Review of Methods for Estimating the Economic Impact of Transportation Improvements

Michael Iacono David Levinson August 1, 2008

Word Count: 4,871

Fellow, University of Minnesota, Department of Civil Engineering [email protected] Braun-CTS Chair of Transportation Engineering; Director of Network, Economics, and Urban Systems Research Group; University of Minnesota, Department of Civil Engineering, 500 Pillsbury Drive SE, Minneapolis, MN 55455 USA, [email protected] http://nexus.umn.edu
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Research

Abstract Transportation analysts and the public decision-makers they support are confronted with a broad range of analytical tools for estimating the economic impacts of improvements to transportation networks. Many of the available models operate at different scales and have distinctly different structures, making them more or less appropriate for analyzing the impacts of different types of projects. Here, we review several of the economic methods and models that have been developed for analyzing the impact of transportation improvements, giving special attention to types of projects that add highway capacity in urban areas. We review project-based methods, including benet-cost analysis and several analytical software tools developed by the Federal Highway Administration (FHWA) for economic analysis of transportation investment. We then move on to aggregate and disaggregate-level econometric methods, including regional economic models, hedonic price functions, production functions and cliometric analyses. We also devote some attention to the role of induced demand in economic evaluation, since it is often one of the most uncertain and confounding factors faced by those charged with conducting economic evaluation of transportation projects.

Introduction
When confronted with the problem of evaluating proposals for projects involving new highway capacity, public decision makers face a bewildering array of options for anticipating and assessing project-related economic impacts. On one hand, the issue of geographic scale is highly relevant. Local or project-level impacts may be very different from those estimated at regional and multiregional levels. Another salient issue is that there are many metrics for assessing economic impacts, ranging from direct user benets and changes in external costs of travel to more aggregate economic indicators, such as employment, income and productivity rates. Several types of economic benets arise from transportation improvements: reductions in travel costs, 1 more efcient supply chains, intra-rm scale economy effects (permitting individual rms to through larger scale operations at fewer locations), agglomeration (including inter-rm scale effects) whereby clusters of competing and complementary rms perform better than rms in isolation, and re-organizational benets, where rms can reorganize the way they produce output, and improve quality or even the goods that can be produced thanks to new infrastructure, just-in-time production is an example. All of these benets relate, and may be fully capitalized into the price of land, property and products. Project-level, disaggregate studies tend to focus on the rst of these effects, while more aggregate methods are applied to the next two. Almost no studies consider the longer term agglomeration or reorganization benets of improved infrastructure (20), and identifying the existence of positive externalities from infrastructure (i.e. gains that are not captured by users) is very difcult. The economic impacts of transportation improvements have been measured alternatively at either a macro or a micro scale. The former contain much of the theoretical literature underlying the calculation of impacts and can be traced back to early works such as (42). The latter have become associated with more general studies of the overall impact of transportation or public capital spending on aggregate measures of output. The development of methodological approaches to economic impact measurement has since evolved to t more practical applications, and these have mostly been carried out at smaller scales, taking the form of benet-cost analyses for particular projects (43), regional or corridor investment analyses (1; 18) , or studies of the impact of specic projects on local property values. This synthesis reviews several strands of relevant literature that aim to assess the basic issue of the economic impact of highways. It begins with a discussion of traditional, project-based economic analysis methods, based on microeconomic foundations and benet-cost analysis methods. Some attention is paid to the specic topic of induced demand, since this issue presents unique difculties for microeconomic analysis methods. Then, the discussion turns to regional
analysts consider reductions in travel costs a user benet, not an economic benet, but we nd it hard to see how users are not part of the economy. We do believe that user costs should be quantied distinctly from other benets and double counting of benets should be avoided.
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and macroeconomic methods, including input-output and econometric modeling. The nal section summarizes the previous discussion and offers some prospective ideas about evaluating the impacts of transportation improvements.

