QUINCY SHIPYARD: VALUATION OF THE YARD FOR INDUSTRIAL WATER-DEPENDENT USES

by

BEATRICE HELENE ESILDE BALLINI

Laurea in Ingegneria Chimica Politecnico di Milano (1983) SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF

MASTER OF SCIENCE IN OCEAN SYSTEMS MANAGEMENT

and by

JAMIE ANN HENSON

B.A., Stanford University (1983)

SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF SCIENCE IN MANAGEMENT at the MASSACHUSETTS INSTITUTE OF TECHNOLOGY June 1986 © Beatrice H.E. Ballini and Jamie Ann Henson 1986 The authors hereby grant to M.I.T. permission to reproduce and to distribute copies of this thesis document in whole or in part.

SIGNATURES OF AUTHORS: ...... red P. Sloan School of Management May 16, 1986

CERTIFIED BY: .. 0 a0 0*

.. Hank.. Marcus and John Parsons Thesis,/Co-Supervisors

ACCEPTED BY: ...... :. 0•• ...... $. Douglas Carmichael Chairman, Departmental Graduate Committee I /. Department of Ocean Engineering ACCEPTED BY: Jeffrey A. Barks Associat ean, Master's and Bachelor's Programs Alfred P. Sloan School of Management QUINCY SHIPYARD: VALUATION OF THE YARD FOR INDUSTRIAL WATER-DEPENDENT USES by BEATRICE HELENE ESILDE BALLINI

Submitted to the Department of Ocean Engineering on May 16, 1986, in partial fulfillment of the requirements for the Degree of Master of Science in Ocean Systems Management and by JAMIE ANN HENSON

Submitted to the Alfred P. Sloan School of Management on May 16, 1986, in partial fulfillment of the requirements for the Degree of Master of Science in Management

ABSTRACT

This thesis evaluates the proposed sale of the Quincy shipyard by General Dynamics Corporation. Its purpose is to understand the economic factors which characterize the sale transaction and to develop a conceptual framework for evaluation of such situations. The shipyard has been chosen for study because it represents an unresolved market transaction, in which the public sector is considering direct or indirect intervention to protect public interest. Further, because much of the data used is specific to the shipbuilding industry, this thesis also contributes insight into the more general problem of shipyard conversion in times of worldwide overcapacity.

The content has two major focuses: (i) determination of a fair market price for the shipyard to a private investor, given future diversification opportunities in industrial water-dependent activities; and (ii) identification and analysis of externalities related to the sale. Both are important to an understanding of the process which will eventually culminate in an agreement on the shipyard's market price.

Due to the complexity of this topic, as well as to the timing of the inquiry, many of the issues addressed are controversial and highly publicized. The findings are based on an extensive volume of data collected, in large part, through interviews with parties involved in different sides of the transaction.

Thesis Co-Supervisor: Henry S. Marcus Title: Associate Professor of Marine Systems Thesis Co-Supervisor: John Parsons Title: Professor of Management -2- TABLE OF CONTENTS

Page CHAPTER 1: INTRODUCTION ...... 8

CHAPTER 2: HISTORICAL OVERVIEW ...... 13

A. The Shipbuilding Industry ...... 15 1. International Scene: Overview and Trends .. 15 2. The U.S. Shipbuilding Industry ...... 20 3. Cost Disadvantages of U.S. Shipyards in Commercial Shipbuilding ...... 25 4. Changes in Federal Support and Protection Programs ...... 28 5. Proposed Solutions to Revitalize the U.S. Shipbuilding Industry ...... 31

B. The Quincy Shipyard and General Dynamics ...... 36 1. History of the Quincy Shipyard ...... 36 2. General Dynamics' Tenure ...... 38 3. The Decision to Close the Shipyard ...... 42 4. The Impact on Labor ...... 44 5. Potential Buyers of the Shipyard ...... 48 C. Public Sector Interest in the Future of Quincy Shipyard ...... 57 1. The Task Force of the Reuse of the Quincy Shipyard ...... 57 2. Intervention Options Held by the State of Massachusetts ...... 61 a. Exercise of Licensing Powers ...... 61 b. Participation in Purchase of the Quincy Shipyard ...... 65 CHAPTER 3: THE THIRD HARBOR TUNNEL PROJECT ...... 67

