WP 1 Economics of European infrastructure funds: methodology

1. WP 1 Economics of European infrastructure funds: methodology Funding SP Dec 2005

2. Objectives of this WP: Methodology of a European infrastructure fund: • How to spend the money: • Selection of projects • Loan or subsidy • Other conditions (tolling, guarantees,…) • Individual accountability of projects • How to finance the working of the fund • Loans (what type?) • Subsidies (what type?) • How to operate the fund • Decision making on selection of projects • Decision making on total capacity of fund • Political feasibility • Membership issues • Termination rules for the fund • Conclude with concrete proposals to study

3. Tasks WP1 • Economics of federal infra funds • What has economic theory to contribute? • Questions for survey about EU and US experience • Survey of experience in EU • Survey of experience in US • Mark up rules for funding investments • Risk taking, financial constraints, multi-government levels, network effects • Conclusion: proposals

4. Survey of Theory with a Graphical example 1 • Consider a bridge or a railway line used by local users and foreign users • The bridge requires a lump sum investment X and we will analyse whether a local govt (member country) makes the right investment and pricing decisions • Public good economics focuses on two motives for federal aid: • Spillovers (use of the good by foreigners) • Insufficient financial capacity (not relevant for member states)

5. Survey of Theory with a Graphical example 2 • The bridge requires a lump sum investment X and we will analyse whether a local govt (member country) makes the right investment decisions • This is a simplification where we have only the 0/1 decision on investment, not the optimal choice of capacity • The bridge or railway will be used by locals and foreigners • We analyse the following cases: • No congestion, no pricing of infrastructure use • Congestion, optimal pricing • Congestion, locally optimal pricing • Corridor effects (or complementarity of investments) • Political economy issues • Two issues are of interest to us: • Does the local government take the right investment decision: will it make the investment when it is worthwhile? • Will it take the right pricing decision? • How can federal government correct this?

6. Economics of infrastructure projects – if unpriced and no congestion price Local govt: Total benefit local (blue)> total cost X Instead of Total benefit local + foreign > total cost X Federal intervention: subsidy rate s1 Total benefit local (blue)> total cost (1-s1) MWPlocal+foreign MWPlocal trips

7. Economics of infrastructure projects – if unpriced and no congestion • Economics of grants: • Mostly Conditional and open • Asymmetric information: Federal government does not know cost of project or precise share of foreign user • Optimise Subsidy contract = working rule of fund

8. Economics of infrastructure projects – if unpriced and congestion price Local govt: Total benefit local (blue)> total cost X Instead of Total benefit local + foreign > total cost X Federal intervention: subsidy rate s2 Total benefit local (blue)> total cost (1-s2) MWPlocal+foreign MWPlocal Average User Cost Loss of surplus due to foreign users trips

9. Economics of infrastructure projects – if priced at SMC and congestion price Local govt: Total benefit local + tax revenue > total cost X This means green area extra Instead of Total benefit local + foreign benefit + tax revenue > total cost X So grey area is still missing Federal intervention?: subsidy rate s3 Total benefit local (blue)> total cost (1-s3) MWPlocal+foreign MWPlocal Optimal toll Average User Cost SMC trips

10. Economics of infrastructure projects – if priced above SMC and congestion price Local govt: Total benefit local + tax revenue > total cost X Compared to SMC pricing, larger chance that project is realised BUT smaller total surplus (mainly for the foreign users) Federal intervention: Pricing contract + investment subsidy ? MWPlocal+foreign MWPlocal Local toll Average User Cost SMC trips

11. Economics of infrastructure projects – if priced, congestion and corridor effects • In a corridor, infrastructure use by foreigners (transit) in one country will depend on capacity and pricing in the other country • De Borger, Proost, Van Dender (2005) and De Borger, Dunkerley,Proost (2005) analysed this issue in more detail

12. TOLLING Corridors– 2 cases PARALLEL TOLL COMPETITION Country A LOCAL TRANSIT TRANSIT LOCAL Country B SERIAL TOLL COMPETITION TRANSIT Country A Country B TRANSIT LOCAL LOCAL

13. Relative efficiency of tolls in corridors(Nash equilibrium - illustration)

14. Relative efficiency of tolls (Nash equilibrium - illustration)

15. Endogeneous investments in serial corridor • 2 stage game with 2 countries, • First stage: decide on capacity • Second stage: pricing game (Nash) • First results for “roads” (constant returns to scale in capacity extension) and symmetrical countries • We start with an equilibrium with no pricing of the use of the road and 50% of roads is used by transit • Examine what capacity choices are made in function of pricing regimes • Introducing pricing leads to lower capacity with uniform pricing and a welfare loss !

17. POLITICAL ECONOMY of infrastructure projects –if unpriced, no congestion price Local govt: lobby for projects that give a local benefit if paid federally Benefit will be larger when use is unpriced or when revenues go to locals MWPlocal+foreign MWPlocal trips