Software Tools for Impact Analysis

The majority of economic impact studies for highway capacity projects are undertaken using conventional methods. These methods tend to focus on the direct user impacts of individual projects in terms of travel costs and outcomes, and compare sums of quantiable, discounted benets and costs. Inputs to benet-cost analyses can typically be obtained from readily available data sources or model outputs (such as construction and maintenance costs, and before and after estimates of travel demand, by vehicle class, along with associated travel times). Valuation of changes in external, somewhat intangible costs of travel (e.g., air pollution and crash injury) can usually be accommodated by using shadow price estimates, such as obtained from FHWA-suggested values, based on recent empirical studies. The primary benets included in such studies are those related to reductions in user cost, such as travel time savings and vehicle operating costs (e.g. fuel costs, vehicle depreciation, etc.). Additional benets may stem from reductions in crash rates, vehicle emissions, noise, and other costs associated with vehicle travel. Project costs are typically conned to expenditures on capital investment, along with ongoing operations and maintenance costs. A number of economic analysis tools have been developed under the auspices of the Federal Highway Administration (FHWA) permitting different forms of benet-cost analysis for different types of projects, at different levels of evaluation. Several of these tools are prevalent in past impact analyses, and are described here. However, none identies the effects of infrastructure on the economy and development.

MicroBENCOST
MicroBENCOST (40) is a sketch planning tool for estimating basic benets and costs of a range of highway improvement projects, including capacity addition projects. In each type of project, attention is focused on corridor trafc conditions and their resulting impact on motorist costs with and without a proposed improvement. This type of approach may be appropriate for situations where projects have relatively isolated impacts and do not require regional modeling.

SPASM
The Sketch Planning Analysis Spreadsheet Model (SPASM) is a benet-cost tool designed for screening level analysis. It outputs estimates of project costs, cost-effectiveness, benets, and energy and air quality impacts. SPASM is designed to allow for comparison among multiple modes and non-modal alternatives, such as travel demand management scenarios. The model is comprised of three modules (worksheets) relating to public agency costs, characteristics of facilities and trips, and a travel demand component. Induced trafc is dealt with through the use of elasticity-based methods, where an elasticity of vehicle-miles of travel (VMT) with respect to travel time is dened and applied. Vehicle emissions are estimated based on calcuations of VMT, trip length and speeds, 4

and assumed shares of travel occuring in cold start, hot start, and hot stabilized conditions. Analysis is conned to a corridor level, with all trips having the same origin, destination and length. This feature is appropriate for analysis of linear transportation corridors, but also greatly limits the ability to deal with trafc drawn to or diverted from outside the corridor. (12) describe the model and its application to a freeway corridor in Salt Lake City, Utah.

STEAM
The Surface Transportation Efciency Analysis Model (STEAM) is a planning-level extension of the SPASM model, designed for a fuller evaluation of cross-modal and demand management policies. STEAM was designed to overcome the most important limitations of its predecessor, namely the assumption of average trip lengths within a single corridor and the inability to analyze systemwide effects. The enhanced modeling capabilities of STEAM feature greater compatibility with existing four-step travel demand models, including a trip table module that is used to calculate user benets and emissions estimates based on changes in network conditions and travel behavior. Also, the package features a risk analysis component to its evaluation summary module, which calculates the likelihood of various outcomes such as benet-cost ratios. An overview of STEAM and a hypothetical application are given by (13).

SMITE
SMITE (Spreadsheet Model for Induced Travel Estimation) is a sketch planning application that was designed for inclusion with STEAM in order to account for the effects of induced travel in trafc forecasting. SMITEs design as a simple spreadsheet application allows it to be used in cases where a conventional, four-step travel demand model is unavailable or cannot account for induced travel effects in its structure (11). SMITE applies elasticity measures that describe the response in demand (VMT) to changes in travel time and the response in supply (travel time) to changes in demand levels.

