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Standing Committee on Infrastructure, Transport and Cities
07/03/2016
Role of transport connectivity in stimulating development and economic activity

ADAMS, Dr David, Director, Strategex Pty Ltd

[09:47]

CHAIR: Welcome. Although this committee does not require you to give evidence under oath, I should advise you that this hearing is a legal proceeding of the parliament and therefore has the same standing as proceedings of the House. I invite you to make an opening statement before we proceed to discussion.

Dr Adams : Thank you. You would not have come across Strategex. It is a microconsulting company owned by my wife and me. I thought it would be useful to give you a small amount of background. I have 25 years of economics-consulting experience in Australia. For Bert's benefit, who is out of the room, I prefer to be called a market economist, not a five- and 10-year centrally-planning economist. That said, you will find my name scattered around the internet. For example, my name is there as the final signature on the business case for the Auckland city rail link—that is the three-kilometre, underground rail line is being built in Auckland at the moment. We may touch on some lessons from that. The other minor point is I have a doctorate in mathematics.

Today, I want to start with a story of an invisible worm. I thought it would be entertaining. It is from a very short poem by William Blake:

O Rose thou art sick.

The invisible worm,

That flies in the night

In the howling storm:

Has found out thy bed

Of crimson joy:

And his dark secret love

Does thy life destroy.

That is relevant because there is an invisible worm in Australia, called the National Guidelines for Transport System Management. The reason this is important is that any time a transport project is evaluated, the person doing the evaluation reaches up to the shelf and pulls down the National Guidelines for Transport System Management. They do their appraisal in accordance with those national guidelines because they are the national guidelines and, therefore, the appraisals have to be done in accordance with them. I am picking up the point that Tim Williams made about appraisal. So investment appraisals have to be made in accordance with the national guidelines.

As I said in my submission, there are five or six volumes of the national guidelines. Volume 4, chapter 2 says:

… increases in land value that may result from urban public transport initiatives are generally a capitalisation of other benefits. Accordingly, they should not be included in economic appraisal of initiatives because this would double-count benefits.

So the invisible worm in Australia is that the national guidelines used for evaluating transport projects instruct the person doing the evaluation to ignore land value impacts. So all of the appraisers in Australia have been instructed to ignore land value impacts. Is it any wonder that land value impacts are not being taken into account if the guidelines have instructed that they not be? That is why I am suggesting that a very important task for this committee is to overturn that part of the guidelines.

The guidelines are being reissued. Draft guidelines are going to be published today or tomorrow. There is a website, which I refer to in my submission. That website has been down over the weekend while the new guidelines are being published. When the new guidelines come up, today or tomorrow, it is highly likely they will continue to instruct people to ignore land value impacts. So your committee is being eaten away by these national guidelines, by this invisible worm that sits at the centre of appraisal in Australia and just eats away at the assessment of land value impacts. Make sense?

I can illustrate with an example why that is nonsense, if you like, or we can pick it up in questions. Let me illustrate it now, in respect of the High speed rail study phase 2. I was intimately involved in the early high-speed rail studies. In 2010, there was a paper published called East coast highcapacity infrastructure corridors. There were four co-authors named on that paper: Brendan Lyon, from Infrastructure Partnerships Australia; Larry McGrath, who is chief of staff to the New South Wales Treasurer; Phil Davies, who is CEO of Infrastructure Australia; and me. It is a serious paper. What we said in that paper was, in brief, take out a call option over high-speed rail because it does not make sense to build it but it does make sense to take a call option. That paper ended up being turned into the high-speed rail phase 1 and high-speed rail phase 2 studies. No doubt you are hearing quite a lot about the high-speed rail phase 2 report.

What I am suggesting to you is that the high-speed rail phase 2 report was derailed because the worm in the national guidelines ate away at it. The terms of reference for the high-speed rail phase 2 study is 17½ pages long. It is a nonsense to have an 18-page terms of reference for a study. They are in the public domain; I have put a link in my submission. Ninety-five per cent of those terms of reference instructed the study to assume that land use was fixed. Ninety-five per cent said, 'Assume that nobody changes where they live as a result of high-speed rail', because that is what the national guidelines say. That is a nonsense, and, by implication, the findings of the study are therefore a nonsense. You ask the wrong question, you get the wrong answer. Make sense?

CHAIR: It does to me.