A. Description of Alternatives ...... 70 1. Bored Tunnel versus Sunken Tube Tunnel ..... 70 2. Concrete versus Steel ...... 72 B. Steel Tube Construction and Site Requirements 74 C. Value of the Steel Tube Construction and Outfitting Project at the Quincy Shipyard ...... 83 1. Cash Flows ...... 84 2. Discount Rate ...... 88 3. Calculation of Project Value ...... 93 CHAPTER 4: VALUATION OF A CALL OPTION

A. Variables Determining the Potential Value of the Shipyard to Private and Public Buyers ...... 97

-3- B. Application of Options Pricing Theory ...... 98 C. Description of Options and Their Valuation ..... 100 D. Calculation of the Call Option ...... 102 CHAPTER 5: EXTERNALITIES ...... 111

A. Return on Public Investments ...... 117 1. General Issues ...... 117 2. Analysis of Three Types of Investments ..... 120 3. Deadweight Loss of Tax Revenues ...... 131 4. Conclusion ...... 134

B. The Existence of Externalities ...... 136 1. A General Definition of Externalities ...... 136 2. Externalities and the Quincy Shipyard ...... 136 3. Discussion of Potential Externalities ...... 138 a. Impacts on the Local Economy ...... 138 b. Education of the Work Force ...... 141 c. Commercial Navigation Activity ...... 147 d. Impact on Other Industrial Activities Around the Weymouth-Fore River Basin ... 151 e. Potential Loss of the Port Facility for Future Use ...... 153 f. Pollution ...... 154 g. Change in the Character of Quincy ...... 158 h. Loss of Defence Mobilization Capability ...... 159

C. Conclusion ...... 162 CHAPTER 6: CONCLUSION ...... 166

FOOTNOTES ...... 170

-4- LIST OF EXHIBITS

Exhibit Page 1: New Building Orders and Total Orderbook ...... 19 2: 1983 Shipbuilding Costs, U.S. and Japan ...... 21 3: New Building Orders for Merchant Ships in the U .S...... 23 4: Trend in U.S. Shipyard Shut-Downs ...... 24 5: Comparison of Labor Costs in Real Terms Between a U.S. and a Japanese Shipyard ...... 26 6: The State of U.S. Shipbuilding ...... 30 7: Proposals to Revitalize the Shipbuilding Industry ...... 32 8: Quincy Shipyard Location ...... 37 9: Layout of the Third Harbor Tunnel ...... 71 10: Sunken Tube Construction Method ...... 73 11: Recent Construction of Tunnels in the U.S ..... 75 12: Construction Operations ...... 77 13: Harbor Tunnel Metal Sunken Tube ...... 78 14: General Dynamics Quincy Shipyard Plan ...... 81 15: Construction Schedule for Third Harbor Tunnel ...... 85 16: Cash Flows for the STCO Project Expressed in 1990 Dollars ...... 86 17: Project Costs and Discounted Cash Flows ...... 89 18: Discount Rate for the STCO Project ...... 92 19: STCO Project Decision Tree ...... 99 20: Payoff Diagrams ...... 103 21: Calculation of Upper and Lower State Asset and Call Values ...... 106 22: Calculation of the Call Option Value ...... 108 23: The Value of the Call Option Under Different Probability Assumptions ...... 109 24: Dredging Projects at Weymouth-Fore River ...... 121 25: Industrial Facilities with Waterfronts on Town River Bay, Fore River Bay and King Cove .. 123 26: Weymouth-Fore River 35-Foot Project Costs ..... 125 27: Map of Fore River Bridge ...... 127 28: Breakdown of Estimated Costs for Bridge Reconstruction ...... 130 29: % Training Obtained in Different Occupations On-the-Job versus Off-Production Site ...... 146 30: Weymouth-Fore River Freight Traffic 1983 ...... 149 31: Type of Activities Conducted by Industries Located on the Waterfront in Town or Fore River Basins ...... 150 32: Net Spillover Benefits: Decisions Available to the Public Sector ...... 168

-5- ACKNOWLEDGEMENTS

The authors would like to express gratitute to

Professors John Parsons and Hank Marcus whose guidance made this thesis possible.

