I was fortunate enough to be out in the spectator fleet for yesterday’s America’s Cup racing between Emirates Team New Zealand and Luna Rosa Prada Pirelli – honours were even in the two races. As with most events, analysts attempt to work out the multiplier effect and the impact it will have on an economy. In 2017 forecast, predicted that the America’s Cup would add between $600 million and $1 billion to the New Zealand economy. Employment would be boosted and in the longer term for every $1 put into infrastructure would generate $7.50 of economic activity. However with the impact of COVID-19, New Zealand will suffer a loss on the $249.5 million it invested in the America’s Cup, but there maybe benefits over time.
The Multiplier Explained
Consider a $300 million increase in business capital investment. This will set off a chain reaction of increases in expenditures. Firms who produce the capital goods that are ultimately purchased will experience an increase in their incomes. If they in turn, collectively spend about 3/5 of that additional income, then $180m will be added to the incomes of others. At this point, total income has grown by ($300m + (0.6 x $300m). The sum will continue to increase as the producers of the additional goods and services realise an increase in their incomes, of which they in turn spend 60% on even more goods and services. The increase in total income will then be ($300m + (0.6 x $300m) + (0.6 x $180m). The process can continue indefinitely. But each time, the additional rise in spending and income is a fraction of the previous addition to the circular flow.
The value of the multiplier can be found by the equation 1 ÷ (1-MPC)
You can also use the following formula which represents a four sector economy
1 ÷ MPS+MRT+MPM
Source: CIE Revision Guide by Susan Grant
The economic impact is based a lot on the multiplier effect but the use of cost benefit analysis also considers those external costs and benefits which are not easily convertible into a monetary value.
Evaluation of CBA
It is clearly more efficient for public spending to be subject to rigorous analysis, rather than based on the whims of politicians. However, there are a number of criticisms of CBA, including:
1. It is often very costly to undertake, though usually this forms a very small proportion of total project spending.
2. Assessing the monetary value of external costs and benefits is often very difficult. What precisely is the value of the congestion that would be reduced if a new bi-pass were built around a busy town? How much extra tourist revenue will actually be gained from a new airport? How long will the building be used as a venue, as in the case of the Viaduct area in Auckland for the 2020/21 America’s Cup. One solution to this problem is shadow pricing, where analysts attempt to place a value on the costs and benefits of a decision or a project where an actual market price does not exist.
3. Changing circumstances can make initial projections appear grossly inaccurate. The Wembley Stadium project in London went considerably over-budget, and the majority Olympic Games are far more costly than originally estimated. For instance the Montreal Olympics in 1976 was eventually paid off in December 2006. Higher interest and inflation rates, and falling exchange rates can all dramatically affect costs.
4. Actual costs can also rise above planned costs as a result of moral hazard, where project managers go over budget because they expect that those who fund the project will make extra funds available, providing an insurance against their over-spending.
5. Ultimately, decisions to go ahead with projects are only guided by CBA, leaving politicians to make the final decision. Politicians are free, of course, to ignore the results of an appraisal.
If you have read the book Circus Maximus you will no doubt be aware that most big sporting events run over budget and in some cases don’t generate the benefits until well after the event if at all. So just because an event runs over budget is that enough to say that we shouldn’t go ahead with the event. There are a great many other benefits of hosting an event like the Americas Cup which are not measured by GDP. The sense of community and wellbeing that comes from New Zealander’s performance whether it be in rugby or at the Olympics. It tends to bring people together feel a sense of belonging which has external benefits.