present value of $184 million, so represents almost 10 per cent of the estimated total economic benefits.

But increased GST from foreigners spending in New Zealand is not the only GST effect likely from extending the runway.  Cheaper travel also works by encouraging more New Zealanders (especially those from around Wellington) to travel abroad.  When New Zealanders travel abroad they pay GST (or the equivalent) to foreign governments.  And the income they spend abroad can’t subsequently be spent at home.  Had they spent the same money in New Zealand, the GST would simply have been, in effect, a transfer from one set of New Zealanders to another.  But with an increase in foreign travel, it is now a transfer to foreign governments. Even on the InterVISTAS/Sapere numbers, around a third of the net increase in foreign travel results from New Zealanders going abroad.  If anything, I’ve suggested that long-haul flights to/from Wellington, if viable, might be more attractive to New Zealanders than to foreigners.  At best, the GST gain is likely to be no more than half the Sapere number.

But much the biggest issues relate to the possibility of benefits to New Zealand from additional foreign tourists buying real goods and services in New Zealand.  Sapere appear to have estimated a total for the likely increase in tourist spending in New Zealand and then subtracted an estimate for the cost of providing those services.  For that they have assumed that 45.5 per cent of the expenditure is domestic value-added (ie returns to labour and capital).  That approach doesn’t seem right and generates highly implausible estimates.

The producer surplus is the gain to the provider of a good or service over and above what he or she would have been willing to provide that service at (see the earlier chart).   The cost of providing the service includes the cost of intermediate inputs (materials etc) but also the cost of the labour and the cost of capital (a normal rate of return).  If the producer sells product at that cost, there is no producer surplus. In this context, there is no net economic benefits –  economiccosts have just been covered.

Over the long haul, in reasonably competitive markets, producer surpluses should be very small (in the limit zero).  For a hotel that budgeted on 80 per cent occupancy, a surprise influx of visitors for the weekend will generate a producer surplus –  the windfall arrivals add much more to revenue than they do to costs of supplying the service.  But over the long haul –  and the airport project is evaluated over the period out to 2060 –  it is fairly implausible that there will be any material producer surplus resulting from well-foreshadowed increases in visitor numbers.  Most of what tourists spend money on in New Zealand are items such as accommodation, domestic travel, and food and beverage.  In all those sectors, capacity is scalable.  One would expect new entrants just to the point where only normal costs of capital were covered.  In the long run, supply curves for most of these sorts of services/products should almost flat.

My proposition is that there are few or no producer surpluses likely to arise from a trend increase in foreign tourism as a result of extending Wellington airport.  But even if there were, any such gains would have to be offset against the loss of producer surplus for New Zealand producer (to foreign producers instead) from New Zealanders taking more holidays abroad.  It makes little difference to the hoteliers if I take my holiday in London instead of Queenstown, while at the some time someone in Manchester takes his in Queenstown instead of taking it in London.

Even if the consultants are right that there would be more additional inward visitors than outward, any producer surpluses from either set of numbers should be small.  And the net of two small offsetting numbers is even smaller.

The safest assumption, in evaluating the WIAL proposal, is to assume that the economic benefits of the proposal all accrue to users, and that there are no material net economic benefits (or costs) to the rest of the community.  Perhaps there is a small amount in the net GST flow, but it is hardly worth focusing on given the scale of the other uncertainties.

Perhaps this point will seem counterintuitive to lay readers and city councillors.  Surely “Wellington” or “New Zealand” is better off from having more foreign visitors (assuming the numbers outweigh the increased outflow of New Zealanders)?  And if so, shouldn’t we –  Councils, government –  be willing to spend money to get those benefits?   The short answer is no.    Good and services cost real resources to provide, and in a competitive market simply providing more goods and services won’t make the city or country better off –  you need to be able to sell stuff that generates more of a return than it costs to provide (including the cost of capital).  Vanilla products and services typically don’t do that.  After all, labour that is used to provide services to tourists is labour that can’t be used for something other activity.  And over a horizon of 45 years we can’t just assume there are spare resources sitting round unused.  Spending public money to generate this economic activity will come at a cost of some other economic activity being displaced (as well as the deadweight costs of taxation, which are allowed for in the cost-benefit analysis).