Thanks are also extended to Peter Gwyn, Judy Kildow, Carl Boutilier, and our anonymous sources, who provided insights and information that made much of this thesis possible.

-6- to our mothers,

-7- CHAPTER 1: INTRODUCTION

After a 102-year history, the Quincy shipyard is closing. The shipyard, owned by General Dynamics

Corporation, adds its name to a long list of U.S.

shipbuilding facilities which have shut-down over the last ten years. Thus, its closure serves as testimony

to the decline of the U.S. shipbuilding industry, and raises interesting questions about future shipyard

conversion. General Dynamics' decision to sell the

yard was only the beginning of its problems. Private

industrial buyers have not shown significant interest

in the yard. In addition, the public sector, in particular state agencies and the city of Quincy, have expressed strong concern about the shipyard's future.

Quincy's conversion process represents a

fascinating and timely opportunity to understand the economic forces behind a heavily publicized event.

The authors approach this challenging topic through the use of financial and economic analysis and concepts, and base their findings on an extensive volume of data collected, in large part, through interviews with the various parties involved in the

-8- situation.

The purpose of this thesis is to understand the economic factors characterizing the Quincy shipyard sale transaction. Given potential opportunities for diversifying into industrial water-dependent projects, the authors assess a fair market price for the

shipyard, from the perspective of a private industrial investor. The recognition that this assessment, based on well-proven financial models, constitutes only part of a more complex problem, leads to an analysis of public interest in the outcome of the sale.

In the case of Quincy, political pressure has been asserted to protect social welfare. The claims for such protection are based on assumptions of varying degrees of legitimacy, but the aggregate effect is interference in a transaction between two private entities, and modification of market mechanisms.

Thus, interested parties -- the buyer, the seller and the public sector -- may all have different assessments of value for the same economic good.

Based on this background, the study proceeds to identify economic factors which may cause price

-9- misplacement. Two potential factors are the expected return on public investments and the effects of externalities. An assessment of the validity of these issues leads to the finding that public concern in the sale transaction is justified. Therefore, the sale of Quincy shipyard represents a case of market failure, where social benefits and costs are connected with the private characteristics of the asset.

Under these circumstances, the public sector has a legitimate reason to steer the market toward a decision which takes account of spillover costs and benefits. The public sector should therefore participate in the sale so as to maximize social welfare. However, there are reasons, described in our conclusion, why the government may in fact not intervene, despite a valuation of net spillover costs.

This thesis begins in Chapter 2 with a description of the current economic situation characterizing the U.S. shipbuilding industry. The recession in the world shipping industry and the loss of competitive advantage by U.S. shipbuilders are presented as the major causes for present excess capacity and for the recent closure of shipyards. Chapter 2 then proceeds

-10- with a more specific analysis of the history of the Quincy yard and the factors leading to General Dynamics' decision to sell. Alternative proposals for helping the industry and Quincy to survive are also presented. The authors argue that diversification in

activities related to ship construction is the best strategy in the current environment.

Chapter 3 analyzes a real diversification project which has been proposed for the Quincy shipyard,

namely the steel tube fabrication for the Third Harbor

Tunnel. A cash flow analysis results in a positive

net present value for the project in year 1990, when it is expected to begin. The project's present value is then determined for use in the option pricing calculation in the following chapter.

Chapter 4 values the implicit option that a

potential industrial buyer can acquire by purchasing

the Quincy shipyard today. The option's future and present values will depend, for the most part, on the availability of projects, like the Third Harbor Tunnel project. The price that an investor will,

theoretically, be willing to pay is the sum of the option value and the value of the land.

-11- Chapter 5 addresses the main dilemma of the Quincy shipyard. If a private investor can theoretically assess that the shipyard has a positive market value, then why does the private sector refuse to buy and why should the public sector intervene. More precisely, the chapter explores two issues: (i) the existence of a gap between the price sought by General Dynamics and the price that a private investor may be willing to offer; and (ii) the motivations for public sector intervention in a transaction between private parties. The distortion from competitive market conditions is explained by studying externalities, which are the costs and benefits that the community will have to bear as a result of the transaction.

