Sunday, November 10th, 2013

Credibility, Cancelling Projects, and Sunk Costs

I was surprised to see that last Wednesday’s post on Cincinnati’s culture of self-sabotage received such a huge response. In light of that, I want to circle back and more fully address the idea of cancelling projects.

What I do not want you to take away from that is that once started, projects should never be stopped on account of the money spent. That’s called the sunk cost fallacy. Money that’s been spent has been spent. One needs to look forward to the future expected benefits and costs. There are certainly many cases in which pulling the plug can be a good idea. For example, Indiana Gov. Mitch Daniels reversed the privatization of certain social services functions after he determined it was unlikely the contract would ever work out like originally envisioned. This an example of someone taking a risk, trying to make it work, then acknowledging it didn’t rather than continuing to double down on a mistake.

On the other hand, I do not see the majority of these rail cancellations as having anything to do with benefit/cost analysis. You may notice, it’s only transit projects that ever seem to get the ax. Since the era of the freeway revolts, it’s tough to name any governor or mayor that has ever sent back earmarks on a highway project, or ever cancelled any road project they could actually get money to build on the grounds that it’s a boondoggle. (My hypothesis continues to be that there’s no highway boondoggle big enough that even the most fiscally conservative governor is willing to kill it). Clearly, the cancellations in these cases is based on an ideological animus to transit specifically.

That is, unless it is baser motivations at play. Chris Christie’s cancellation of the ARC tunnel project enabled him to use the funds New Jersey had pledged to the project to bailout the state’s bankrupt highway fund. He’s not demonstrated any hesitancy to push even questionable and expensive transit projects when they involve Somebody Else’s Money. For example, he wants the Port Authority to spend a billion dollars on an extension of PATH service to Newark Airport, which many consider an inappropriate use of funds. Christie’s motivation appears to be bribing United Airlines to add flights to Atlantic City, whose gambling market is imploding. (Read up on the Revel Casino deal if you want to know more about this sordid story).

Meanwhile, many of these cancellations are proving to be costly in their own right. I noted before how Cincinnati had already let $95 million in contracts out the total $133 million cost of the streetcar, how it will have to repay federal grants that were going to pay for a big slug of the project, and likely end up with at best a minor financial win and potentially a loss.

It’s the same in Wisconsin. Gov. Scott Walker trumpeted that he was returning an $810 million stimulus grant for rail upgrades between Madison and Milwaukee. Apparently although the federal government was going to pay 100% of the construction costs through the stimulus bill, he didn’t want the state to have to pick up the estimated $7.5 million in annual operating costs. (How much the state actually would have had to pay incrementally is a an open point. The existing Hiawatha operating costs were being 90% paid for by federal funds. It’s by no means clear that the state would have been on the hook for the full amount anyway). The feds were actually generous enough to reimburse Wisconsin for money it had spent on the rail line it decided not to build. However, that did not prove to be the end of the matter. Train maker Talgo is planning to sue the state of Wisconsin for $66 million for breach of contract. Given that it actually built trainsets for the state, this seems like a strong case. Also, if the state does lose, it might also be forced to immediately repay an additional $70 million in loans. The state could have paid operating costs for a long time for that kind of money – and it would actually having something to show for it other than a hole in its bank account.

So from a financial perspective, it’s not even clear cancelling these projects was a good move – even if you look solely at costs and ignore benefits.

But beyond the financials, these types of things also show communities that have deep internal divides, and which as a result require businesses and residents to apply an additional uncertainty premium into investment business cases there to account for the likelihood that a) promised actions by the government may not actually occur, even if they are in flight and b) that the community may not be able to muster the staying power to make the kind of long term investments that are necessary for any community to retain marketplace relevance. Though hardly immune to infrastructure drama, New York City just put water tunnel #3 into service for Manhattan. This is a project that was started in the 1970s. That’s the type of long term thinking that has kept a place like New York on top. In short, credibility counts for something, and places like Cincinnati and Wisconsin have damaged theirs.

I want to contrast this with one of the legendary stories of Indianapolis. In the late 1980s it embarked on construction of a downtown mall. Maybe that wasn’t the best idea in the world. The city definitely didn’t have its act fully together. Two entire city blocks had been excavated and were literally holes in the ground. No anchor stores had been signed and it wasn’t clear if the project would or even could be finished. A lot of the public suggested scrapping the project. Some suggested turning the empty blocks into ice rinks. Others trying to bring in a Wal-Mart. Instead, city leaders across the board came together to commit to the project, including many of the downtown corporations investing in the project. It got built. While generally successful, the mall has certainly had its share of troubles over the years and may not even survive over the long term given the disfavor of the mall format. However, one thing that project demonstrated is that Indianapolis finishes what it starts. In short, they have credibility and an ability to execute that’s simply better than most places. I suspect that’s one of the reasons metro Indy has so outperformed Cincinnati in population, job, and reputational growth, despite having far, far fewer natural assets to start with. They aren’t constantly shooting themselves in the foot.

