20th September 2018
Why government CBAs are highly unreliable compared with private sector CBAs
In principle a low discount rate is not a problem. Were it not for the difficulty in estimating future demand, one could always build wide roads and even tunnels in anticipation of repayment by future generations who are invariably wealthier than the current one, in a free society.
But the real problem in infrastructure projects is the under-estimation of costs, as seen in repeated cost blow outs. These cost blowouts can significantly reduce net benefits.
Given the strongly proclivity of government CBAs to underestimate costs and over-estimate benefits, a 7 per cent discount rate is justified. Even higher would be better.
I’d like to add that this is not a problem in private investment CBAs in which costs are over-estimated and benefits under-estimated. No bank would lend money to investment proposals in which benefits are exaggerated.
The reason government CBAs are badly skewed is because there is no skin in the game for anyone involved. No one loses their job for bad CBAs, and it is all other people’s money. Everyone involved gets paid big bucks from taxpayers money.