List of Abbreviations
2 Identifying benefits
2.7 Wider economic benefits
2.7.6 Job creation
Another common source of error in economic appraisals is the treatment of employment. Whereas job creation is good and is welcomed, it is very common to cite job creation as a justification for an investment project. On the other hand, there is no need to explain to business people that labour constitutes a cost. Labour is a scarce productive resource. Occupying a worker in a project precludes other businesses from employing that worker. Therefore, subject to the frequent distortions in labour markets (such as taxes, social security con-tributions, and restrictive labour market laws), salaries reflect the opportunity cost of labour, a scarce service.
The opportunity cost of labour can be illustrated with a simple example that reminds us that countries become richer when a task can be done with less labour input (increasing labour productivity), freeing labour resources for other tasks. If society can make a B-747 fly with three pilots (two in the cockpit plus one in reserve) instead of four (three in the cockpit plus one in reserve) society will be richer because it can create a service (flying a B-747) with fewer resources (labour input), releasing a pilot to operate other flights.
However, whereas labour is an input, as we saw above in section 2.3.2, input costs can be distorted due to the presence of taxes or subsidies. In the calculation of economic returns, labour taxes and social security contributions should be deducted from the money labour costs to estimate the shadow price of labour. In that sense, there is a ‘benefit’ to using labour inputs in a project in the form of a deduction from project costs of what is in fact a transfer to the government or to a social security fund.24 Such a ‘benefit’ works out to a lower input cost, rather than a net benefit.
In addition to taxes and social security contributions, shadow wages can also correct for additional distortions to the labour market, such as high un-employment benefits, the existence of minimum salaries, and rigid labour market laws that may result in unemployment.25
Appendix A2.1: Productivity and the value of time
When travelling for work, the time spent travelling can be most immediately valued by referring to hourly earnings. But to operate within a more complete framework for valuing travel time savings, including travelling during both leisure and working time, it is necessary to embed time valuation into con-sumer theory. The framework is also to allow for distortions caused by taxation. There are various models to embed time into microeconomic theory. For a review of these models, including their evolution through time, see Jara-Díaz (2007).
What follows here is a graphical representation of a generic model.
Individual models may differ from this generic model in matters of detail in various ways. The intention is for the reader to understand how the various categories of time values that analysts will find when appraising air transport projects fit into the broader set of prices and magnitudes relevant for the appraisal. A central one is labour productivity, which explains much of the differences in time values that project analysts will encounter across countries.
Figure A2.1 represents the labour market. The horizontal axis measures the total number of hours available. It could be thought of as hours in an average day, month, or year. Likewise, the axis could represent an individual, a seg-ment of population, or indeed the population at large. There is a minimum hours set aside for vital needs, such as sleep and so on. This would determine the maximum amount of working hours, as represented by the long-dashed, vertical line. Once personal preferences are set, the decision as to how much of the remaining hours are split between working and leisure would depend on the wage rate. The wage rate itself would be the result of the supply and demand for labour, together with any distortions present in the labour market.
d c
b a
SL StL
VoT2 VoT3
Time (hours) EUR
VoT1
0
Max. work
Leisure DL DtL
Work Basic needs
L
Figure A2.1 Labour productivity and the values of time.
This appendix illustrates distortions through taxes. Other distortions frequent in the labour market are a minimum wage and involuntary unemployment.
SL represents the after tax labour supply schedule. The supply of labour would depend on the preferences of individuals as to how much they are willing to trade work for leisure. Generally, as the salary increases the quantity of working hours supplied will go up, hence the upward sloping SL curve. As people work longer hours, the marginal utility of the remaining leisure hours increases. Therefore the SL schedule becomes steeper as more hours are worked and there are fewer remaining hours of leisure. StL corresponds to the supply of labour before tax, where t would represent tax on salary income. Full labour compensation should also include fringe benefits, but for simplicity these are excluded from the presentation as a separate item. The reader could think of them as being present in hourly, net of tax compensation.
Meanwhile the demand for labour schedule DL is downward sloping, dis-playing a decreasing marginal product of labour as more hours are worked.
The first few working hours are dedicated to the most productive tasks and are therefore highly valued. As more hours are worked, they are dedicated to less productive output, decreasing the willingness to pay for such additional work.
Companies would hire additional workers to the extent that the marginal value product of labour (that is, labour productivity) equals the salary de-manded by workers, gross of personal income tax. This corresponds to point a in Figure A2.1. If there are additional taxes paid by the employer that vary with employment, then the demand for labour by employers will not measure the full marginal product of labour, which would also include the taxes paid by the employer as a result of the additional labour input. Schedule DtL re-presents this full, or social, marginal product of labour. In other words, how much society values the marginal work effort.