This is also why even though there are road projects out there I did not think were a wise use of funds – say I-69 in Indiana, to pick one I’ve criticized – once they are being built I’m all in favor of getting them done as quickly and cheaply as possible. And then letting the communities in question live with the consequences of making that choice, for good or ill. Again, that doesn’t mean no project should ever be cancelled, but you need to pick your battles. Communities are not well served when project debates turn into endless years of scorched earth politics, litigation, etc. in which neither side will ever given an inch on anything.

26 Comments
Topics: Public Policy, Transportation
Cities: Cincinnati, Indianapolis, Madison (Wisconsin), Milwaukee, New York

26 Responses to “Credibility, Cancelling Projects, and Sunk Costs”

  1. MichaelSchwartz says:

    I think it is downright criminal that funds allocated to a state/municipality by the Feds are yanked if and when a project is abandoned like the high speed rail. If I were a citizen in those states where this has happened I would be screaming bloody murder. They should be reallocated to another perhaps more worthy project in the same state. That being said it would appear that the Cincy trolley project was never fully a go so it is questionable what should happen besides the understandable emotional angst.

  2. Bill C from Cincinnati says:

    @MichealSchartz “Never fully a go?” Rails are in the ground!

    http://www.cincinnati-oh.gov/streetcar/news/streetcar-progress-update-nov-8-2013/

  3. Bill C from Cincinnati says:

    @MichaelSchwartz Sorry I got your name wrong, the text I was typing was showing up very small on my phone.

  4. Matthew hall says:

    Michael needs to see cincinnati as a failure for some reason. He can’t handle the truth. A city fails because it’s in enough people’s interests for it to fail. it’s a choice.cincinnati’s future mayor wants cincinnati to fail. he needs it to fail, so he can succeed. Detroit failed because it failure benefited people.

  5. 14th&Bremen says:

    @MichaelSchwartz Wouldn’t redirecting the money allocated to a specific project be just like reallocating a home mortgage during the homes construction? If you go to a bank for a home loan and get approval you can’t then spend the money on a new boat, new car, and cosmetic surgery, unless specially outlined in the original agreement. You agreed to spend the money on a new home.

    Wouldn’t the streetcar money work the same way?

    We got the loan/grants and agreed to spend it on the Streetcar. It would be like starting to build the new home and then stopping midway to go purchase a new BMW.

    The bank would want the money back, file a lawsuit or expect you to pay back any money spent. Then the home builder and subcontractors would file a lawsuit for not finishing the project.

  6. Rod Stevens says:

    I do think this ability to make decisions, and how they’re made, is all important. Note that some of these canceled projects involve a “strong man” coming in and canceling something. That doesn’t speak well for the ability of the community to get along, to tap its various internal talents and use the decision to build or strengthen a long term vision that other decisions can fit within.

    Some years ago I was at dinner with an engineer who was on the team to extend the Portland light rail system south on I-205. He told me there were 25 people on the weekly team meetings. I asked him if these weren’t terrible meetings, because of having so many people in attendance. No, he said, in fact, the experience was the best of his career, that the meetings worked really well. The team was mostly comprised of people who had worked together on the previous light rail project, it had a very good manager in charge, and everyone expected everyone else to come to the meeting prepared. If there was something that needed a side meeting, those people went off during the meeting and worked it out and brought it back in the same session. If there was something that needed research between the end of that meeting and the next one, the person responsible was expected to have the answer at the next meeting, or else they would be deeply embarrassed. In short, this had become an effective task force: it had expectations and working rules, the people knew one another well enough to work with one another, and there was pride at getting things done. That is the way things are supposed to work.

    Maybe we now manage things so poorly that we have lost our expectations.

