Latest / The Fiscal Policy Podcast with Fexingo: Government Budgets, Stimulus, and Public Spending / Why Governments Keep Overpaying for Construction
Transcript
- Lucas: So, there's this number that's been bugging me all week. The California High-Speed Rail project, which was originally estimated at around thirty billion dollars, is now projected to cost over a hundred billion. That's a 200 percent cost overrun before the trains even run. Luna: Yeah, I've seen that headline too. And people always say, 'Well, that's just California.' But the data suggests it's not just California. It's a systemic problem across public construction. Lucas: Exactly. There's a well-known study by Bent Flyvbjerg that looked at hundreds of infrastructure projects globally. Nine out of ten of them went over budget. And the average cost overrun was about 28 percent. But here's the twist: it's not just cost overruns. It's the sheer price difference between what governments pay and what private developers pay for the same kind of building. Luna: That's the gap I want to dig into. How big is it actually? And why does it exist? Lucas: Well, one of the most cited comparisons comes from a 2014 study that looked at transit projects in the U.S. and Europe. They found that, per mile, public transit projects cost anywhere from 30 to 50 percent more than comparable private developments. And that's controlling for land costs and labor rates. Luna: So it's not just that the projects are bigger or more complex. There's something about the public procurement process itself that inflates costs. Lucas: Right. And one of the biggest culprits is the way governments buy construction. Most public agencies are required to go with the lowest responsible bidder. That sounds fiscally prudent, but it actually encourages contractors to lowball their bids and then hit you with change orders later. Luna: Ah, the classic bait and switch. So you get a low bid upfront, but then 'unforeseen conditions' magically appear. Lucas: Exactly. And compare that to a private developer. They can negotiate with a contractor based on past performance, shared risk, and often get a fixed-price contract. The incentives are completely different. Luna: But it's not just procurement. I read that environmental reviews and community input processes add significant costs too. Not that they're bad, but they take time, and time is money. Lucas: That's a huge factor. A study from the Reason Foundation found that the average environmental review for a major highway project in the U.S. takes over six years. And during that time, you've got inflation, you've got legal fees, you've got design changes. All of that adds up before you even break ground. Luna: So the process itself is a cost multiplier. But there's also this thing about accountability, or lack thereof. If a public project goes over budget, no one gets fired, right? Lucas: Right. There's no real skin in the game. A private developer is using their own money, or their investors' money, so they're going to be ruthless about cost control. A government agency is spending taxpayer money, and the downside of a cost overrun is diffuse. It's spread across millions of taxpayers. Luna: And politicians want to cut ribbons, not cut costs. So they might approve projects that don't even make economic sense, just to get something built before the next election. Lucas: Exactly. And that's where you get what Flyvbjerg calls 'strategic misrepresentation.' Politicians and agencies deliberately underestimate costs to get a project approved, knowing that once it's underway, it's politically too costly to stop. It's called the 'sunk cost effect.' Luna: So the numbers you see at the start are often fiction. That's depressing. Lucas: It is. But there are also some concrete structural reasons. For one, public projects have to comply with a lot of mandates that private projects don't. Things like local hiring requirements, prevailing wage laws, and set-asides for minority-owned businesses. Those are all well-intentioned, but they add costs. Luna: And then there's the issue of risk. Governments are risk-averse, so they over-engineer things. They add redundancies, they demand a higher margin of safety, and they specify materials that are more expensive but easier to defend politically. Lucas: Yeah, and that's why a public hospital can cost twice as much per square foot as a private one. There's a study from the Manhattan Institute that found public hospitals in New York cost about eight hundred dollars per square foot, while private ones cost around four hundred. Same city, same labor market, same materials. Luna: That's a wild gap. So what's the fix? Can governments ever build like the private sector? Lucas: There are a few ideas that have been tried. One is 'design-build' contracts, where the design and construction are bundled into a single contract. That aligns incentives and reduces the risk of change orders. Some studies suggest that can save up to 10 percent. Luna: Another is benchmarking. If you can show that a private hospital costs four hundred dollars a square foot, you can put pressure on public agencies to get closer to that number. Lucas: Right. And some places have started doing something called 'reference class forecasting,' where you look at the actual cost overruns of similar projects in the past, and you adjust your budget accordingly from the start. So you don't start with a fantasy number. Luna: But even with those fixes, there's still the political problem. So what's a realistic expectation? Are we ever going to see public construction costs come down to private levels? Lucas: Probably not all the way, because there are legitimate reasons for some of the gap. Public accountability, safety, transparency. But we could certainly close a big chunk of it. I mean, if we could get from 50 percent higher to, say, 20 percent higher, that would save tens of billions of dollars on a single major project. Luna: That's worth a lot of coffees. Lucas: Ha, exactly. And speaking of coffee, if today's episode made something click about how government spending works, you can support the show at buy me a coffee dot com slash fexingo. It's a small way to keep this podcast ad-free and independent. Luna: Yeah, we really appreciate that. And honestly, if we saved you a bit of time or gave you a new perspective, that's worth a cup. Lucas: So back to that high-speed rail. If we could cut the cost overrun in half, that would free up billions for other infrastructure. But the key is political will. Luna: And that's the thing. It's not just about technical fixes. It's about changing the incentives for politicians and agencies. Lucas: One idea that's been floated is to make agencies eat some of the cost overruns. Like, if a project goes over, the agency has to cut other spending to cover it. That would create a real downside. Luna: But wouldn't that just lead to worse projects? Agencies might become so risk-averse that they don't build anything. Lucas: Maybe. But there's a middle ground. You could allow more public-private partnerships, where the private sector takes on more of the risk. And that's been tried in places like Texas and Virginia, with mixed results. Luna: Mixed results is not a ringing endorsement. Lucas: No, it's not. But the point is, there are options. We just have to be willing to try something different than the status quo. Luna: So if we walk away with one thing, what should it be? Lucas: That the public construction cost gap is not inevitable. It's the product of specific incentives and processes. And if we can change those, we can deliver better infrastructure at a lower cost. It's not about cutting corners; it's about being smarter. Luna: That's a good place to leave it. Thanks for listening, everyone.