If, to a first approximation, there are no “net incremental economic benefits” for the “rest of the community” then even if the WIAL/Sapere passenger number estimates are totally robust, the net benefits of the project drop from $2090 million to $954 million.

In my earlier post, I noted that the cost-benefit analysis had been done using a 7 per cent real discount rate.

The authors defend it by reference to the Treasury’s guidance on evaluating infrastructure and single-use building projects (eg hospitals and prisons).

Frankly, I’m sceptical that that is an appropriate discount rate for this project.  And I would be astonished if Infratil –  the dominant shareholders in WIAL – treated their own marginal cost of capital for a project like this as being as low as 7 per cent real.  Perhaps a case might be made for something that low in respect of projects that depend simply on existing traffic (growth) patterns –  eg the current extension to the domestic terminal at Wellington –  but at the margin this runway extension has the feel of a much higher risk project.  After all, they could build it and no one might come.  I’ve written previously about government discount rates, and also linked to a recent Reserve Bank of Australia article suggesting that private sector firms are typically using hurdle rates of at least 10-13 per cent nominal (almost as many in the 13-16 per cent range).

I would reiterate the point here. For a project like this, a much higher discount rate should be being used.  Perhaps if it all goes wrong, WIAL itself might be able to recoup the costs from all airport users (I don’t know the Commerce Commission limitations on that), but even if so, this evaluation is being undertaken from a national benefit perspective.  The risk of all users being lumbered with higher charges to cover the cost of a project gone wrong has to be factored in to any evaluation as to whether public money should be used. A 10 per cent real discount rate seems a pretty reasonable commercial benchmark, and the sensitivity analysis (table 33) indicates that using a 10 per cent discount rate rather than a 7 per cent rate roughly halves the estimated net economic benefits of the project on the “most likely” scenario.

Using a higher discount rate and removing the producer surpluses (that are most unlikely to exist)  would reduce the estimated net national gains of the runway extension proposal –  advertised at in excess of $2 billion – by around three-quarters, even if the passenger number estimates were totally robust.

If one uses the low scenario instead (Table 33), net economic benefits are estimated at $802 million.  But $533 million of those benefits were estimated to accrue to the rest of the community –  and I’ve argued that those producer surpluses just don’t exist to any material extent.   And on that scenario, using a 10 per cent discount rate reduces the net economic benefits by 57 per cent relative to the estimate done using a 7 per cent discount rate.

Perhaps there is a viable proposition in all this for the airport company itself.  I rather doubt it.  I suspect that the additional landing and passenger charges that would have to be levied on the new wide-bodied/log haul services would undermine the additional demand to the extent where it was simply uneconomic to provide those services. Wellington doesn’t look like a natural place for economic long haul services. But that should be the airport company’s call, with their own money at stake

Councils –  and especially Wellington City Council –  should steer well clear of the temptation to put ratepayer money into this proposal.  It is not as if Infratil appears to be proposing to reduce its stake in the airport.  What is apparently proposed is a ratepayer/taxpayer capital subsidy, without the councils gaining any additional ownership interest.    If things go wrong, the airport company itself may well, over time, be able to recover its investment, since many people need to use Wellington airport.  Even if things go right, the Wellington City Council has little way of recouping the cost of its gift/investment.  And if things go wrong, it has no way at all.  Only the chimera of alleged “wider economic benefits” could lure otherwise intelligent people into a proposition with such a weirdly asymmetric payoff structure.

Shortly after the release of the cost-benefit analysis of the proposed Wellington airport runway extension, prepared by Sapere for Wellington International Airport Limited (WIAL) I wrote a post in which I posed the question “If they build it, what if no one comes?”

Since that post, I’ve been to one of the open day/public consultation meetings, have read and thought about the documents more thoroughly, and have read various pieces written by others, including the new one by Ian Harrison that I linked to yesterday.  I have also had some engagement with Sapere and WIAL, which has helped to sharpen my sense of what the issues really are.

The cost-benefit analysis is not a business case document.  It has been prepared in support of a resource consent application.  What I hadn’t known when I wrote earlier (and was advised of by Sapere) is that  under the RMA the applicants will need to be able to demonstrate national benefits to get permission to fill in some more of Lyall Bay, to extend the runway.