SCRITS
As a practical matter, highway corridor improvements involving intelligent transportation systems (ITS) applications to smooth trafc ow can be considered capacity enhancements, at least in the short term. The FHWAs SCRITS (SCReening for ITS) is a sketch planning tool that offers rough estimates of ITS benets, for screening-level analysis. SCRITS utilizes aggregate relationships between average weekday trafc levels and capacity to estimate travel speed impacts and vehiclehours of travel (VHT). Like many other FHWA sketch planning tools, it is organized in spreadsheet format and can be used in situations where more sophisticated modeling systems are unavailable or insufcient.

HERS
In addition to helping states plan and manage their highway systems, the FHWAs Highway Economic Requirements System for states (HERS-ST) offers a model for economic impacts evaluation. In once case, (37) use HERS-ST to conclude that Texas is under-invested in highways particularly 5

urban systems and lower-order functional classes by 50 percent. Combining economic priniciples with engineering criteria, HERS evaluates competing projects via benet-cost ratios. Recognizing user benets, emissions levels, and construction and maintenance costs, HERS operates within a GIS environment and will be evaluated under this project, for discussion in project deliverables. Well established software like HERS offer states and regions an oportunity to readily pursue standardized economic impact evaluations on all projects, a key advantage for many users, as well as the greater community.

Summary of Software Tools

Many analytical tools, like those described above, are favored due to their relative ease of use and employment of readily available or easily acquired data. However, several characteristics limit their effectiveness in evaluating the effects of new highway capacity. First, they are almost always insufcient to describe the full range of impacts of new highway capacity. Such methods deliberately reduce economic analysis to the most important components, resorting to several simplifying assumptions. If a project adds capacity to a particularly important link in the transportation network, its effects on travel patterns may be felt outside the immediate area. Also, the effects of induced travel, in terms of either route switching or longer trips, may not be accounted for in travel models based on a static, equilibrum assignment of trafc. In the longer term, added highway capacity may lead to the spatial reorganization of activities as a result of changes in regional accessibility. These types of changes cannot typically be accounted for in analysis methods. Second, there is the general criticism of methods based on benet-cost analysis that they cannot account for all possible impacts of a project. Benet-cost methods deliberately reduce economic analysis to the most important components and often must make simplifying assumptions. The project-based methods described here generally do not describe the economic effects of a project on different user or non-user groups. Winners and losers from a new capacity project cannot be effectively identied and differentiated. Third, a signicant amount of uncertainty and risk is involved in the employment of projectbased methods. Methods that use benet-cost techniques to calculate B/C ratios, rates of return, and/or net present values are often sensitive to certain assumptions and inputs. With transportation infrastructure projects, the choice of discount rate is often critical, due to the long life of projects and large, up-front costs. Also, the presumed value of travel time savings is often pivotal, since it typically reects the majority of project benets. Valuations of travel time savings vary dramatically across the traveler population, as a function of trip purpose, traveler wage, household income, and time of day. It is useful to test several plausible values. Assessment procedures in the UK and other parts of Europe have moved towards a multi-criteria approach, where economic development is only one of several appraisal criteria. Environmental, equity, safety, and the overall integration with other policy sectors are examined in a transparent framework for decision makers. In the UK, the Guidance on the Methodologies for Multi-Modal Studies provides such a framework (14). These procedures require a clear denition of project goals and objectives, so that actual effects can be tied to project objectives, as part of the assessment procedure. This is critical for understanding induced travel effects. Noland (47)has argued that this implies that comprehensive economic assessment, including estimation of land valuation effects, is the only way to fully assess the potential benecial impacts of projects.