  7. KerryH says:

    Aaron, I agree with what you are saying and there is another major factor at play in Cincinnati. John Cranley, the newly elected mayor who is determined to destroy the streetcar project is registered as a Democrat but is a Democrat in name only. He was endorsed by COAST who is the litigation happy tea party killer of any project that involves public spending (except highways of course).If you listen to Cranley without knowing his political party you could easily mistake him for Scott Walker in Wisconsin. What is occurring with the streetcar in Cincinnati is a mayor masquerading as a Democrat and who has a tea party style agenda of killing any transportation infrastructure project that doesn’t involve automobiles. He is no different than the Republican governor John Kasich in this regard. Cranley is hell bent on destroying the streetcar project without even publicly or privately determining the full details on what the cost to shut the project down will be. Right now tracks are being laid, streetcar maintenance buildings are under construction and the streetcar manufacturer has started work on the streetcars. Investors in buildings along the streetcar route are now on hold and feel they cannot trust anything the city says as far as development thanks to Cranley and COAST. The subsidizing of this project is a pittance compared to auto related subsidies in the region. When listening to Cranley you would think this streetcar is the worst thing to happen to Cincinnnati in the last 50 years.

  8. @Rod Stevens, I hadn’t necessarily thought it about this way, but you are right that these were all cancelled by ‘strongman’ type leaders. However, most of them (including Cranley and Walker) actually campaigned on project cancellation in their platform. So it seems clear the votes endorsed the idea. It’ always an easy out to blame bad leadership (that’s a perennial favorite in Rhode Island). But how to those leaders obtain and maintain power? At some level the people need to look in the mirror and acknowledge their own share of the culpability in what happened. Not every city and state elects politicians in this stripe.

  9. Bob Schwartz says:

    Cranley tapped into the usual tea party tactic of spreading fear. The streetcar and parking deal would bankrupt the city he claimed. Getting elected by 16% of voters isn’t anything to be proud of and there was strong support for the streetcar but after 7 years of getting beat down by the local media giving the anti-city tea party a megaphone I think people were wore down and tired. And as we all know there are core conservatives who are going to vote come hell or high water.
    And that’s exactly what happened.
    Voter fatigue.

  10. Eric Hammer says:

    Cranley has a very weak case for a mandate on this issue. Not once, but twice, we held referenda with much greater turnout, that produced many more votes for the streetcar than Cranley received in this election. It’s clear that the parking issue also clouds the interpretation of the voters’ will. Just when it seemed that Cincinnati was no longer the nation’s joke, here we go again!

  11. Dan borsch says:

    Is it to late to stop the downtown bridge in Louisville ky?

  12. Well, Dan. That’s probably one I would have to take a look at cancelling, though honestly a ton of money has already spent spend. In any case, the chances of cancellation are nearly zero. Best to be thinking about the post-bridges city and how best to mitigate the damage.

  13. Should John Cranley go forward with this unnecessarily aggressive and divisive move to kill Cincinnati’s modern streetcar project, the city will not only lose huge credibility with the federal government and lending institutions, but also with small business owners and individuals that are considering investing in the city.

    $30M or so has already been spent on the project.
    $95M is committed in contracts.
    $45M is from the Feds (CMAQ, TIGER, Urban Circulator) who will take all of that money back.

    Then on top of all of that you have the ongoing litigation with Duke Energy about the cost of relocating its utilities. Should Cranley kill the project the city will almost certainly lose the case and be forced to pay all of those incurred costs, plus potentially all of the incurred costs by the other utility providers who have already relocated their assets.

    As illustrated in the Wisconsin example, killing a project at this stage in the game can have very long and dire consequences. It is likely that should Cranley move to kill the project, Cincinnatians will continue paying the cost of litigation and penalties for years to come. Does John Cranley really want his entire first term dominated by disputes and challenges to his attempt to kill a single project? A project for which Cincinnatians are only paying $88M.

  14. Matthew hall says:

    randy, yes he does. without such sensationalism his appalling ineptitude will be quickly revealed.

  15. JimD says:

    The Wisconsin brouhaha with Talgo is more a reflection on the previous state administration and the contracts they signed, in my opinion. Why should the state be on the hook for tens of millions of dollars because they are not using the train cars they bought? Why wasn’t the equipment they purchased built to Amtrak specifications so that they could easily be sold in the event that the project fell short? If I was going start a shortline railraod and I had to shut down, I would have a ready market for my unused locomotives. The train sets should have been the easiest part of the project to liquidate.

  16. Eric says:

    I’m pro streetcar but I don’t buy the whole credibility argument for continuing the streetcar. Looking at how HUD operates, supposedly, money is being withheld in Texas and HUD will no longer be allowing rampant noncompliance going forward, but the whole issue of compliance tied to Federal money seems arbitrary. Cincinnati will have to come up with some kind of payment arrangement to pay back the money similar to communities that misappropriate CDBG money, for example. It’s going to be funny/sad/interesting how all this goes down, I’m not sure Cincinnatians care much what their national reputation is, anyways.