Therefore, hour worked L along the horizontal axis would produce value to society equal to the distance cL. Of this, bL accrues to the employee as after-tax salary. Distance ab accrues to the government as tax on salary income, paid by the employee. Finally, distance ca is paid by the corporation as tax resulting from the employment of labour hour L. It is being assumed that the corporation operates in a competitive market with no distortions other than the tax. The corporation therefore makes a normal profit that just covers its cost of capital. Employment by a company that operates in an uncompetitive market, generating super-normal profits, would yield additional value, which would be represented graphically by a further wedge between demand and supply of labour at point a.
In terms of value of travel time savings, let us assume first that the passenger views time spent travelling as a cost and does not derive any utility from it.
The traveller (as opposed to the employer) would be willing to pay to avoid an hour spent travelling the same amount of money as would be willing to pay to enjoy an extra hour of leisure. This amount would be measured by the amount of (after tax) salary that would be needed to compensate the traveller from giving up an hour of leisure. That is, the marginal value of time (VoT) for someone working L hours would be equal to the hourly after tax salary bL,
equal to VoT1 on the vertical axis, which becomes the value of time when travelling for leisure.
When that passenger travels for work, the trip must pay for the salary, gross of income tax, incurred by the company employing that person. The relevant marginal product of labour for the employer would be that which the cor-poration can generate net of corporate tax. The willingness to pay to save one hour would then be aL, equal to an hourly value of time of VoT2. This is the main reason explaining why time values are higher when the trip motive is work rather than leisure.
This willingness to pay of the employer for reducing employee travel time drives the decisions by the employer as to the means of travel of the employee.
Say the employer of a passenger considering to travel on airline route A is willing to pay EUR50 to save one hour of employee travel time. Another airline route (or mode of transport) B is EUR30 cheaper but the trip takes one hour longer. Then the employer would be happy to pay for the employee to travel via A rather than B. Since such value of time measure explains passenger behaviour it is referred to as a behavioural value of time. This would correspond to VoT2 on the graph. However, the value to society of the labour output lost by travelling would not be just the EUR50. Such societal measure would also need to include the corporate taxes paid by the employer in devoting employee time to the trip. The social, or economic, value of time would then be VoT3.
In principle, therefore, economic appraisals should use two values of working time simultaneously. Firstly, VoT2 to explain business passenger behaviour, that is, to estimate the private or behavioural generalised cost of travel with and without the project and with it to estimate changes in traffic.
And secondly, VoT3 to place a societal value on the increase or decrease of travel time with the project relative to the without project scenario, through estimates of the total, or societal, generalised cost of travel. In practice, though, appraisals use a single working value of time for both behavioural estimation and societal valuation. Corporate taxes that vary with employment may not account to much or are taken to be related to capital rather than labour.
Meanwhile, for leisure trips, VoT1 would constitute both the behavioural and societal value of time.
Note that VoT1 measures labour productivity as appropriated by the worker, VoT2, labour productivity as experienced by the corporation, and VoT3 labour productivity as measured by society. As an aside, assume that there are no corporate taxes, so that schedule DL represents both corporate and societal demand for labour. The schedule intersects the (income taxed) supply of labour at point a. At that market equilibrium, VoT2 represents both societal labour productivity and labour productivity (marginal value product of labour) as perceived by the employer. Assume now that there is a positive productivity shock, due to, say, a transfer of knowledge from some other economy, causing an increase in demand for labour, shifting DL upwards to DtL, while continuing to assume that there are no corporate taxes. The new labour
productivity, following the productivity shock, would be measured by the distance between point d and the horizontal axis. Projecting horizontally from point d to the vertical axis we will see that the value of time would increase, up from that implied by the pre-shock market clearing point a.
This outcome illustrates that in more productive, higher income economies, the values of business travel time are normally higher than in less productive, lower income economies. Likewise, projecting vertically from point d down-wards todown-wards the horizontal axis we will see that that projection would in-tersect schedule SL at a higher point, relative to the vertical axis, than b. That is, in more productive economies, the value of travel time on leisure trips is also higher than in lower income economies. Still a word of caution is required for air travel in lower income countries. These economies often portray dual economic systems with marked differences on labour productivity between the two, or otherwise have a more skewed income distribution than higher income countries. Air travel in such lower income countries would be used by the segments of the population with higher income. Therefore, there may be less difference in the values of time for aviation between upper and lower income countries than would be suggested by per capita national income measures.