Chapter 5 proceeds with a detailed assessment of each externality related to closure of the shipyard. The authors conclude that there are compelling reasons for public concern with the fate of the shipyard. The public sector therefore has an incentive to intervene in a private market transaction. Obviously, this condition adds an element of complexity to the Quincy shipyard situation, since the seller, the potential buyer, and numerous public entities have conflicting interests and different assessments of the asset's value. -12- CHAPTER 2: HISTORICAL OVERVIEW

This chapter is an introduction to the industrial setting in which the Quincy shipyard, owned by General Dynamics, operates. An explanation of past and current events in the shipbuilding industry and at the Quincy shipyard leads to a discussion of the current decision to sell the yard.

The purpose of this chapter is two-fold. First, the authors want to understand the factors that have affected the destiny of the Quincy shipyard. Second, the authors want to understand what alternative opportunities can be envisioned both for U.S. shipyards in general, and for the Quincy shipyard in particular.

The first goal is achieved by considering overviews of the U.S. shipbuilding industry and of the tenure of General Dynamics at Quincy. International competition and changes in government policies which affect the U.S. shipbuilding industry are explored in section A of this chapter. The relative competitive position of the Quincy shipyard and its managerial

-13- implications are described in section B.

The second goal really underlies the entire thesis project, but it already becomes relevant here. In general, the authors advocate that shipyards should diversify their product lines in order to survive the current recession in the shipbuilding industry.

However, when this concept is applied to the specific case of Quincy, several concerns and constraints become apparent. An initial description of these issues is undertaken in sections B and C of this chapter. In particular, section C concentrates on the interest of the public sector in the fate of the

Quincy shipyard. Several agencies and public concerns advocate a claim on the outcome of the decision to sell the shipyard. Their role and their regulatory power are also described in section C.

-14- A. THE SHIPBUILDING INDUSTRY

1. International Scene: Overview and Trends

The demand for new ships, which constitutes the primary product of any shipyard, is derived from the demand for trade of physical goods. Any impact on shipping services is reflected in shipbuilding sales.

In fact, at any given moment in time, there is a certain stock of ships in the world. Some of them may be under repair, and others temporarily laid up, but their supply potential is real. When demand for shipping services is strong and ships' capacities are fully utilized, a rush of orders for new ships affects the shipbuilding industry; but as soon as demand for shipping services decreases below full capacity, orders are converted or cancelled. The shipbuilding industry is therefore heavily dependent on the status and on the expectations of the shipping industry.

With the volume of world trade increasing rapidly and ninety-five percent of all international physical trade movements made by sea [11, there is no doubt that the shipping and shipbuilding industries have to compete within an international environment. Besides

-15- the fact that most countries tend to protect and subsidize their own fleets, advocating some kind of mercantilistic policy, international competition largely affects the shipping industry. Vessels with lower operating costs, due to a lower cost of national labor, have a competitive advantage vessels over nations with higher wages, especially when there is a general surplus in shipping capacity. Shipyards, where most of the value added to input materials is represented by labor costs, also strive in an international environment for some form of cost advantage. Dependency of the shipbuilding industry on the demand for shipping services and the international competition characteristic of both industries are two critical factors that will underline the analysis of this section.

Before we investigate the competitive position of U.S. shipyards with respect to foreign shipyards, we need to discuss two issues:

a. recent trends in the shipping industry;

b. recent trends in shipbuilding orders and their worldwide geographical distribution.

-16- The analysis is kept at a general level and is focused on the commercial sector. In fact, our intent is to develop a perception of major constraints and potential opportunities facing the U.S. shipbuilding

industry.

From 1974 until now, the supply of world shipping capacity in the merchant fleet has exceeded demand

causing a world surplus that reached 160 million dead weight tons (dwt) in 1984. [21 (Dead weight tons measure the weight that a ship can carry in tons.) The two major sectors of the world merchant marine

fleet, the dry-bulk and the tanker sectors, are both

in trouble. The dry-bulk sector is experiencing a chronic overcapacity, and the tanker sector is just beginning to emerge from a decade of loss-making

freight rates, still with an urgent need to reduce fleet surplus.