  17. Rod Stevens says:

    Eric,

    City reputations are much more important than most people realize. As much as town center projects are called tools of economic development, they are usually about boosting civic pride. Too, when it comes to attracting money and talent, no one wants to be cast by outsiders as clowns, people that can’t get anything done. Why do you suppose Proctor and Gamble has been so important to the city’s reputation. Beyond the fact that the company draws a lot of smart people there, and gives them interesting things to work on, everyone buys and uses its products every day. There is a trust and familiarity built up in those associations. You don’t want to undermine that with a reputation of not being able to get things built, much less unbuilt.

  18. Tom Rubin says:

    To begin, yes, there WAS a program that allowed for the cancellation of freeway projects and the use of the Federal funds for transit, namely “Interstate Transfer.” This allowed the local governments that had been approved — and funded — for construction of Interstate Highway segments to cancel the roadway and, instead, use it for transit projects — including the cancellation of the Mount Hood Freeway in Portland, the funding for which paid for the major share of the construction of the first light rail line in Portland. This was also the funding source for much of Washington DC’s MetroRail system (you may have noticed that, relative to almost any other major U.S. city you can think of, there is very little in the way of “freeways” inside the Beltway). The reroute of the MBTA Orange Line in Boston, and the Southwest Corridor Park, where I-95/Southwest Expressway was originally to have run, is another.

    Because the U.S. Interstate System has now been built out, Interstate Transfer, which was authorized in 1973, no longer exists as a method of funding. However, there are three other “flexible funding” sources in the Federal Highway Trust Fund, the two largest, by far, being the Surface Transportation Program (STP) and Congestion Management Air Quality (CMAQ), that allow local (and, in some cases, state) transportation agencies to take funding original designated for roads to be used for transit projects. These do not generally mean that a specific road already planned and designed will not be built and the funding used for transit, as these allow the local agencies to make a decision as to their use of these funds from the get-go. The can decide from day one that these funds will go for transit and, in statute and in effect, convert road funding into transit funding.

    Keep in mind that the majority of the funding for the Federal transit program comes from the Highway Trust Fund (HTF), including $.0286 of the $.184 in Federal excise charges per gallon of gasoline that is earmarked for transit. Along with the funding that is locally allocated from STP and CAMQ, and minor amounts from other HTF programs, generally something in the order of 20-25% of the annual HTF funding goes for transit, not counting HTF funding that goes for some other non-automotive purposes, such as cycling (and a few odd transit and railway museums and things of that sort).

    It is unlikely — but not totally impossible — that the Federal funding for the Cinci streetcar will be reallocated for another purpose in the Cinci area. This funding is coming from about the only major Federal transit grant program that does not come the HTF, namely the 49 USC 5309 discretionary capital grant program, “new starts/small starts,” which gets its monies from the Federal “general fund” and cannot be used for a road project (Cinci may have allocated some of its STP and/or CMAQ funds for the streetcar project, which can be transferred for roads). These funds could only be utilized for another guideway transit project, such as rail line or a dedicated or semi-dedicated busway — and, to the best of my knowledge, Cinci does not have any of these on the shelf, ready to be rolled out as alternatives. If the Administration is willing — which is very questionable, IMHO — it is possible that these funds might be reserved for it while it develops such a plan (DOT has reserved funding for rail in Milwaukee for decades in a somewhat similar type of maneuver, but the statutory basis is different); perhaps even something like a combined HOT lane/busway that could speed commuters to and from downtown at very low cost per lane mile, a good part of which could be funded by the HOT lane tolls. (I wouldn’t hold my breath on that being developed and Federally funding in the near future, even if the Mayor of Cinci was interested in promoting a project that would likely see much of its construction and users outside of his City limits.)

    However, my understanding is that only a relatively small share of the Federal allocation for the streetcar has actually been spent, so while it is likely not going to result in funding for other projects, there will likely not be all that much that will have to be sent back — and, with good attorneys that know what they are doing, there is a fair chance that something can be worked out so no money has to go back; these types of trades have been done before when there is a Federally-funded transit project that died for various reasons).

    But, so we are clear, while there has been an almost 40-year history of Highway Trust Fund monies, including the funding specifically allocated for several major Interstate roads, which came out of highway user fees, going to construct (and operate) transit systems, there is not much in the way of transit projects giving up funding so that roads can be built — primarily because transit does not generate much in the way of funding for the HTF in the first place. Even buses, running on roads built by user charges, do not pay into the HTF for their fuel because they have a specific exemption from doing so.