As mentioned at the beginning of this appendix, the travel time model presented here is generic, and put together to illustrate the underlying rationale for differences in travel time value. Detail can be added. For example, the model assumes that travelling (in the sense of in-vehicle time) is not in itself a particular source of utility or disutility. If a person enjoys travelling, the willingness to pay to save travel time would be lower. When that person flies on holidays, the willingness to pay to save one hour of flying time would be less than VoT1 in Figure A2.1. The opposite would happen if a person dislikes travelling. A complete estimate of the value of leisure travel time would re-quire valuing also the alternative uses of leisure time (see Jara-Díaz, 2007, for a review of the various theoretical models). Another factor loosening the link between the value of leisure travel time and personal income is that, on an average household, some leisure travel is conducted by household members that do not generate income, further lowering willingness to pay to save time.
As a result of all these factors, guidance often includes a wedge between personal income and leisure travel time value. As an example, the US Department of Transportation (2016) values personal (i.e. leisure) air travel time at 70 per cent of earnings.
Likewise, when travelling for work, if people can take advantage of in-vehicle time to work, the willingness to pay to reduce travel time would be lower than VoT2. At the extreme, notionally, if a person is as productive while travelling as while in the office, the value of travel time savings would be EUR0. These cir-cumstances illustrate why ultimately the analyst, when appraising projects, must often rely on direct estimations of values of time, derived from actual behaviour through revealed preference studies or from surveys through stated preference techniques. Reference to hourly earnings could be a fall-back, indirect approach to estimate values of time, when no direct estimates are available.
In other modes of transport, planning and appraisal studies often make a difference between waiting time and in-vehicle time. For urban transport, it is often necessary to substitute the working-leisure trip purpose dichotomy by a working-commuting-leisure trichotomy. Also, given the differences in speed of different modes of transport, the choice of mode of transport is itself a means for travellers to reveal their willingness to pay to save time. It is therefore common to see differences in estimated values of time across transport modes.
For aviation, further differentiation may be introduced by adding categories such as airport processing time, in-vehicle (or flying) time, access and egress time, etc. In the presence of congestion at peak times in a given facility, there may also be a case to draw a difference between, on the one hand, the value of delay to passengers that still travel through the same facility but divert to travel at less preferred departure times and, on the other hand, to passengers that rather than travelling at a less preferred time, divert to an alternative transport mode or an alternative airport. These two forms of traffic diversion are introduced in Chapter 3.
For simplicity though, a single, average value of time is used throughout the book. Appraisals that focus on specific service attributes like, say, reducing waiting time in security checks, may conduct time valuation studies that target specific components of travel time. Transport operators and authorities may conduct tailored time valuation studies for a variety of purposes apart from investment appraisal, such as formulating marketing or competitive strategies, valuing service quality, planning, or supporting a case before the competition authorities.
Appendix A2.2: Cap and trade and offsetting schemes compared
A2.2.1 Introduction
This appendix presents in more detail how generic market-based mechanisms (MBM) to internalise emissions would operate. The presentation in the chapter focused on permits in cap and trade systems (the terms permits and allowances are used interchangeably). This appendix extends the presentation in two directions. Firstly, it goes beyond the tradable permits market to in-clude the permit buying and permit selling markets as well. Taking the selling market to be the electricity generating market, it explores the consequences of the market displaying an inelastic demand curve versus a more normal downward sloping demand curve. Secondly, it illustrates offset schemes, in-cluding also upstream and downstream markets.The appendix modifies the graph for the permits market to leave it only as the market for permits, rather than the composite of emissions and fuel of Figures 2.3 and 2.4. This is because the presentation in this appendix includes different sectors among which the fuel causing the GHG emission may differ, and with it the fuel-emissions ratio
in the composite measure. The horizontal axes in the various relevant figures now measure tonnes of CO2 rather than a composite measure of fuel and emissions. The vertical axis in the figure representing the permits market now includes measures net of fuel cost for both emission permits (or offsets) and the social cost of carbon.
Both the cap and trade and offset schemes are represented with the same Figure A2.2.
A2.2.2 Cap and trade
Quadrant a) in Figure A2.2 represents a growth in demand for airline services (or air travel) through a shift in the demand schedule from Da1 to Da2. Supply for airline services excluding permits is represented by supply curve Saxp (‘a’
stands or airline, ‘x’ for exclusion, and ‘p’ for permit). When airlines are not required to buy emission permits, the shift in demand for air travel would not cause a change in the price of airline tickets.