I’m sure that the cost-benefit analysis is not serving as a business case for Infratil, the major shareholder in WIAL.  But since this project is generally accepted to be viable only if there is significant public funding, and any such funding can only be defended if there would be material net public benefits , the Sapere cost-benefit analysis is by default serving as something of a business case at present.  If the numbers don’t stack up, neither the Wellington region councils nor central government should be putting any money into the project (beyond WIAL’s resources, and of course Wellington City Council is a 34 per cent shareholder in WIAL).

In this post, I will offer a few thoughts on the plausibility of the assumed increase in international passenger traffic to/from New Zealand as a result of the extension

Extending the runway at Wellington airport could materially reduce the cost of some forms of international travel in and out of Wellington. If long-haul flights were offered,  lower costs could result by reducing the time taken (eg. by eliminating the one hour flight to Auckland and the stopover time in Auckland, it might reduce the total time for a trip to Singapore (and onward points) by perhaps 2.5 hours).  For those travelling anyway, those gains could be material –  time has an opportunity cost.  In addition, by allowing long-haul aircraft to fly into Wellington, the direct cost of international airfares in and out of Wellington could also be expected to fall –  quite materially, if the numbers Sapere quotes are correct.  Those gains apply not just to long haul routes themselves –  a Wellington-Singapore direct fare should be materially cheaper than the current options via Auckland, Christchurch or Sydney –  but also to trans-Tasman flights, as the longer runway would also facilitate used of wide-bodied aircraft on trans-Tasman routes (as for examples, the Emirates flights between Christchurch and Australia).

Of course, simply building the runway extension does not bring about any of these savings.  They depend on airlines finding it profitable to run additional services.  And although international air travel has increased enormously to and from New Zealand in recent decades, provincial New Zealand is littered with the dreams of local authorities (airport owners) with aspirations to have an international airport.  New Zealand has plenty of attractive places, but one main international airport.

Wellington, of course, has a significant business market, and business travel is typically much more profitable for airlines than leisure travel. And unlike the predominantly leisure travel into Christchurch, the Wellington business travel probably isn’t very seasonal.  So the idea the long haul flights into Wellington could be viable isn’t self-evidently absurd.  But, on the other hand, the economic cost of making such flights technically feasible – lengthening the runway –  is far higher than in many other places.  At $1m a metre, it is considerably more costly than putting some asphalt on some more grassy fields in Christchurch.  Wellington isn’t a natural place for a long-haul international airport.

The WIAL proposal uses modelling by international consultants to estimate likely growth in traffic and passenger numbers with and without the extension.  There are some questions about the baseline forecast, including for example around the potential future impact of climate change mitigation policies.  But my main interest is the difference between these two –  the increase in traffic that would result from the runway extension itself.

It is hard to pick one’s way through all the numbers, but the bottom line appears to be that the cost-benefit analysis is done on the basis that by 2060 there will be an additional 400000 foreign international passengers per annum arriving in Wellington, and an additional 200000 New Zealand international departures per annum through Wellington[1].  Many of these are people who would otherwise have travelled via Auckland or Christchurch, so that the net gain in international travel numbers to New Zealand is around 200000, with an additional 100000 or so New Zealanders travelling abroad.    Many of the gains are forecast to occur early in the period.  Thus, by 2035, the analysis assumes an annual net gain to New Zealand of around 125000 international visitors (relative to the no-extension baseline).

How plausible is this?    The various reports highlight the phenomenon of “market stimulation” –  putting on new air services tends to stimulate total passenger numbers.  That shouldn’t be surprising.  Not only do point-to-point services lower the cost of visiting a particular place, but marketing expenditure raises awareness of the destinations concerned.

On the other hand, one can’t just take for granted that such market stimulation will render long haul flights into and out of Wellington viable.  After all, there are plenty of cities around the world with few or no long haul flights.  Closer to home, Rotorua is an attractive tourist destination and can’t sustain direct flights even to Sydney.

