The notion that the government should invest in infrastructure simply because the interest rate is currently low constitutes a logical error, according to transport economist Disa Asplund in a new SNS report. The interest rate is just one element in the calculations used for deciding upon investments. Not only should the entire risk of a project be taken into account, but also whether its overall benefits exceed its costs. Public investments in infrastructure are almost as risky and sensitive as diversified stock portfolios.
Prior to deciding upon public infrastructure investments cost-benefit analyses are usually carried out. Calculations in which the discount rate is crucial for the outcome. This discount rate can be seen as the desired annual return on the investment. Among other things, it shows how society values time and determines how future costs and benefits should be considered in the calculation.
In the report, Disa Asplund shows that several methods can be used to determine the discount rate. However, she also argues that regardless of the method used, a significantly higher discount rate must be applied compared to the current low interest rate at which the government may borrow money. Primarily, this is due to the fact that infrastructure investments are not free from risk. The government, and thus the taxpayer, takes on the credit risk. The government cannot avoid risks linked to the economy as a whole, something all projects have in common. In addition, these risks are likely underestimated due to, for instance, not taking extreme events into account. One example of such an event, which we are currently experiencing, is the corona pandemic.
»Investments in infrastructure should be based on real transport needs not being met by current transport systems and where the costs for projects are lower than the subsequent benefits. Such projects may be identified with and without low discount rates, and simply low interest rates cannot justify investments in infrastructure«, says Disa Asplund, researcher at the Swedish National Road and Transport Research Institute.
Typically, the return on infrastructure investments is lower than what is possible to achieve by means of financial instruments. Asplund shows that Swedish investments in transport infrastructure have historically been almost as risky as investments in diversified stock portfolios.
»The government should be able to obtain a higher return if investing in securities rather than infrastructure with the corresponding level of economic risk. Investments in securities also include an additional advantage in that the return can be distributed evenly across the country, whereas profitable investments in infrastructure are concentrated in specific geographical areas«, says Disa Asplund.
This report is published within the framework of SNS research project Sustainable Urban and Rural Planning.