In contrast, supply curve Saip represents the airline supply curve including permits (where ‘i’ stands for inclusion), which become a required input for airlines. The curve is upward sloping because the higher the number of per-mits required the higher their price. When demand is at Da1 the price of airline tickets is pa1, which includes the permit price pp1. The shift in demand to Da2
increases the price of airline tickets from pa1 to pa2, due exclusively to the increase in the price of permits from pp1 to pp2.
Airlines acquire their emission permits on the permits market, represented by quadrant b) of Figure A2.2. The permits market experiences the growth in airline demand (Da1 to Da2 in quadrant a)) as a shift in demand for permits from Dp1 to Dp2. This results in the price of permits increasing from pp1 to pp2. Notice the difference in the vertical axis between this quadrant b) and the vertical axis in Figures 2.3 and 2.4. Quadrant b) represents only the permits market, whereas the vertical axes in Figures 2.3 and 2.4 include also the associated fuel price.
The growth in demand for air travel leaves total societal emissions un-changed at Q, on the horizontal axis in quadrant b). The amount of permits bought by airlines to accommodate the growth in air travel demand is equal to the distance between points c and d along the horizontal axis in quadrant b).
These permits used by the airlines are sold by some other GHG emitting sectors which, as the permit price increases from pp1 to pp2, find it financially worthwhile to either cease production altogether or to continue producing but by switching to a technology that does not emit GHG. For these other sectors, the path describing the permit price-quantity combination at which the switching takes place is represented by the section in the demand curve Dp1 linking points a to b in quadrant b). The permits bill paid by airlines, measured by the area of the shaded trapezoid in quadrant a), measures the size of the transaction in euros, which is mirrored by the shaded trapezoid in quadrant b).
Sellers of permits can come from any of the sectors included in the cap and trade scheme, including as well other airlines. But since Da consists of total demand of permits by the airline sector as a whole, the illustration assumes that the airline sector is a net buyer of permits. Let us assume for simplicity that all permit sellers come from coal energy generation, represented in quadrant c).
In the absence of a tradable emission permits scheme, coal energy gen-erators would have a supply curve depicted by Scxp (‘c’ meaning coal, ‘x’
exclusion and ‘p’ permits). By introducing permits, the coal energy supply curve becomes Scip (where the ‘i’ stands for inclusion). As with airlines in quadrant a), the supply curve is upward sloping because greater production of coal-generated energy would require the purchase of ever pricier emission permits. The growth of demand for permits by airlines (quadrant a)), and the resulting increase in the price of permits (quadrant b)), is perceived by the coal energy generating market as an exogenous upward shift in the supply curve from Scip1 to Scip2 (quadrant c)). This shift is explained fully by an increase in the price of permits from pp1 to pp2, and results in the price of energy generated with coal to increase from pc1 to pc2, alongside a reduction in the quantity of energy generated with coal from qc1 to qc2. The amount of permits involved in this reduction in coal energy generation corresponds to the amount of permits cd along the horizontal axis in quadrant b), which in turn corresponds to the permits associated to the increase in air transport output from qa1 to qa2 in quadrant a). Note that the units in the horizontal axis of each of these three graphs differs: quadrant a) would measure, say, million tonne-kilometres (tonne referring to aircraft payload, not GHG emissions); quadrant b) would measure, say, thousand of 1-tonne permits (tonne referring to GHG emissions); and quadrant c) would measure, say, megawatt-hours.
The area of the shaded trapezoid in quadrant c) would measure the value of the lost coal-generated energy, caused by the higher price of emission permits.
It also measures the total revenues of the coal energy sector from the sale of the emission permits. That is, it has the same area, in euros, as the shaded trapezoid in quadrants a) and b). Indeed, this is the key conclusion in this section, namely the value of the emission permits bill paid by the airlines equals the loss in value associated to coal energy generation. 26
This could well be the final outcome as far as energy production is con-cerned. Should there be no substitute to coal for energy generation, the increase in supply of air transport would involve a reduction in energy gen-eration (where energy is understood to be, say, electricity or heat, rather than aviation kerosene). Fortunately, energy generation normally has other sub-stitute technologies to coal (and assuming there are no national policies pro-tecting the coal industry). Quadrant d) depicts the market for renewable energy. It could be viewed either as the aggregate supply curve of renewable energy technologies or, more abstractly, as a single source of renewable en-ergy. The important condition is that such renewable energy source does not require the purchase of emission permits.27