What of Wellington?  The modelling exercise involves lowering the cost of foreigners visiting Wellington –  to some extent artificially, because the costs of providing the longer runway are not passed back in additional charges to those using long haul flights –  but not the cost of them visiting New Zealand (since Auckland and Christchurch fares would stay largely unchanged).   Any long-haul flights into Wellington will almost certainly be from cities that already have flights to Auckland (and possibly to Christchurch).  Is it really plausible that an additional 200000 people per annum (or even 125000 by 2035) will visit New Zealand simply because they can fly direct to Wellington, or (in respect of trans-Tasman traffic) fly into Wellington more cheaply than previously?

Perhaps I’m excessively negative on Wellington.    I reckon it is a nice place for a weekend, but not a destination that many long haul leisure travellers would choose.  What is there to do after the first two days?  And there is little or nothing else in the rest of the bottom of the North Island.   So it is plausible that lower fares resulting from additional competition would attract more weekend visitors from Australia. But no one is going to come for a weekend in Wellington all the way from China or Los Angeles.  And since the principal attractions of New Zealand are either in the upper North Island or the South Island, how many  more people are likely to come to New Zealand just because they can choose Wellington as the gateway for their New Zealand holiday?

And what of New Zealanders travelling abroad?  Since the costs of Wellingtonians (and others in the nearby areas) getting to desirable destinations abroad would be cheaper if there were direct flights from Wellington, it is credible that the total number of New Zealand overseas travellers would increase.  In fact, whereas the modelling suggests twice as many new foreign visitors as new New Zealand international travellers (and in total there are twice as many international visitors to New Zealand as travelling New Zealanders), in this case I wonder if the putative new  routes would not be more attractive to New Zealanders than to foreigners?  One can illustrate the point with a deliberately absurd example: put on long haul international flights to Palmerston North, and they would be quite attractive to people in Manawatu (much easier/cheaper to get to desirable places like New York or London) but not very attractive at all to foreigners (for whom Manawatu has few attractions).

But even if wide-bodied aircraft flights from Wellington did make overseas travel more attractive to New Zealanders, is the effect really large enough to be equivalent to one more trip every year for every 10 people in Wellington and its hinterland?  And would the effect still be remotely that large if passengers (users) had to cover the cost of providing the longer runway (which should really be the default option)?

Reasonable people can differ on these issues. In my discussions, a lot seems to turn on just how attractive people think Wellington is.  I’m pretty sceptical that long haul tourists will ever come to New Zealand to see cities.  Perhaps if one is thinking of visiting New Zealand cities, Wellington is more attractive than our other cities, but even if so Wellington still has the feel of being a logical gateway to nowhere much.  It isn’t an obvious starting point for a “whole of New Zealand” trip, or a North Island one (given that most of the attractions are further north), or a South Island one.   So I’m left (a) sceptical that the net addition to visitor numbers to New Zealand will be as large as the analysis assumes even if the users don’t bear the costs, and (b) suspecting that the boost to the demand for New Zealanders to travel abroad might be greater than the boost to the demand for foreigners to visit New Zealand.

On that latter point, the experts point out that they assume that the new long haul services will be provided by foreign airlines, and that the evidence of recent new air services to New Zealand provided  by foreign airlines is that they disproportionately boost the number of foreigners travelling.  I have no reason to doubt the numbers, but I still wonder if the same result would apply to routes into Wellington.  New flights into Auckland are often the first direct flights offered into New Zealand (as a whole) from that city or country.   My impression is that “New Zealand” is the destination marketed to long haul passengers.  But direct flights to/from Wellington do more to open up the world (more cheaply) to Wellingtonians than they do to open New Zealand to foreigners.   And if so, would the foreign airlines be keen to offer the Wellington services at all?

This post has been about the sort of increased passenger numbers that might be expected if the runway was extended.  In some sense, that should be largely an issue for WIAL.  If they can extend their capacity and attract sufficient users at a price that covers the cost of capital of WIAL and its shareholders, the rest of us might not care much (I’m not much bothered about environmental issues, although my family enjoys the waves at Lyall Bay beach).    But the cost-benefit analysis being used to lure ratepayers and taxpayers into funding much of the proposed expansion suggests that there are very large economic benefits to New Zealand which cannot be captured directly by airlines or airports.  I think they are wrong, and my next post will explain why.

[1] From tables 5.11 and 5.12 in the InterVISTAS report.