Induced Demand
Since so many assessments of project benets are based on travel-time savings, the issue of induced or elastic demand merits special attention. Since (26) provided evidence of an elasticity of 0.9 between road supply (capacity) and the demand for road use (VMT) among Californias counties, there has been a great deal of concern over how the provision of new highway capacity might affect travel behavior and whether new capacity policies might be self-defeating. Such ndings may have important implications for the long-term economic and social effects of highway capacity provision. However, there is still a great deal that is not known about the fundamental causal structure underlying the phenomenon of induced demand. Research attempting to decompose the complex issue of induced demand (29; 31) has emphasized that there are both short-run and long-run effects of highway capacity additions. Specically, in the short run, movements along the demand curve for road use are observed, as travelers may switch routes or substitute destinations. In the longer term, xed adjustments by travelers and location decisions by households and rms in response to changes in travel time and accessibility may affect levels of overall travel, leading to an overall shift in the demand curve. Recent research has only begun to address these issues in practice by substituting micro-level data and methods for macroscopic anlayses (21; 33; 44; 49) and addressing the reciprocal relationship between supply and demand (10; 32; 34). The relationship between road capacity supply and demand is a dynamic process and is difcult to model with conventional models of travel demand. Since project-based microeconomic analysis techniques, including some developed by FHWA, use output from these models as inputs to benet or cost calculations, their results may be somewhat skewed. Even the elasticity-based techniques provided in models like STEAM are likely to overestimate the response of travel demand to new capacity. The lack of a dynamic element in these analysis tools means that they are likely to overestimate user benets due to a) an inability to capture short-term behavioral changes as the transportation network evolves toward a new equilibrium and b) an inability to capture the codevelopment process in the long run, whereby infrastrucutre and land use develop jointly over time in response to each other. While the benets for individual users may drop in response to induced demand that diminishes the travel time savings, the fact that demand rises when capacity is added is indicative both of gains to users in general (more users take advantage of the facility), and of other economic benets that this research aims to capture.

Aggregate Economic and Econometric Methods

An alternative method for exploring the economic impacts of transportation investment is to observe and measure, at a larger scale, the relationship between investment in transportation infrastructure and indices of economic performance. A range of different methods fall under this general category, including the use of regional economic models, aggregate productivity functions, as well as more disaggregate model specications that allow for measurement at local and regional levels.

Regional Economic Models

One approach to measuring the effects of transportation investment at a regional level is to apply macroeconomic simulation modeling methods to represent the effects of cost savings and productivity enhancements due to transportation infrastructure investment. Economic impacts from such a model are measured in terms of employment, income and value added. A basic method for estimating the impacts of investment in a transportation project would involve estimating user benets from the project, translating these benets into economic consequences, allocating benets to specic economic sectors, and nally estimating the additional impact due to changes in logistics and product markets (59). Regional input-output models, such as IMPLAN and RIMS II, have seen extensive application in the transportation sector to issues such as the economic impact of highway and bridge construction (3) and regional estimates of commodity ows (58). (61) have noted a more recent shift in economic impact modeling toward the REMI (Regional Economic Models, Inc.) regional economic model (57). This has been attributed to the fact that while Implan and RIMS II are largely expenditure-driven (implying that, from a local perspective, a larger project is invariably a better project), the REMI model is able to translate the results of an analysis of the transportation impacts of a project into regional economic performance via its effects on business costs and productivity. For example, since trucking costs are an important input to most economic sectors, any cost savings attributable to a project can be traced through the local economy. One may question though, the extent to which a single transportation project (such as the addition of capacity to a local highway) will register signicant economic impacts, especially in larger urban areas. Since the changes to the transportation network and their associated cost savings are often modeled using static forecasting procedures, as described earlier, it is possible that any erosion of future benets, due to unanticipated changes in network conditions, would also limit the economic impact forecasted by a regional economic model. Furthermore, the quality of the data on which regional economic forecasts are made can be considered suspect. It is inherently difcult to measure, with a high degree of precision, trade ows between counties or other relevant economic units. This problem is compounded at larger scales of analysis. A nal note of caution is that regional economic models, like other types of complex, computer-based analysis tools, are vulnerable to misuse and abuse in order to justify new government projects. (41) identies some of the more common errors, such as ignoring the need of state and local governments to raise money to nance capital projects and treating construction wages as benets instead of costs.

