Governments need to change the way they conduct business cases for major transport projects, or risk wasting billions, the Grattan Institute has said.
The think tank has taken aim at the high discount rates which Australian governments apply to assess the costs and benefits of transport infrastructure over time.
The report, Unfreezing discount rates: transport infrastructure for tomorrow, found that the discount rate had been stuck at seven per cent since the late 1980s, even though the real interest rate – which should be a key component in setting a discount rate – had fallen from eight per cent to one per cent.
The Grattan Institute suggests the discount rate should be halved to 3.5 per cent for low-risk transport projects like trains, buses and urban roads, and reduced to five per cent for higher risk projects like ferries and freight rail.
In the private sector and other agencies that regulate non-transport infrastructure, the report said, it was standard practice to adjust discount rates to reflect level of risk and real interest rates, and there was no rationale for not doing the same in the transport space.
“With our cities growing rapidly, smart investment in infrastructure is vital,” transport program director Marion Terrill said.
“We need to improve our project evaluation, so we build the right transport projects in the right order. Better discounting would be a big step in that direction.”
The report found that if current transport projects were evaluated under the proposed discount rates, the benefit-cost ratios (BCRs) could be wildly different.
For example, marginal projects like the Melbourne Metro and Inland Rail Freight would go from BCRs of about 1:1 to 2.5:1.
“The choice of discount rate can affect not only whether a project is assessed as worthwhile, but also which project among several is assessed as the most worthwhile,” the report said.
For example, at a seven per cent discount rate, the Murray Basin Rail project has the highest BCR, though at a four per cent discount rate, the benefits of the Melbourne Metro and Inland Rail Freight were deemed higher.
“As a general rule, projects with deferred benefits are hit hardest by high discount rates,” the report said.
“Using an inappropriate discount rate is likely to distort the priority that is assigned to different projects, and so distort choices involving billions of dollars of public investment. We may end up building projects in the wrong order, or worse, building the wrong projects.”
The Grattan Institute is calling on governments to establish “an authoritative, evidence-based approach to setting discount rates”, and in the interim lower the discount rates to those suggested above.