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Modelling to a standstill

20 November 2008

None of us were around in 1870 when Vogel chose to build the railways in New Zealand but we might speculate that the economic rationale supporting a £7.5 million project for a country of 250,000 people went something like: “A prosperous modern economy needs a comprehensive rail network. We want New Zealand to be prosperous. We will build a railway.”

It is interesting to reflect on what would have happened had Vogel submitted his proposal to a modern economic regulator. The regulator would have sat down and earnestly compiled a view of the costs and the benefits, subtracted the former from the latter, found an enormously negative number, and dismissed the idea as lunacy. And that would have been a disaster.

The new Government has vowed to focus on infrastructure. Doesn’t take a rocket scientist – or economic modeller – to tell us there’s plenty that needs doing, and it’s not a bad time to get on with it as we march towards recession. The question is how to ensure it happens at a decent clip so that our economic performance can improve both in absolute and relative terms.

Of course, it’s a tricky issue. We don’t want to plough increasingly scarce capital resources into the wrong thing, but how do we recognise the wrong thing when we see it?

The current approach of the Electricity Commission to the supervision of transmission investment by Transpower is a classic case where we are striving to prove that an investment is optimal. How do we prove it? We build an economic model, of course. But the sad truth is, you can’t prove it because most of “it” hasn’t happened yet.

Ultimately, an economic model is just a forecast, which is just a fancy word for a guess. The only thing we know for certain is that it will be wrong. These modeller characters are bright, really bright. But the world is too complex for even the brightest. How good was the model that Lehman Brothers were working off? Or AIG? Or Iceland? What is around the corner for the hedge funds? The models are incredibly sophisticated but nowhere near as sophisticated as the increasingly globalised economic organism.

To climb back into the top half of the OECD, we are going to need ambition, vision and leadership. We can’t afford to wait patiently for a bunch of clever people to debate the imponderables at the margins of a particular transmission proposal that – on a particular view of the world – might be a bit over the top.

We’re not just talking about the ignominy of forgoing heating the living room during another “dry winter”. We are talking about the backbone of our economy. Let’s get on with it! We’re desperately trying to avoid committing the cardinal sin of “gold plating”. God forbid we end up a little bit future-proofed. We crave instead something perfect – not too big, not too small, and just in time. Well that would be just fine if it was realistic to expect a modelling exercise to distinguish between a really, really good proposal and an optimal one.

On the flipside there are the risks associated with underinvestment. Yes, we’ve built a couple of White Elephants over the years – the Synfuels plant being an obvious one – but we’ve also missed opportunities. Don’t we wish Robbie had been allowed to build his rapid transit light rail system around Auckland? Don’t we wish that our ports were in a better position to deploy capital strategically for the good of the nation rather than smearing it across a multiplicity of sites each pursuing a parochial regional agenda?

Take “Fibre to the Home”. Expensive. Especially out in the wops. But so was “Electricity to the Home”. The developed world has committed to an online future. We conquered distance once with refrigerated shipping. If the vision is that we conquer it again with Broadband, let’s go for it. Surely, if there is a potential economic uplift buried somewhere in this fibre revolution, it will be disproportionately high for us.

Understandably, a private company’s investment horizon may well not accommodate such boldness. The demand, and the wealth, just isn’t there yet. So it’s chicken and egg. Unlike a commercial entity, the Government is in a position to take a truly inter-generational view of economic transformation. The Nats are right then to subsidise the investment from the public purse. Is $1.5 billion enough? Hard to say. Maybe an economic model can help us out a bit here. Used sensibly, it can identify the boundary between where the commercial business case stops and the strategic or transformative decision starts.

No-one would argue that there is not a use for economic modelling but it should not be allowed to substitute for larger judgements. Identify the need, design the solution and execute. Then get on with the next thing. Action, not prevarication. Less talk, more do. It’s what New Zealand was known for back in Vogel’s day.

This article was first published (in shortened form) in The Independent. Neil Anderson is a Partner at Chapman Tripp. These views are his own rather than those of the firm or its clients.

For more information, contact our Web Editorwebeditor@chapmantripp.com+64 9 357 9622

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