Aggregate Production Functions

During the early 1990s, there was a resurgence of interest in research attempting to measure the contribution of public capital to economic productivity, following the publication of work by (2) and (45). Both of these researchers estimated econometric production functions for national productivity using time series data and treating public capital stocks as a separate input. Both studies found enormous returns to public capital and suggested that declines in spending on infrastructure as a share of GDP during the 1970s and 1980s might have been a cause for the decline in productivity observed during that period. This immediately prompted national debate over whether there was an infrastructure shortfall, a debate recently re-ignited by the collapse of the I-35W Mississippi River Bridge in Minneapolis. Subsequent research largely dispelled these claims. For 8

example, federal spending on public nonmilitary capital was shown to be roughly constant from 1950 to 1990, while state and local capital stocks (which tend to be much larger), grew considerably (23). Also, research that focused on industry-specic and state-level production functions, while controlling for unobservable differences in state-specic conditions, found much lower (and in some cases, statistically indistinguishable) rates of return (19; 30). (46) estimated the benets of highway investment at the national level between the 1950s and the 1980s and concluded that in the early years returns were as high as 35 percent per year, but that by late in the years of the construction of the Interstate system that contribution had dropped to roughly the same as the return from private capital, about 11 percent. One of the benets that has been associated with transportation improvements is the impact that increased accessibility has on agglomeration of urban areas. Agglomeration economies are an external benet that arise from the interaction and co-location of productive factors within an economy, such as infrastructure, suppliers and customers, as well as a pool of labor with the needed skills. This can provide added economic value to an economy. Agglomeration economies are mitigated by various diseconomies, such as congestion, that may also occur. Recent research by (22) has examined these impacts which may effect different industry sectors in different ways. The urry of economic research into the role of public capital and, in particular, highway infrastructure capital, shed light on an important way to measure the economic returns from transportation infrastructure investment, albeit at a highly aggregate level. With the aid of time series data, public infrastructure capital can be specied as a factor of production, and its contribution to productivity tracked over time. This information is critically important at a time when the U.S. National Highway System is essentially complete, and marginal improvements to the network must be evaluated. Care needs to be taken, though, in the specication and interpretation of the results from aggregate production function research. Denitions of public capital and other factors of production need to be rigorous (e.g. separating public highway capital from schools, airports, water systems, etc.). Also, the geographic scale of the research (local, state, national) needs to be clearly dened.

Cliometric Methods
Economic historians, utilizing so-called Cliometric methods (after Clio, the muse of history), have assessed the long-term retrospective impacts of major infrastructure investments. Among the more noted of these is the assessment by (17) of railroads and economic growth in the nineteenth century, which sought to estimate the incremental economic contribution of railroads compared with its precursor system of canals. Fogel concluded that railroads contributed an increment of only 0.4 percent per year of growth in economic output, compared with competing estimates as high as 4 percent per year (16). Fogel later won a Nobel Prize in Economics for his work. What is noteworthy about the economic history assessments of infrastructure assessments is that they underscore the profound difculty of a deep assessment of the impact of major infrastructure system implementations even a century after the fact. Of course, investments at a smaller scale pose less daunting challenges for analysis. The larger point is that the scale of investment is in many respects inversely proportionate to the difculty of measuring impacts. Thus, assessing the effects of a Washington Beltway is an order of magnitude more difcult that assessing the impact of adding a single link to an already deployed network. 9

Disaggregate Economic and Econometric Methods

Disaggregate Econometric Models
An alternative to using aggregate production functions is to specify econometric models relating levels of highway capital spending to economic indices such as employment, income, or various forms of output. Some of the later production function studies noted that, at smaller geographic scales, the effect of highway capital spending was to redistribute, rather than generate, economic activity (7). A related nding was that there were spillover effects from the provision of new highway infrastructure (8; 27; 62). These ndings were not necessarily new previous research had examined spatially-differentiated effects of highway capital spending (53; 54; 55), but they did signal a new direction for econometric research into the economic effects of highway capital. The contribution of much of the recent research into the relationships between transportation infrastruture provision and economic performance has been to rene methods of analysis. New methodologies aim to correct for potential temporal and/or spatial autocorrelation in datasets (4; 8; 15). Finally, new conceptualizations of the link between transportation investment and economic performance have been suggested, such as relationships between improved accessibility and employment outcomes (5; 48), rm inventory behavior as a way to measure the returns from highway infrastructure (50), and hybrid economic evaluation approaches that attempt to bridge the project-specic and macroeconomic approaches described herein (60). It should also be noted that there have been signicant advances in methodologies for disaggregate spatial econometric models, including generalized method of moments, maximum likelihood estimation, Prais-Winsten regression, and other techniques for dealing with spatially distributed panel data. These methods are becoming increasingly popular in current empirical research on infrastructure investment.

