Beware the Economic Con

John Hewson wrote in The Age (May 5, 2017) warning readers not to fall for the Federal Treasurer’s simplistic distinction between ‘good’ and ‘bad’ debt. He rightly notes the wisdom in distinguishing between capital and recurrent budgets for individuals, businesses and governments and ensuring that recurrent revenues balance recurrent spending. Investments that are expected to return more over the life of the asset than their cost of creation are appropriate targets for financing though debt. This, after all is how people buy the roof over their head, at least those fortunate enough to access mortgages do so.

But because the future is radically uncertain no one can know with certainty whether, in fact, future returns will be adequate to justify the initial decision to build and borrow. And so, judgment is called for. And judgment necessarily requires assessment of probabilities of outcome and values that determine which outcomes are desirable (and which undesirable) for whom. Whose values are to count? In a democracy, elected governments make final decisions.

Hewson is also right to warn us that when it comes to large and expensive infrastructure projects like airports, business and political vested interests often intrude. Lobbying, log rolling and pork barreling take over. Bad debt masquerades as good debt with dire consequences for future taxpayers stuck with paying off the white elephants bequeathed by today’s politicians. Politicians are notoriously prone to dress up projects of dubious economic and social value as generators of jobs and growth – in the uncertain future.

Hewson’s solution is to hive off decisions about long-term infrastructure investments to an ‘independent’ agency required to use the conventional techniques of social cost-benefit analysis.

Such an agency would be protected from the blandishments of politicians and other chancers by its independent charter, much like the Reserve Bank. It sounds good. But what is missing from the picture – ignoring for the moment the problems of getting agreement on the form, powers, personnel and accountability arrangements of such a body –is recognition of the essentially flawed and biased nature of the tool proposed. Cost-benefit analysis has value biases built into its arcane structure. Its application inherently favours projects that deliver benefits to the wealthy and powerful in the community while heaping costs on the least fortunate. It is assumed that a dollar of benefit (or cost) to Jamie Packer is the same as a dollar benefit (or cost) to a homeless person at his mansion gate. More worryingly, it assumes that a two dollar benefit to Jamie justifies a one dollar loss to a poor person.

Any effect of a project that can’t be allocated a dollar value is implicitly treated as irrelevant, consigned in footnotes to the status of ‘intangibles’, forgotten in the glare of the headline benefit-cost ratio trotted out to justify the project on ‘scientific’ grounds. End of debate, next project please. Again, it is the long list of ‘intangible’ consequences that most heavily impact on the least advantaged, as in the diverse negative effects of pollution and urban congestion, loss of public open space and the decrease in public safety in areas of the city undergoing terminal economic decline.

The interests of the wealthy are also over-counted in cost-benefit analysis because they have more ‘dollar votes’. They can afford to pay more than poorer people to both gain a good and avoid a bad. All consumers are sovereign but some are more sovereign than others! Cost-benefit analysis, even when not corrupted by fiddling the discount rate or deliberately ignoring difficult to identify effects, can produce the equivalent of ‘rotten boroughs’, situations in which policy reflects the interests of a narrow range of affluent influentials.

In fact, the conventional use of cost-benefit analysis closes public policy debate precisely at the point at which serious considerations should begin. This is where Hewson’s proposal to leave it to the experts should raise warning bells. It is a conceit of economists that they both know best and can be left to provide a purely technical, value-free answer to which social investments should be funded by some ‘mix of equity and debt’.

There are many examples where the unthinking use of cost benefit analysis has resulted in socially and economically disastrous outcomes. An infamous (hypothetical) case was provided by Lawrence Summers, ex-Deputy Secretary of the US Treasury, who semi-seriously noted that exporting toxic waste from the advanced economies to the poorest would generate a massively large benefit-cost ratio, even using the most sophisticated methods of putting dollar values on ‘intangibles’. The fact that such a trade exists is hardly a compelling reason for endorsing it.

There is no easy way to divorce judgments about what investments are technically feasible from whether or not they are ‘good’ for different interests across society. Beware the experts who say – ‘leave it to us’. Democratic processes may be, as Churchill famously informed the British House of Commons, ‘the worst form of government, except for all those other forms that have been tried from time to time’. Far better to openly engage debate about what projects and policies are to benefit us as citizens than outsource such decisions to an ‘independent’ agency relying on flawed tools.

For a detailed argument developing this critique, see my new book Morality and Power: On Ethics Economics and Public Policy.