    And if, for example, a transit project that had been funded with STP and CMAQ were to be cancelled and a road project substituted instead, this would STILL not be a case of transit funding going for roads — it would be a case of road user charges that had been allocated for a transit project being returned for road use.

    Just so we have full disclosure here, for the past several years, after many decades of being totally funded from road user charges and funding many non-road projects and even going to pay off part of the national debt, the HTF has been run at a deficit. This is due to Congress refusing to consider either (a) living with its means by not continuing to spend more money out of the HTF than is coming in, (b) increasing any of the road user changes to make it again entirely self-funding, and/or (c) stop using HTF funds for non-road purposes. Any of these could make the Highway Trust Fund back into a “real” trust fund, but Congress is just not interested.

    As to your comment, “You may notice, it’s only transit projects that ever seem to get the ax,” I would be very happy to show you an extremely long list of road projects that were never built after they were very far along in planning and design. In addition to those I have already mentioned in Boston, Portland, and Washington, DC, there were 20 freeways cancelled IN LOS ANGELES COUNTY ALONE, which is one of the main reasons why the Los Angeles urbanized area is, by far, the densest in the U.S., but is second to LAST for freeway centerline miles and road miles per capita (yes, you DID read that right). San Francisco also has a noted history for canceling freeway projects and it is not at all difficult to name many others.

    I’m all for local transportation project decisions being made by locals on the basis of what is best for their locality, as they see it — but I am very much an advocate of such decisions being made on the basis of proper facts and sound analysis.

    Tom Rubin

  19. Eric says:

    Rod- I was speaking more to credibility with the Feds. Plus, I’m not sure how P&G views the city’s image since they’ve largely been silent on the streetcar being stopped. They don’t seem to be making the connection with attracting potential employees.

  20. @Tom Rubin, you may note that I qualified the road cancellation statement with “since the freeway revolt era”. Today if a highway project is cancelled, it’s likely because there wasn’t enough money drummed up to fund it, not because somebody decided to pull the plug after construction was already underway.

    I might also add that part of the streetcar funding is from a TIGER grant, which is a competitive, project specific grant that I’d be very surprised if the feds let it be repurposed.

  21. @Eric, aren’t P&G and other major corporations the backers of 3CDC? The cancellation of the streetcar will certainly affect the value of their real estate portfolio and pipeline. They can’t be amused by that.

  22. Ed says:

    Tom, funny you should mention buses. Recently, a pilot commuter bus service known as MetroMoves just began running from Kenwood to downtown. I don’t think Cranley’s smart enough to see the potential with that switch as his supporters came up with a cross-town bus trolly publicity stunt alternative to the streetcar during his campaign.

    What he’s trying to do is build a needed highway interchange at MLK and I-71 and he needs $20 million city funds to contribute to ODOT. This, I believe, is the bait-and-switch he’s trying to pull when he meets with Obama officials in Dec. Hopefully, they see through the local politics and stand firm to the LaHood and Mallory administrations, but who knows.

  23. Eric says:

    @Aaron, you’d think they’d have something to say. Headline: “City Business Leaders Silent on Streetcar While Parking Deal Falls Apart”
    http://news.cincinnati.com/proart/20131112/biz/311120064?pagerestricted=1

  24. @Eric, companies like P&G don’t have to go complain to the newspapers. They’ve got other channels for accomplishing what they want.

  25. Earlier this year the Federal government said that Cincinnati would lose at least $41M out of the total $45M contribution to the streetcar project if it were cancelled. I believe the other $4M is the CMAQ money that was allocated to the project through the region’s MPO. Opponents had previously tried to reallocate that money to other projects, but the Feds at that time said it was not legal, so I’m not exactly sure what will happen with those funds.

    One thing is for sure, this will be a boon for Cincinnati’s legal industry.

  26. Nathanael says:

    Cancellation of a project in planning stages is one thing.

    Cancellation of a project where tracks are in the ground, utilities have been relocated, contracts have been signed, trains have been built, concrete has been poured — this ends up being pure waste.

    Cancelling such a project, one which is more-than-half-built already, is a form of the sunk costs fallacy, actually.

    Compute the cost-benefit of the project *ignoring* all the sunk costs — and you find that the cost is practically nil, because no *more* money needs to be spent. So if the benefit is even slightly positive, it’s worth finishing the project.

    But people like Cranley and Walker with “sunk costs” thinking complain about the money previously spent, which is gone, and which they can’t get back.

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