Wednesday, 22 November 2017

Beware economists bearing impact studies of the America's Cup

Auckland Council decides tomorrow about their preferred option for the location of the America's Cup bases. And right on cue, a new report has been released outlining the economic case for hosting the Cup. The New Zealand Herald reported today:
It will inject up to $1 billion into the economy; thousands of jobs will be created; it will revitalise Auckland's dilapidated downtown wharves and bring fleets of superyachts in need of multimillion-dollar repairs.
Or so has been widely reported in the frantic last few weeks of negotiations and protestations about where and how to host the 2021 America's Cup in Auckland, but some have questioned these expectations.
The Ministry of Business, Innovation and Employment (MBIE) yesterday released a glowing report about the economic benefits of hosting the regatta, concluding that every $1 invested would come back more than seven-fold by 2055.
Between $600 million and $1 billion would be injected New Zealand's economy between 2018 and 2021 - far outweighing the $200-odd-million it will cost to host the event, according to the report.
I've read the report, which can be found on the MBIE website here. Most studies of the economic impact of sports are subject to a number of severe limitations, which were usefully summarised by Andrew Zimbalist in his excellent book, Circus Maximus: The Economic Gamble behind Hosting the Olympics and the World Cup (which I reviewed here). One of the biggest problems is the lack of an appropriate counterfactual. These studies usually assume that visitors will come for the event (this assumption is of course reasonable). However, working out the economic impact of the event is not as simple as comparing the economy with the 'usual' number of visitors with the economy with the 'usual' visitors plus the additional visitors for the event ('event visitors'). This is because some of the event visitors would have come to Auckland anyway, even if the event hadn't happened. Other event visitors simply change the timing of their visit to coincide with the event, when they would have come earlier or later anyway. Including those two groups of visitors in the analysis would tend to overstate the economic impact of the event. On top of that, there will be some other visitors, who would have come to Auckland at the time of the event but, perhaps because they can't find a hotel because of the event, or because they don't want to deal with the crowds, they decide not to come at all. This latter effect is termed 'crowding out', and also leads the simple analysis to overstate the economic impact of the event. [*]

The economic impact report for the America's Cup, authored by Greg Akehurst and Lawrence McIlraith of Market Economics, adopts multiple approaches to the assessment and is to be commended for doing so. The report uses three different approaches: (1) the 'standard' economic impact assessment approach based on an input-output (IO) model; (2) a supplementary long-term assessment of impacts on the super-yacht sector, based on a computable general equilibrium (CGE) model; and (3) a cost-benefit analysis based on a comparison of the costs of infrastructure and the direct spending impacts. Each approach also looks at low, medium, and high scenarios.

The 'standard' approach shows an economic impact of $555 million (low scenario) to $977 million (high scenario). However, as we know that is subject to substantial problems and should be treated with a great deal of scepticism.

The CGE modelling approach shows a final realised impact of $123 million per year. However, one of the real problems with this analysis is that it assumes that hosting the America's Cup will have an enduring effect on the super-yacht industry (and in fact a growing impact over time in the high scenario). That assumption might be attractive, but it is unlikely to hold true. The super-yacht industry did get a boost in New Zealand when we last hosted the America's Cup, but that boost was not enduring and by 2014 super-yacht firms were shutting down (see here and here for example). If future America's Cups are not hosted in New Zealand, then at least some of the super-yacht industry is likely to move along with the Cup. So, I would take the CGE analysis with an enormous grain of salt (and it provides the greatest headline number of $7.50 of economic activity for every $1 of investment, which in spite of the authors explicitly noting that this is not a ratio of benefits to costs, the media is interpreting it as such).

The cost-benefit analysis is the best of the three alternatives. Here's the key table from the report, showing the cost-benefit ratios (CBRs) under the different scenarios, as well as some sensitivity analysis based on higher costs, or lower benefits:

Notice that the unadjusted CBRs are all over one (the benefits are greater than the costs). The medium scenario has a lower CBR than the low scenario because it assumes a higher cost (a larger event). Notice also that the cost only needs to increase by 20% (from $200 million to $240 million) in order to eliminate the net benefits of the event (the CBR falls to 1.0). If you think that any project the government is involved in is able to be completed without a serious budget blowout, then you haven't been paying attention over the past forever. A 20% cost overrun would be at the low end.

On the benefits side, it probably pays not to dig too deep into the spending assumptions as they appear to be on fairly shaky ground. For example, they make an adjustment for the proportion of international tourists who note that the America's Cup was one reason (that is, not the main reason) for coming to Auckland, but they don't make the same adjustment for domestic visitors. Domestic visitor spending is only a small proportion of the total, so this probably doesn't affect things too badly. However, the number of syndicates has the biggest effect on the estimates and the medium scenario assumes ten challenger syndicates, but the 2017 America's Cup only had seven syndicates (the low scenario assumes six, the high scenario assumes twelve). If you adjust the number of syndicates down in the medium scenario, then those CBRs are going to look a lot worse.

So, my takeaway from the report is that the benefits might outweigh the costs of hosting the America's Cup, but that relies on the costs being kept under control and the number of challenger syndicates increasing by nearly half over the previous Cup. As with most of these events, you could argue that the spending is good value for a big party, but arguing that it has an overall economic gain for the country (or for Auckland) is probably too strong a claim.


[*] Of course, some of these 'crowded out' visitors might adjust the timing of their visit, coming earlier or later than during the event.


  1. I started doing some consulting work on the Wellington airport extension. My starting point, as always, is where are the incomplete property rights? The only spillover from the airport extension would be more noise.

    If entrepreneurs forecast profit from building a America's Cup village with their own money at stake, let them go for it.

    Coming in it at the other end of this spillovers bonanza, when you consider the urban wage premium is barely North of 5% as I recall, maybe 10%, agglomeration externalities will not save you because they have to all add up to an urban wage premium of about 5 to 10%.

    You only use cost benefit analysis for infrastructure investments for which you are to stupid to charge for your output.

    I recently read an autobiographical note by Stephen Cheung. In 1967, he asked Ronald coase what was an externality? Coase has never heard of externalities! Cheung spent maybe the next 15 years writing articles that came out of the conversation to answer the question which ended with his paper myth of social cost.

    1. I agree on the point about entrepreneurs. I really worry that a lot of (especially local) government support for events really turns out to be a subsidy for private business.

      I'm surprised on that Coase story, but at that stage the term externality might not have been coined. Coase's 1960 paper was titled "The Problem of Social Cost", and so at that stage I expect that was the terminology in use?

    2. Coase may have been goading Cheung. He certainly got a great result. Cheong spent the next 15 years answering the question and rewriting property rights and contract economics in the course of the same.

      Laffont’s definition of an externality in the New Palgrave in 2008 is "effects on agents other than the originator of such activity which do not work through the price system.”