FUNDING - SP -Dec 8+9 WP 1 Economics of European infrastructure funds: methodology Funding SP Dec 2005

FUNDING - SP -Dec 8+9 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

FUNDING - SP -Dec 8+9 Tasks WP1 1.Economics of federal infra funds 1.What has economic theory to contribute? 2.Questions for survey about EU and US experience 2.Survey of experience in EU 3.Survey of experience in US 4.Mark up rules for funding investments 5.Risk taking, financial constraints, multi- government levels, network effects 6.Conclusion: proposals

FUNDING - SP -Dec 8+9 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)

FUNDING - SP -Dec 8+9 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?

FUNDING - SP -Dec 8+9 Economics of infrastructure projects – if unpriced and no congestion price trips MWP local MWP local+foreign 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)

FUNDING - SP -Dec 8+9 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

FUNDING - SP -Dec 8+9 Economics of infrastructure projects – if unpriced and congestion price trips MWP local MWP local+foreign 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) Average User Cost Loss of surplus due to foreign users

FUNDING - SP -Dec 8+9 Economics of infrastructure projects – if priced at SMC and congestion price trips MWP local MWP local+foreign 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) Average User Cost SMC Optimal toll

FUNDING - SP -Dec 8+9 Economics of infrastructure projects – if priced above SMC and congestion price trips MWP local MWP local+foreign 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 ? Average User Cost SMC Local toll

FUNDING - SP -Dec 8+9 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

FUNDING - SP -Dec 8+9 TOLLING Corridors– 2 cases Country A Country B Country ACountry B TRANSIT LOCAL TRANSIT LOCAL PARALLEL TOLL COMPETITION SERIAL TOLL COMPETITION TRANSIT

FUNDING - SP -Dec 8+9 Relative efficiency of tolls in corridors (Nash equilibrium - illustration) 50% local,50% transit – welfare gain w.r.t no tolling Parallel Network (2 links) Serial Network (2 links) 1st Best100% Competition + toll discrimination 93%-1087% Competition+ uniform toll 89%- 665% Toll on locals only22%37%

FUNDING - SP -Dec 8+9 Relative efficiency of tolls (Nash equilibrium - illustration) 50% (90) local, 50% (10) transit – welfare gain w.r.t no tolling Parallel Network (2 links) Serial Network (2 links) 1st Best100% Competition + toll discrimination 93% (99.9%)-1087%(-126%) Competition+ uniform toll 89% (99%)- 665%(+63%) Toll on locals only22% (63%)37% (+89%)

FUNDING - SP -Dec 8+9 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 !

VariableUnit Nash Equilibrium differentiation Nash Equilibrium uniform Nash Equilibrium local tolls only Local demand (1300 in no toll equil)Trips Transit demand (1300 in no toll equil)Trips Trip volume, country levelTrips Generalised price, localEuro/Trip Generalised price, transitEuro/Trip Capacity (2000 in no toll equilibrium) Inverse capacity Local TollEuro/Trip Transit TollEuro/Trip Local MECEuro/Trip Global MECEuro/Trip Local CSEuro Tax revenue, country levelEuro Cost of capacityEuro Welfare, country levelEuro Transit welfare (CS)Euro Overall welfareEuro Change compared to Non toll equil%

FUNDING - SP -Dec 8+9 POLITICAL ECONOMY of infrastructure projects –if unpriced, no congestion price trips MWP local MWP local+foreign 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