21-04-2014, 11:42 AM
Cost Overruns in Large-scale Transportation Infrastructure Projects: Explanations and Their Theoretical Embeddedness
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ABSTRACT
Managing large-scale transportation infrastructure projects is difficult due to frequent misinformation about the costs which results in large cost overruns that often threaten the overall project viability. This paper investigates the explanations for cost overruns that are given in the literature. Overall, four categories of explanations can be distinguished: technical, economic, psychological, and political. Political explanations have been seen to be the most dominant explanations for cost overruns. Agency theory is considered the most interesting for political explanations and an eclectic theory is also considered possible. Non-political explanations are diverse in character, therefore a range of different theories (including rational choice theory and prospect theory), depending on the kind of explanation is considered more appropriate than one all-embracing theory.
Introduction
Investments in infrastructure are a considerable burden on a country’s gross domestic product (GDP). For example, in 2005 the Dutch government invested about 8 billion euros (CBS, 2005 in KIM, 2007) in infrastructure, amounting to 1.55% of GDP. This is of even greater concern if the inefficient allocation of financial resources as the result of decisions based on misinformation .
Methodology
In line with the conventional methodology, the inaccuracy of cost estimates is measured as the size of cost overruns. Cost overrun is measured as actual out-turn costs minus estimated costs as a percentage of estimated costs. Actual costs are defined as real, accounted construction costs determined at the time of project completion. Estimated costs are defined as budgeted or forecasted construction costs determined at the time of the decision to build. Cost estimates become more accurate during the project process. However, what is relevant here is the estimate known by the decision maker, i.e. the estimate based upon which the decision maker decides whether or not to implement the project. A particular moment in time is often taken to represent the moment at which the decision to implement the project was made (‘formal decision to build’). Cost overruns are generally calculated according to the costs estimated at this ‘formal decision to build’ (these are the costs at the initial funding level).
Studies with a broad focus
Hall (1980) conducted one of the first empirical studies with a broad focus on inadequate planning of large infrastructure projects incorporating cost overruns. The research starts with the notion that many of the planning disasters seem to have been initiated on the basis of forecasts that were later found to be inadequate and misleading. Searching for a better understanding of the failures in planning, Hall (1980) considers planning uncertainty to be an important element and makes a distinction between three categories of uncertainty. They are: uncertainty in the planning environment, uncertainty in related decision areas and uncertainty about value judgments (see: Hall, 1980, for an elaboration on these types of uncertainty). He further considers whether the difference between public and private goods has any effect on the planning failures. According to Hall (1980), the main problem is the way in which societies plan the output of the public good (goods and services which the public is willing to pay for but which the private sector is not motivated to provide (Hall, 1980)). Public goods are characterised by non- exclusiveness and non-control over exclusion (Snidal, 1979). Suppliers of the public good do not have the opportunity not to provide the good (non-exclusiveness). This difference between public and private goods is particularly important in the research on cost overruns.
Mackie and Preston (1998) present twenty-one sources of error and bias in the appraisal of transport projects. They mainly relate to measurement error and appraisal optimism. They conclude that appraisal optimism is the greatest danger in transport investment analysis. ‘Appraisal optimism happens because the information contained in the appraisal tends to be owned by scheme promoters who have obvious incentives to bias the appraisal - deliberately or unwittingly’.
Technical explanations
Three theories were used to support technical explanations: forecasting theory, planning theory and decision-making theory. Forecasting theory examines estimations in uncertain future situations. It studies the understanding of the forecasting process at large and aims to clarify how and why the various successes and failures come about (Armstrong, 2001). Failures in estimates may arise as a result of the cognitive mind in the forecasting process. Forecasting models were used to gain a better understanding of the problems with errors in forecasting techniques or inappropriate forecasting approaches that lead to poor cost estimates. Planning theory examines how projects and policy are established (Faludi, 1973). Planning concepts were used to refer to the inappropriate planning process of projects and the poor design and implementation as a main explanation for cost overruns.