Freeman

ARTICLE

The Road to Ruin

DECEMBER 01, 1981 by JOHN SEMMENS

Mr. Semmens is an economist for the Arizona Department of Transportation.

In our private lives it seems that crises are relatively rare events brought on by extreme circumstances and unforeseen situations. In the realm of public policy, however, crises seem to be the norm rather than the exception. We have international crises, domestic crises, monetary crises, fiscal crises, energy crises, crises of confidence, ad nau-seam. The government apparently has the capacity to turn the most prosaic and mundane circumstances into crises.

The “crisis” of the ‘80s will be the need to rebuild America and make her great again. Dire consequences are predicted if we fail to meet this challenge. A subsidiary “crisis” to the more general need to rebuild America is a “public sector in ruins.” Within the public sector, few things are as threatened with ruination as our highway system. In state after state, the cry has gone out that our roads are crumbling, that without drastic action (a doubling or tripling of taxes) we won’t be able to get from here to there. Our economy will collapse and savagery ensue.

Why has the highway finance issue reached a crisis stage? Examination of the nature of the highway product and how the government has sought to provide it will reveal a classic example of public sector failure. The tragedy is that the failure was foreseeable and predicted by many critics of government waste and mismanagement.

We will be able to make more sense of the issues in highway financing if we realize that highways are investments. The decision to build a highway will have consequences very similar in nature to the decision to build any other capital facility. To insist, as some do, that since highways are publicly owned they are exempt from normal investment decision criteria will be destructive to the general welfare.

Regardless of whether a facility is owned and operated as a public or private undertaking, the economic law of scarcity still applies. This law of scarcity is a common-sense recognition of the finite nature of our existence. In the final analysis, there is only a limited amount of time available to us to devote to efforts aimed at serving a multitude of needs. Time consumed in acquiring or manufacturing the resources to serve a portion of our needs is not available to spend in efforts to serve other needs.

Recognition of this finite limit is important if we are to rationally manage our time and effort. Of necessity, any one need or problem cannot be considered in isolation from all other needs or problems. This might appear to make for an unwieldy mess, since it is unlikely that any one person or group of persons could conceivably consider all needs or problems simultaneously. Fortunately, society has evolved the market institutions that serve to calculate the best uses of scarce re-sources for the constantly changing needs and problems of a diverse world.

The Function of Prices

The price system of the marketplace yields us a “best estimate” of the current and future values of various resources in meeting human needs. This price system applies both to the commodities that might be employed in implementing our plans to meet our needs and to the capital required to purchase the commodities. By comparing the prices we must pay with the revenues we anticipate from our planned investments, we can determine whether what we intend to do is financially feasible. Inasmuch as the price system is a reflection of a continuous stream of voluntary choices, reliance upon its verdicts will also produce investments which are socially desirable.

Unfortunately, utilization of the market and its price system has not been well developed in the public sector. Past decisions in public highway construction were made on the basis of other factors. The result has been the creation of a roadway infrastructure which is becoming increasingly out of balance with the means to finance it. We cannot just build all that highway officials say we must build without massive increases in the amount of resources consumed by this activity. Our needs for roadways must compete with a multiplicity of needs for every sort of good or service. To devote resources to highway construction will mean, of necessity, that these resources cannot be devoted to other uses. In order to employ resources for the maximum benefit, it is necessary to determine how highways compare with other investments in terms of the benefits produced.

The cost of errors in the expenditure of resources on highway facilities is considerable. Once time, effort, and money have been converted into a roadway, they are irretrievable. Decisions on highway construction are cast in concrete. This irretrievability factor raises the risk of highway investment. Roads which do not return as much in value as they cost to build and maintain cause total economic output to decline.

The long-term effects of lower economic output are reduced welfare throughout society. There would be fewer employment opportunities, more poverty (as well as the social ills associated with poverty), fewer resources available to meet other human needs in the areas of health, housing, education, and the like, including other transportation needs.

Measuring the Value of Public Investment

It is not enough to assert that roads are “essential” to a community’s well-being. A lot of things are “essential” to this well-being. How are we to allocate scarce resources between competing “essential” goods or services? Given that wants are virtually unlimited, it is obvious that there won’t be enough resources to satisfy all demands. Consequently, society will be forced to choose which wants go unfulfilled.

In a market economy, society’s investments are made based upon the perceived return to be earned. That is, if the decision-maker believes that his gains from an investment decision will exceed the costs incurred in pursuing that decision, he will implement the investment. If he is right, he will enjoy profits which can be used for future investment or consumption. If he is wrong, he will suffer losses. If the losses are severe enough, the resources will be depleted and no future decisions or investments will be possible.

In the public sector, the connections between decisions and outcomes are more indirect. Establishing the costs and benefits for the purpose of estimating a future return on investment is more complex and difficult. The responsibility for the decision-making may be obscure. The profits or losses are diffuse and ambiguous. The short-term political impact of the decision will be more prominent in guiding public policy than the longer term investment returns. Nevertheless, these problems and complexities do not relieve society of the consequences of bad decisions made in the government sector.

The simplest approach to evaluating an investment is to match cash inflows to cash outflows. If more cash is coming in than going out, the activity is sustainable. If the reverse is the case, namely more cash on the way out than on the way in, the activity is unsustainable. Unsustainable activities may be rescued in one of two ways: reduce expenditures or increase revenues.

Private businesses might resolve a cash flow problem by either cutting out losing product lines, or increasing prices, or both. The public sector could well take heed of this approach. There are a few barriers that must be overcome, though, before a rational public policy can be adopted. First to go must be the notion that access to the road system is some sort of inherent right to which persons or corporations are entitled. Roads are material goods that cost real resources to construct, operate, and maintain. Individuals or businesses have no right to demand access to highway services without paying the costs of that service.