Dr Adams : So the worm of the national guidelines ate away at the high-speed rail studies and, in my view, fatally damaged the value of the study, and yet you will hear it quoted as the best and most recent example of a high-speed rail study. Anything else that we are doing while these guidelines exist is going to get eaten away by the worm, unless you can change the guidelines. In my submission, there are some quite specific suggestions for what to do with the guidelines. There is also an academic explanation of why the guidelines went off track. There is this implicit belief that land value impacts double-count travel-time savings. People believe this, without going back and checking. But, because I am a mathematician, I go back and read the fine print and read the assumptions very carefully. As I say in my submission, the assumption that land value impacts are exactly the same as travel-time savings came from a paper in the 1960s, but that paper, by an American, Herbert Mohring, is being misused. The finding in the paper only holds if the land market is in equilibrium.

A road project tends not to change the equilibrium in the land market, and that makes the guidelines perfectly fine for assessing road projects. But a large urban rail project changes the equilibrium in the land market. It changes where people live. Therefore, if you are assessing a large urban rail project, you need to look at the land value impacts; it is not just enough to look at the travel-time savings. We have this misunderstanding that has come from the sixties; people are not going back and checking the assumptions and, therefore, that is distorting the investment appraisal for large urban rail projects and, potentially, large urban road projects.

My suggestion to the committee is that the appraisal give equal weight to both land value impacts and travel-time savings and that you check, empirically, whether the two are equal. There is this assumption that the two are equal, which is only true if the land market is in equilibrium. But why don't we go back and evaluate some of the projects that have been done and check whether the two are the same, get some evidence into it? I think it is time now for a discussion.

Mr VAN MANEN: Thank you for your opening statement. We were chatting earlier this morning and, from that discussion, I am interested in your observations about the guidelines. I think they are incredibly telling. It shows up in other areas, in budget processes, where we cannot take into account the impacts of second-round effects and those sorts of things. I go back to an earlier question I asked of previous witnesses around long-term strategic planning—and I did notice you had a bit of a wry smile on your face when I asked the question. I would be interested to get your observations on the long-term strategic planning that creates the corridors that procreate the development opportunities, on what role the bureaucracy and the planners have to play in that and on where the hold-ups are in creating that longer term planning infrastructure. In my view, the current IA report that has just been released is at least a step in the right direction, in that it is starting to look at a longer term infrastructure plan. I would be interested in your observations.

Dr Adams : I had a go at you while you were out of the room about central planning versus market economics! Where I can, I always try to look for a market solution rather than a bureaucracy-planned solution. I think we have achieved it in some—

Mr VAN MANEN: It was more about the vision of that, not necessarily—

Dr Adams : I think a dictatorship is always easier to run than a democracy. I think, in another industry, we have demonstrated that the market can deliver long-term plan solutions, namely in the energy industry.

Governments are no longer in the business of planning power stations or planning electricity transmission lines. In the 1990s I was fortunate enough to work during the reform of the energy industry, when governments put in place a set of framework that allowed the market to deliver long-term plan solutions rather than having bureaucrats deliver long-term plan solutions. If the committee were really ambitious then it would be looking to try and put in place similar market mechanisms for delivery of long-term transport infrastructure.

My suggestion would be to look to the land market. The land market tells us which areas are well connected by transport. It is a relatively efficient market. As I have spoken about on occasions, you can strip out the property part and be left with unimproved land values. Australia is almost unique in the world, and extraordinarily fortunate, in having a system of unimproved land values that are already used as the basis for property taxation. It is a robust system. Those unimproved land values signal the value of connectedness in a location. I am wandering off point, but look to the market for long-term solutions.

Clearly there are market failures and we can talk about them at length. There are market failures in respect of corridor protection, because the costs of financing corridor protection are too long. That is why, with the High Speed Rail Study, with the East coast High Capacity Infrastructure Corridors, we focused on protecting the corridor by taking out a call option over the corridor. The High Speed Rail Study that should have been done was, 'What is the case for taking out a call option over the corridor?' But it got distorted by this invisible worm called 'the guidelines' and ended up as, 'What is the value of building high-speed rail?' because the guidelines do not allow assessment of call options. They only allow assessments of base case—'Don't build the project and people live in this way'—and project case—'Build the project and they live in exactly the same way as the base case.' They do not allow an assessment of the call option, and the terms of reference went the traditional route, because the worm got to them.

Mr VAN MANEN: From testimony we have had from other witnesses last week on the Japanese experience, that is actually not what happens. Businesses have relocated back office functions from Tokyo to other cities where the costs of living are less et cetera, but if they need to come into Tokyo it is an easy trip on high-speed rail. I think that is a classic case in point.

Dr Adams : Yes. There is a long-term role for government in planning to an extent, but the first role for government is to try and get the appraisal guidelines right, for a start, and then get the market frameworks right so that the market can actually deliver these long-term transport solutions, rather than perennially relying on bureaucrats and consultants doing benefit-cost assessments, which are a third-best method of assessing infrastructure.