Hedonic Models for Property Valuation

Hedonic methods to capture the element of property value that is associated with infrastructure accessibility are arguably the most prevalent in the literature. These types of studies have been carried out mostly at local scales and attempt to capture the capitalization of transportation-related benets (and costs) on nearby properties. The analytical framework that is typically employed is that of least-squares regression, where the value of property can be decomposed into individual attributes of a structure and land value, based on neighborhood attributes that property buyers implicitly value. Recent examples include (6; 24; 28; 52; 56) and (9), which emphasize access to a particular freeway corridor. The application of hedonic modeling has been paralleled by attempts to probe the underlying causal relationship between transportation and land use (35) and specify the relationship within existing models. This line of research has asserted the importance of accessibility as the mechanism linking transportation and land use (38), (39) by lowering the cost of interaction between individuals and various types of opportunities (e.g. work, shopping).

Other Methodologies for Consideration

Of course, not all impacts can be quantied with available data sets. (36) survey employers near Dallas new high-ve interchange (the largest project of its kind in the State of Texas) reveal a 10

wide variety of fundamental information, including employers valuations of employee commute time and anticipated, as well as, ultimately, perceived, effects of project construction (on employee and customer access, for example). (25) survey of residents in bypassed Texas towns illuminate a range of meaningful, perceived benets (including diminished downtown congestion and noise), even in the wake of reduced sales in these same communities (51). Such details can serve as a priceless supplement to more numeric studies, emphasizing modeled travel time savings, hedonic values, employment levels, and the like.

Conclusion
This paper has reviewed a variety of approaches that might be employed to analyze the economic impacts of a highway network improvement. Several types of project-specic and more aggregate econometric methods have been described, each with important limitations for modeling the effects of upgraded facilities. The project-based methods reviewed here share the common limitation of being insufciently dynamic to model accurately the short-term (much less longer-term) impacts of changes to the service level provided by highways. The issue of induced demand and its effect on both travel behavior and location choice cause estimates of user benets to be unreliable, particularly in the long run. On the other hand, the econometric modeling approaches to the evaluation of highway improvements may provide plausible estimates of the economic effects of highway investment at an aggregate level, though they perform less well at specifying this relationship at the level of an individual project. This is particularly true of aggregate production function approaches, which have emphasized macroeconomic modeling at the expense of actual transportation economics (50). Hence, they lack the policy sensitivity to accurately reect the economic impacts of small-scale changes to transportation networks. Noting these limitations, the best way to proceed with an evaluation of the impact of a new or upgraded transportation link might be to combine one or more of the above approaches, perhaps across spatial scales, and compare the results. For example, in the case of an upgraded highway in a small urban or rural area, one might choose to evaluate the impact of this new link by estimating the increment in land values near the highway, then comparing this result to results obtained by modeling city or county-wide employment and income with and without the upgraded facility. Both of these results could be compared with the benets estimated from standard engineering economic models of highway performance. If the results of the different approaches largely agree with another, then this is a sign that the different approaches are essentially measuring the same thing and can be used to bound the true value of the economic impacts. If they differ greatly, then some effort should be devoted to uncovering the different assumptions and methodological concepts that underlie each approach. A good evaluation approach should both provide consistent estimates of project impacts and provide insight into the process that generated those impacts, so that the results can be applied in a policy-relevant context.

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