A second barrier to be overcome is the idea that it is not possible to fairly assess highway users for the cost of the services they require. Granted, the public sector has little experience with pricing and marketing its products. This is not to say that it should not be done.

A third barrier to be overcome is the notion that the value of road services can or should be determined independently of the use and fees collected for that use. It has been stated that user fees do not capture all of the benefits enjoyed by road users. In this respect, roadways are no different than any other economic good. Everything exchanged in a voluntary transaction produces benefits above and beyond the revenues collected by the seller.

Uncaptured Benefits

The problem of uncaptured benefits is not unique to highways, or to the public sector for that matter. To argue that higher taxes for highway purposes are justified because of the non-revenue- producing benefits occasioned does nothing to establish what priority, if any, highways are to have over any other use for resources. The fact that highways are public facilities often conveys the erroneous idea that this in itself makes them especially productive in terms of non-revenue- producing benefits. There is no basis for assuming that public sector investments do, while private sector investments don’t, produce these benefits. Yet, many analyses conducted by government economists implicitly make this assumption.

Since there is such widespread confusion surrounding this issue, an example may be most illustrative. A frequently cited example of a road’s non-revenue-producing benefits is the reduced travel time for emergency vehicles. Cutting an ambulance’s transit time by a few minutes may save a life. The value of this life is not reflected in the user fees collected from whatever highway taxes may be paid by the beneficiary of the life-saving event.

There can be little argument with the proposition that in instances like the aforementioned example, the benefits exceed the revenues produced. What isn’t answered is how the benefits of better roadways compare to the benefits produced by the other components of the life-saving event. Isn’t the phone call which summoned the medical help worth more than the 10 cents it may have cost? Isn’t the medical equipment that may be used—cardiopulmonary resuscitation machines, surgical tools, and the like—worth more than the cost? Isn’t the vehicle doing the transporting worth more than the cost? The list of other factors can be quite extensive. In the case of each component, it can be justly argued that the benefits to the person served exceeded the revenues captured by the manufacturers of the components.

The difficult question is how do we compare the non-revenue-producing benefits of each component? If we ignore the non-revenue contributions of every component other than the highway system, we will distort the investment picture. Universal application of a methodology which computed non-revenue-producing benefits for public sector investments only would result in a costly transfer of resources from their most productive uses to a series of largely arbitrarily selected public sector projects. This would reduce social welfare. The best road system in the world would be useless if vehicle manufacturers couldn’t obtain resources.

Arizona: A Case Study

Investigation of the Arizona State Highway System in terms of return on investment demonstrates the folly of ignoring the market in highway investment decisions. Over 60 per cent of the mileage on the State System does not generate enough revenue to cover the cost of upkeep. That is, nearly 4000 miles of roadway operate at a loss. These are roads under state jurisdiction. The situation appears to be even worse for county and local roads.

The investment performance of various portions of the State Highway System shows wide disparities in the returns generated vs. the costs incurred. Some segments cover their costs many times over. On the other hand, many segments won’t even generate enough revenues to cover

a fraction of their anticipated costs. Even if taxes were doubled, over 45 per cent of the system’s mileage would not generate enough revenue to cover the cost. If taxes were quadrupled, nearly 30 per cent of the State System would not cover the cost of upkeep. Finally, there are segments where the expenses are so high, or the revenues so low, that they can’t even cover 10 per cent of the cost. Over 780 miles of the Arizona State Highway System falls into this category. Roadways in this category include the fantastically expensive urban freeways and portions of rural highways that see little use.

The Market Is the Answer

The profit/loss profile of the highway system is a reflection of past decisions in highway investments. The crazy quilt pattern of viable and nonviable road segments serves as an indictment of the previous highway planning process. The schemes, the mechanisms that have been used in the name of the “public interest” or “general welfare” have been a complete flop. The resulting highway infrastructure serves transportation demand worse than a random system of roadway funding would have done.

Contemporary public debate has shunned the issue of government responsibility. The mismatch of highway expenditures and demand that has produced clogged urban streets and nearly vacant rural roads is portrayed as an accident, or a result of OPEC manipulations, or Japa nese auto manufacturers—anything but what it is: the failure of government in the provision of material goods and services.

It is easy to take the products of modern capitalism for granted. It would not be so easy to live without these products. If more and more resources are diverted to the public sector, because the total return on investment (with non-revenue benefits added) in the public sector appears better than the purely financial returns calculated for private sector firms, human welfare would be reduced.

It is not really feasible for us to attempt to measure the non-revenue-producing benefits of every possible use of resources. Fortunately, it is not necessary to do this. Comparability between alternative uses of scarce resources can be achieved by restricting analysis of benefits to the revenue-generating services for which users are willing and able to pay. This puts the onus on the public sector to exert more effort in ascertaining appropriate pricing systems in order to capture a larger portion of claimed benefits as cash inflow.

The fact that new pricing systems may be unprecedented or difficult to initiate is no argument against the legitimacy or the advisability of devising them. The advantages of developing a more market-oriented pricing system and using it to fund sustainable highway investments are persuasive. The foremost advantage is that it would most fully employ the device of allowing consumer choice. Consumers would have the option of using—and paying for what they use. This would move from a politically determined decision- making environment toward a more market determined environment. Greater customer satisfaction could be anticipated. Cash flows would be more stable—responding to the demand and use of the facilities, rather than to the political popularity of the road system. The continuous expression of market demand via user purchases of highway services would simplify the task of deciding what services to supply. Government would be more assured that it is providing value for the fees it collects.

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