CHAIR: Thank you for your paper and for your opening comments. I am in violent agreement with you. Given the imbalance of settlement around Sydney and Melbourne, the vacating of the regions between, leading to some of the highest property prices in the world—Sydney second highest, Melbourne fourth highest—the imbalance of the economy, and the constriction of growth of competitiveness, efficiencies and productivity that has taken us into account, does this present a perfect storm of opportunity, if you can get rid of the national guidelines, for the government, through value capture, to form powerful relationships with property developers to literally look at the purpose of high-speed rail to be the essential infrastructure for property development?

Dr Adams : For me, first-best is if the market brings forward a solution. There are some thoughts being kicked around out in the market, but my back-of-the-envelope calculations are that they are falling a bit short. There was a discussion last week about faster rail out to Western Sydney Airport. That is falling a bit short of being bankable as a private project. Yes, we then need to look back to government to tip some money in. How big is the case for government intervention?

Governments are not particularly flush with money at the moment. If we wait for Treasury to approve expenditure on these matters, we might continue to miss the opportunity, so what else can governments do other than directly tip money in to help do what I call levelling the land price gradient?

I think in my submission—you will probably hear about it later in the day from Mr Bell—I have put a chart of unimproved land value dollars per square metre as a function of radial distance from Sydney CBD, and you will see that that falls off very quickly. Fast rail or fast transport levels that land price gradient. It either drops it in the centre or raises it further out or both. That, in my view, makes a city more equitable because it makes housing more affordable for people who can only spend a certain time travelling every day.

So, yes, I think it makes sense, but the question is: what is the appropriate role for government in that? No-one is asking the question about the appropriate role for government, because if it is a transport project there seems to be a priori assumption that government has to fund it.

CHAIR: If we were to look at rail projects as an essential component of real estate development—and that the government had a value capture combining with stamp duties, two levels of government and capital gains taxes—and we were to look at it as a real estate development project where, when you put in infrastructure, you accompany that with zoning and planning, and given that the government then has windfall revenues that would not happen if this did not happen, should it be reasonable to then quarantine those revenues that come to the government to hypothecate towards the cost of that infrastructure?

Dr Adams : My view is: yes. We did this calculation in Auckland in 2010 when we did the first business case for Auckland City Rail Link, which is undergrounding of the rail in Auckland. I was fortunate enough to be assisted—or taught—by a guy called Bill Lee, a fantastic land and transport economist from the States, and we did the business case for the rail line. It was based on both travel time savings and hypothecated revenue calculated at three layers: a layer immediately around the stations, 400 to 800 metres, with one rate because they get absolutely direct benefit; a wider Auckland city-wide layer because everyone in Auckland benefits; and then a smaller but New Zealand national layer because Auckland is commercially the most important city in New Zealand and therefore any improvement in productivity of Auckland ultimately affects all the taxpayers in New Zealand. So we did that.

We earned the ire of the New Zealand government for our business case. First of all, they imported Steer Davies Gleave from the UK to explain why our business case was rubbish. Then they commissioned another study called the Auckland City Centre Future Access Study to demonstrate that our business case was rubbish. Then they said they were not going to fund the rail anyway. As of a month ago they have basically backtracked completely. The Prime Minister said he was not going to fund it to 2023. He has now backtracked completely and he is going to start funding it in 2018, I think.

There is a worm in New Zealand as well, at the New Zealand Transport Agency, because their guidelines also do not admit value uplift. We got attacked by it, but in that case it was so long ago that history has proved we were right.

CHAIR: Would you say the main purpose for high-speed rail between Sydney and Melbourne is transport from Sydney to Melbourne or the opportunities of real estate development and to plan, for the first time, our settlement to avoid the problems that we have had?

Dr Adams : I have always been clear that the purpose of high-capacity infrastructure corridors is about where people want to live and work. It is technology neutral. Whether you put high speed rail or whether you put Hyperloops or something else in, it is about where people want to live and work. It is about planning the pattern of settlement, but the worm got to it. I tried to run that line in the paper, but the invisible worm got to me, and I lost, and the study ended up being about competition with airlines.

Mr VAN MANEN: One of the interesting things I look at with infrastructure development is that very often in the road network we talk about ring roads to distribute traffic around areas that it does not need to go through, but we never seem to do that with our rail network. Our rail network is focused on bringing people into a central point and then out. For example, if I want to go from where I am in Beenleigh, which is on the Gold Coast rail line, to Ipswich, I have to go into Brisbane and out to Ipswich; I cannot go around. Our rail network is basically a hub with spokes, and no interconnecting loops. It is probably a bit of a digression from the high-speed rail discussion, but isn't that also part of the discussion about not having things go into a certain point and having people work and live where they want to live—the inefficiency of the public transport network, particularly the rail network, because it is all focused on coming to single point rather than being able to travel around the periphery on public transport, particularly rail?