In 1985 the amount of surplus dry-bulk carrier tonnage was estimated to be at almost 50 million dwt. [3] Little comfort comes from a possible boost in the demand for dry-bulk shipping caused by a growth in the world's GDP, since the growth in the world's GDP in 1985 was only 2.7% in real terms, and forecasts for

-17- 1986 are not much higher. Also, the scrapping rate (the rate at which ships are sold for scrap when not used for transportation anymore) for dry bulk carriers was 3.5 million dwt in 1984, 4 million dwt in 1985, and is expected to reach 6 million dwt in 1986; but the rate is still too small to considerably improve the current overcapacity. The tanker fleet also reduced its tonnage to 276 million dwt in 1985, down by 28.2 million dwt from 1984. However, only if the recent drop in oil prices continues over a long-term period and the market does not plunge into a rush of new orders, will the tanker market eventually emerge from its chronic overcapacity.

The surplus tonnage in the merchant fleet has caused a slowdown in new building orders. Exhibit 1 reports new building orders in 1983 and 1984, and the world orderbook (record of backlog orders for ship construction) in 1984 and 1985. The Exhibit shows a decrease in both new building and cumulative new orders worldwide. The recession of the shipping industry therefore has a direct negative impact on the shipbuilding industry.

This negative impact affects some nations more

-18- EXHIBIT 1

......

...... ° ...... li~I~~~ii~~):. ~...... I~i:::::::: ...... ·a~l~i[-[ ...... r ~ ......

7 9

3 ,4

1980 1981 1982 1983 1984

Sources:" US Shipping and Shipbuilding: Trends and Policy Choices," Congress of the US, Congressional Budget Office, August 1984

" Shipping Shipyards and Sealift: Issues of National Security and Federal Support," Nacoa Report, preliminary draft, 1985

...... ° ...... • •...... •...... •...... o .... , ...... o ...... • ...... • ...... ,. .. . .• ...... • ......

-19- than others, namely those nations that are at a comparative disadvantage in building ships, either because of higher costs or use of less advanced technologies. The results from Exhibit 1 indicate that two nations, Japan and Korea, have the largest share of world merchant shipbuilding orders, and therefore should have some form of competitive advantage or strong government support to maintain their dominant positions. In fact, more efficient production methods, low real cost of labor, and a supportive national industrial policy have enabled Japan and South Korea to cut their shipbuilding costs and gain a competitive edge. Exhibit 2 shows shipbuilding costs in the U.S. and Japan. It indicates that, for example, a merchant ship built in Japan costs one third as much as the same ship built in the United States. [4]

2. The U.S. Shipbuilding Industry

The excess capacity in the world shipping industry and the competitive cost advantage of foreign yards have put the U.S. shipbuilding industry in an unfavorable situation. A large part of that industry's business has historically come from two

-20- EXHIBIT 2

(90 ,000dwt) country built

Japan 69.0 96.0 US 22.5 34-3

source: "US Shipping and Shipbuilding: Trends and Policy Choices," Congres s of the US,

Congressional Budget Of ...... ic, • 8 • • • • • .84..... • • •. • • • • •... ------

-21- major sectors: commercial and military. Commercial shipbuilding orders have reached very low levels in

the last five years, and naval orders have not been sufficient to support the shipbuilding capacity of

major yards in the United States. (Major yards are defined as having at least one shipbuilding position large enough for a vessel of minimum 475 foot length by 68 foot beam.) In 1982, out of twenty-seven major shipyards in the U.S., only three were doing

commercial work. Four have since gone out of business

or run out of ships to build, and ten more will finish

Navy construction projects in the next three years.

[51 If we add to this situation the decline in building orders for merchant ships over the period

1981-1983 and the inadequate recovery of 1984, we have the major reasons for an increase in plant shutdowns.

Exhibit 3 shows the trend in new shipbuilding orders for merchant ships in the U.S., and Exhibit 4 the trend in plant shutdowns.

