The Transit Costs Project adjusts all construction costs for purchasing power parities. This means that, for example, a Chinese subway is converted into dollars not at the exchange rate of $1 = 6.7¥, but at the PPP rate of $1 = 4.2¥; this means that present-day Chinese subways look 1.5 times more expensive in our analysis than in analyses that use exchange rate values, and projects from 10 years ago look twice as expensive. I believe our choice is correct, and would like to explain why, since it has gotten some criticism from serious people, who’s prefer exchange rates.

Local costs

I started this comparing mature developed countries. The US and Europe have largely separate markets for construction, and so American work is almost entirely done in dollars and European work in euros (or pounds, or kronor, etc.). Japan is likewise very local and so is China. In that case, local costs matter far more than international ones.

But what’s interesting is that even in countries that use imported technology and international consultants and contractors and have low wages, costs are almost entirely local. I wrote about this last year, referencing an article out of India about the small cost impact of indigenization and an interview I made with a Philippine planner who told me 90% of the value of civil works is local. Rolling stock is internationally traded, but we exclude it from our cost estimates whenever possible.

The impact of currency changes

Using PPPs, if a country undergoes a bout of inflation, this should be reflected in changes in construction costs. This is intentional. The example given to me in the critique linked in the lede is that if Bangladeshi food prices rise, then this makes the PPP exchange rate look less favorable (a taka in Bangladesh can then buy less relative to a dollar in the US). But that’s fine – if Bangladeshi food prices rise then this forces Dhaka to pay higher wages to MRT construction workers, so overall it’s just domestic inflation. It’s no different from how, today, we’re seeing nominal construction cost growth in the United States and Europe because of high inflation.

At least the inflation today is moderate by any developing-country standard. Core inflation in the United States is 6%; in Germany it’s 3%. This may introduce third-order errors into the database as we deflate costs to the midpoint of construction. In contrast, 50-60% annual inflation is sustained over years in some middle-income countries like Iran, and then the choice of year for prices has significant impact, to the point that Iranian costs have a significant error bar. But that’s regardless of whether one adjusts for PPP or not, since usually inflation leads to deteriorating terms of trade.

In contrast, if prices are compared in exchange rate terms, then international fluctuations create fictitious changes in construction costs. When China permitted the renminbi to appreciate in the mid-2000s, this would have looked like an increase in costs of about 20% – but the costs of local inputs did not change, so in reality there was no increase in costs. The euro:dollar rate peaked around 1€ = $1.58 in 2008, before tumbling to 1€ = $1.28 in the financial crisis – but nothing material happened that would reduce European construction costs by 19% relative to American ones; right now it’s trading at 1€ = $1.05, but this again does not mean that construction in Europe is suddenly a third cheaper compared with in the US relative to 15 years ago.

Unusual currency values

Some patterns are systemic – richer countries have stronger currencies relative to PPP value than poor countries. But others are not, and it’s important to control for them. A currency can be weak due to the risk of war or disaster; the Taiwanese dollar is unusually weak for how rich Taiwan is, and this should not mean that Taiwanese construction costs are half what they really are. Or it can be strong or weak based on long-term investment proposition: investors will bid up the value of a currency in a country they expect to profit in in the long term, perhaps due to population growth coming from high birthrates or immigration, and this does not mean that today, it builds infrastructure more expensively.

In any of those cases, the unusual value of the currency really reflects capital availability. Capital for investment in Australia is plentiful, but this by itself does not raise its construction costs; capital for investment in Taiwan is scarce, but this certainly does not make it a cheap place to build infrastructure.

Foreign-denominated construction

In some peripheral countries with unstable currencies, costs are quoted in foreign currency – dollars or euros. Some Turkish contracts are so quoted, and this is also common in Latin America and sometimes Southeast Asia. But ultimately, the vast majority of the contract’s value is paid out in the local currency, not just labor but also locally-made materials like concrete. This creates a weird-looking statistical artifact in which we convert dollars or euros to local currency in exchange rate terms and then back in PPP terms.

This, we do because the quotation of the contract (in dollars or euros) is not the real value. Rather, it comes out of one of two artifacts. The first is data reporting: we rely on international trade media, and those often quote prices in exchange rate dollars or euros, even if the contract is in local currency (and in all cases where we’ve seen both, they match in exchange rate value).

The second is that an international consultancy may demand actual payment in foreign currency as a hedge against currency depreciation; in that case its rate of profit should be dollar- or euro-denominated. However, this again is a small minority of overall contract value. Moreover, if a country’s institutions can’t produce enough capital stability to do business in their own currency, it’s a problem that should be reflected in global indices; ultimately, if costs are higher in PPP terms as a result, this means that the country really does have greater problem affording infrastructure.

A posteriori justification

The above reasoning is all a priori. When I started comparing costs in the early 2010s, I was comparing developed countries and the euro:dollar rate was in flux in the early financial crisis, so I just went with one long-term PPP rate.

However, a posteriori, there is another positive feature of PPP adjustment: it levels the differences in construction costs by income. There is positive correlation between metro cost per km and the GDP per capita of the country the metro is built in, about 0.22, but it comes entirely out of the fact that poorer countries (especially India) build more elevated and fewer subway lines; correcting for this factor, the correlation vanishes. This is as it should be: PPP is a way of averaging out costs in different countries, first because it levels short-term fluctuations such as between different developed countries, and second because exchange rate value is dominated by internationally tradable goods, which are relatively more expensive in poor countries than non-tradable goods like food and housing.

What this says is that infrastructure should be viewed as an average-tradable good, at least a posteriori: its variation in costs across the world is such that there is no correlation with GDP per capita, whereas food prices display positive correlation even after PPP adjustment, and tradables like smartphones display negative correlation (because they cost largely the same in exchange rate terms).