Dr Adams : Again, I can blame the worm—it is a very convenient worm; it is responsible for most! It is an invisible worm. Rail projects have, according to the guidelines, always been evaluated on travel time savings. And if you look only at travel time savings you get your biggest benefit by going into the centre of the city. If you require the appraisal equally to consider land value impacts, you would change the pattern of investment in rail. Rail suffers more than road under this appraisal method, because rail affects land values much more than road does, because it is fixed, and you do not have to run a car. Light rail, for the same reason, is better than buses in terms of land value impacts, because it is fixed. So, there is a non-neutral distortion of investment appraisal in favour of roads. You only have to look at the amount of money being spent on roads versus rail to see that the investment appraisal is distorted.

The other distortion in roads, just as a very small digression, is that when I travel on a rail line I pay a return on the land underneath the rail line. When I travel on a road, I do not pay anything for the use of that land under the road. I did not put it in my submission, but I once calculated the area under roads in Melbourne: 17½ per cent of Melbourne land area is road. And when I did that, which was a few years ago, I actually tried to value the land under roads based on the value either side of the road, and it was $250 billion. So, we have a $250 billion land asset sitting underneath roads in Victoria. What return is charged on that $250 billion asset? Zero. If you are the owner of a $250 billion asset and you do not have to earn any return on it, you are a pretty lucky asset owner. So, there is another distortion in that land under roads is free and land under rail is not.

Mr VAN MANEN: Wouldn't people argue that the fuel taxes and registration that you pay contribute somewhat to that?

Dr Adams : They fall way short. I did that calculation, and they fall short.

CHAIR: Could you provide us with those calculations?

Dr Adams : My slight hesitation is that they were done for the Victorian Competition and Efficiency Commission in 2011, I think. VCEC has seen fit not to publish them, which is a shame. And they are owned by VCEC. If you can possibly dig them out of the Victorian Competition and Efficiency Commission, that would be fantastic. If not, I will just go and see whether they are already in the public domain. I think one of them is in the public domain but the other is not, and if it is not then I cannot give it to you.

CHAIR: in essence, your two driving points are that market impact should drive public policy with regard to infrastructure?

Dr Adams : No, I would not go as far as saying that it should drive public policy—public policy first, but delivery from markets; investment appraisal on a market basis rather than a benefit-cost assessment that is flawed.

CHAIR: We had a presentation from Professor Peter Newman a week or so ago. He advocated an entrepreneurial value capture system, which was essentially a privatised value capture system where developers buying large amounts of land in various places would fund the infrastructure to connect those and be self-serving, elevating their value. If we are to act as a government serving all the needs of a community, possibly that should be married to the needs of the existing community and some of that infrastructure could therefore be designed to benefit both or be part of a master plan. Would you agree with that as a concept?

Dr Adams : I agree with that. The slight issue I have with Peter Newman's proposition is—it depends whether it is greenfield or brownfield—if you are trying to retrofit a piece of rail in a brownfield environment, the transaction costs of negotiating with every small residence in the site where you want to put your station is going to cripple your project. I had this discussion with him on Friday. The costs of getting an easement for a piece of linear infrastructure, like a pipeline or a transmission line, are usually pretty high, and then it is only a small number of landholders. But if you are trying to retrofit a station in a city and you have to negotiate with 2,000 small residences, the transaction costs will kill you, and therefore I think there is a case for government intervention with a value capture mechanism.

CHAIR: For instance, looking at our current problems in major cities and putting in a light rail system along a congested main road artery, zoning around those train stations and then affecting a value capture mechanism that would effectively put a capital gains tax on a private residence—the private residence, the landowner, is not just getting a speculative price from a developer; it is being wrapped up with the certainty that the developers want, as far as zoning, infrastructure and certainty of planning approval are concerned. So, the landowner will benefit from what the government has done, and therefore it is reasonable to think that the government should take a reward for that. Are those the components that you would like to see as part of our ability to retrofit and master-plan our cities?

Dr Adams : Broadly yes. My slight issue with the proposition around the light rail in Parramatta is that the government has dictated what the contribution will be—namely, a proposed $200 a square metre. That is a government-imposed solution rather than a market-measured solution. Surely the market will determine what those houses are worth once the light rail goes in. And why do we have Treasury or some agency of the New South Wales government trying to second-guess what the market is going to deliver, how the market is going to value light rail?

