Malinvestments caused by the Bank of Canada´s low interest rates know no bounds. In a move that must be making all Canadians the 4,500 odd people who live in Tuktoyaktuk and Inuvik happy, the Federal government has just announced that it will start constructing what has been a dream since the 1950s – the Inuvik-Tuktoyaktuk gravel highway.
The 140 km highway is projected to cost $300mn., $200mn. of which Ottawa will contribute. In return, it is estimated to cut the cost of living in remote Tuktoyaktuk by $1.5mn. per year, boost the region´s GDP by $330,000 and increase tourism by $2.7mn. (I’m still unsure why the government doesn’t include tourism in GDP, but it’s largely beside the point.) On an investment of $300mn., primarily funded through tax dollars from the more Southern parts of Canada, the region expects to see a yearly benefit of about $4.5mn.
To make this investment work, the appropriate discount rate on the investment must be no higher than 1.5%. That is, if the benefits are as high as they are made out to be, and if the road doesn’t run into cost overruns. I won’t even get into the yearly maintenance cost for this road, but I imagine it is not cheap on a road which will almost certainly have to be insulated to withstand the punishment permafrost will subject it to. (If you live in Quebec and thought the winters made quick work of your beautiful roads, consider this worse fate.)
When Austrian-school economists talk about malinvestment during the boom, this is exactly what they have in mind. Artificially low interest rates by the Bank of Canada induce investments that just don’t make sense in a higher interest rate environment. I would hazard a guess that the Northwest Territory will never see lower interest rates than what it has today, and that investments like this will never payoff the initial investment when rates rise. Of course it doesn’t much matter because people living in the Northwest Territory are not paying the lion’s share of this project´s cost.
Malinvestments matter. They are the crazy hair-schemed projects that are undertaken during the boom under an atmosphere of low interest rate hubris. When interest rates rise, either because the Bank of Canada raises them or because inflation expectations force them higher, these projects are exposed as the white elephants they were destined to be. The problem is, as this project demonstrates, that few recognize this unfortunate fate while they are being constructed.