CHAIR: Is it muddying and confusing and making it overcomplicated when a state government is going forth with such a plan, when, if we were working cooperatively together, the federal government could be quarantining such value capture and capital gains taxes and hypothecating it back to the state and not confusing it with these one-off things? So we could have, if you will, master funding for master planning of state projects with strings.

Mr Adams : Now you are getting me excited! I will refer back to what happened with the energy reform in the 1990s. COAG, or whatever it was—National Grid Management Council—ran energy reform in the 1990s, and because it was a consensus project it ran at a glacial pace and achieved very little, until Victoria, under Premier Jeff Kennett, acted unilaterally. So it was a unilateral action that forced the pace on energy reform, not a consensus process. I tend to favour the combination of competition and consensus: consensus is slower; competition gets us there a little bit faster. I, therefore, applaud the New South Wales government for acting ahead rather than waiting to drag every other state along with it through a consensus project.

CHAIR: Thank you very much for your paper. We have another question from Columbo here!

Mr VAN MANEN: One of the things that I see frequently with infrastructure development is that the rail projects will be over here, the road projects will be over here and if, as in Queensland, we still have state-owned electricity assets, their projects will be here in the middle somewhere. You have all of these pieces of infrastructure that arguably could, in some cases—not in every case, but in a lot of cases—be co-located to reduce the cost of the infrastructure and the efficiency. Have you done any work on that and how we can better co-locate pieces of infrastructure across government departments—heaven forbid that they actually work together!—on a solution to reduce the cost?

I go back to my earlier point about linking the legs of your rail network. You have, for example, high-transmission powerline corridors through developed and undeveloped areas in South-East Queensland. You could run light rail—maybe not heavy rail—in that corridor to link up various residential developments or your various rail lines at a cost that would be far cheaper than if you have to buy private land in a brownfield development site. Have you ever given any thought to, or had a look at, that?

Dr Adams : Absolutely. That was the thesis of the 2010 Infrastructure Partnerships Australia paper, which was called East coast high capacity infrastructure corridors:a realistic pathwayto very fast trains. Corridors are very difficult to get because they are long and thin. If you have to go through a brownfield area, it is almost impossible to get a corridor. So the proposition was to look at the corridors that we need out till 2050, based on the settlement patterns that we think the country ought to have out to 2050, reserve the corridors now for shared infrastructure, whether it be road, rail, power, water, gas, hydrogen—I mean, let's think ahead—or optic fibre, and make the corridors wide enough, so that when we need the infrastructure in 20, 30 years time we do not have to go and tunnel it. The price of land is rising very quickly and if we do not have the corridors we have to tunnel. That keeps pushing out the date at which it is possible to build these things because the costs of tunnelling basically cripple most infrastructure projects. So, yes, absolutely, we are thinking about that.

One other minor point—sorry for cutting into your morning tea—is the point about sharing land uses. It seems to be an understandable position to have a minister for roads and a minister for rail. But each of them has an incentive to maximise the expenditure in their portfolios. If the outcome is land transport, why don't we have a minister for land transport whose job it is to deliver the outcome of land transport, not X-many kilometres of roads and Y-many kilometres of rail? We wrote this fantastic VCEC paper called More productive space and time. It was trying to capture this notion that what really matters is the productivity of both land use and travel time savings. It was a fantastic paper. What we wrote about was actually swapping land uses. We calculated that rail is a more productive use of land than road. You can get more passenger kilometres per square metre on a rail line than you can get on a road, because you are jammed up in a train and you are spread out in a car. So if land is scarce, as it is in the centre of a city, you should be using rail, and if land is cheap, as it is in the outskirts, you should be using road. Does that make sense?

But there is a crossover. You go from that: sparse land, you use roads; really congested, valuable land, you use rail—somewhere in between, you cross over. And that led us to the view that at some point you might actually take a road corridor and turn it into a rail corridor because it lifts the productivity of the land. But that will never happen while you have a minister for roads who is being instructed by his bureaucrats to protect the roads empire, and a minister for rail who is being instructed by his bureaucrats to protect the rail empire. So it is an incentive problem that goes right to the top of cabinet, unfortunately—right to the top of state cabinets.

Mr ZIMMERMAN: It is hard enough to get a cycle lane; the concept of ripping up a whole road is challenging!

Dr Adams : Indeed.

CHAIR: That is a very valuable contribution. Thank you very much for attending today's hearing and for your submission. The secretariat will send you a draft transcript of proceedings so that requests can be made to correct any errors of transcription. Thank you.

Dr Adams : Thank you very much—and kill that worm!

Proceedings suspended from 10 : 26 to 11:13