The decline in commercial shipbuilding orders is caused by the following factors:

a. the real cost disadvantage of U.S. shipyards with respect to yards in Japanese, South

-22- EXHIBIT 3

1983 1984 1985

million market million market million grt share W grt share W grt

new building orders

SJapan 11.13 56.8 8.39 55.4 6.63

South Korea 3.74 19.1 2.29 15.1 1.2

WORLD TOT AL 19.6 100 15.14 100 n.a

total orderbook

SJapan 20 2 43 10.45 .

South Korea 7.05 15 4.67

VORLD TOT AL 47 100 27.5

SSource: Lloyd's Register, Far eastern Economic R vie.w Feb.13, 1986, pp 47 :.South Korea 3.74 19.1 2.29 15.1 1..2 .

-23- EXHIBIT 4

...... •...... ~.••.....o..o...... o.o...... • . • . ° ..° . •. .. • . . . ° . . ° • • . . •

. . • ...... • • . ° ...... •...... •...... •....°•...o...... ••...... °°..=.•.o•...... •.... .°...... •...... °.•.°...... •....:::::::::::::::::::::::rQ .... ,...... o.,.•...... •...... •o.•

1956-65 1966-75 1976-85

Source: Booz Allen & Hamilton, "Potential reuse study of the Quincy Shipyard," February 1986

• •. ... o •.-: .* . . • ° .- -...... ° .*••° *. . • •. • .* .*...... ° .•.. • °

-24- Korean and Taiwanese yards, stemming from the lower productive efficiency and higher cost of

labor (in real terms) at the U.S. yards;_

b. changes in federal support and programs protecting the maritime industry.

Both factors are analyzed hereafter and supported by industry data.

3. Cost Disadvantages of U.S. Shipyards in Commercial Shipbuilding

It is estimated that 34% of a ship's value comes from input materials and 66% from the labor intensive manufacturing process. [6] Thus the cost of labor and labor productivity are two critical parameters for the measurement of competitive position in the shipbuilding industry. The higher cost of labor in real terms has put U.S. yards at a competitive disadvantage with respect to yards in Asia. Exhibit 5 shows a comparison of labor costs in real terms between a U.S. and a Japanese shipyard. Not only are U.S. costs higher than foreign costs, but also production efficiency is lower. It is estimated that

-25- EXHIBIT 5

...... -...... I...... I

...... • ,. . .l,:. . . 't....w.. 6-t.. =. . .. b-OiI .bs--.=. . 9• .. *..- . ..in ==......

inflation rate ( i. in %) 1980 19814.9 19822.6 i JAPAN 1729 1773 Labor cost in manufacturing of transport equipment (gen/hr) inflation rate ( i in %) 109 2.6

Labor cost i n manufacturing 10-39 11-12 of transport equipment (yen/hr)

inflation rate ( i in %) 10 6 us Exchange rate ( E $/__enl .0049 .0045 .0042

Real Exchange rate( __$genX (i+i ) ja .0043 .0040 X= E (1+i ) us Real Japanese vges in $ 7.43 7.09

sources: Yearbook of Labor Statistics, tnternational Labour Office of Geneva, 43rd issue, 1983 .1 ...! . . .International . . . .. Moody's,1981,1982,1983...... :· :·-:·...... ·: · · ·:·i· ·: :-·:·· ·:-..... ·

-26- the delivery time of yards in Asia is almost always less than for a U.S.-built ship. For example, a recent proposal by Lykes Bros. Steamship Company to build C-9 container ships calculated a delivery time of 24 months for foreign-built ships and 36 months for American-built ships. [7]

Historically, the competitive disadvantage of the U.S. maritime industry has been supported by construction and operating subsidies (CDS and ODS respectively) to make up for the cost differentials in constructing and operating U.S. vessels. Cargo preferences under the Jones Act have also supported the U.S. flag shipping industry by requiring that all cargo shipped by water from one U.S. port to another U.S. port must be carried in U.S. flag ships, built in U.S. shipyards, and owned by U.S. citizens. Financing subsidies under Title XI, the Capital Construction

Fund (CCF) and Investment Tax Credit (ITC) legislation have provided substantial incentives for capital investments in ship construction.

-27- 4. Changes in Federal Support and Protection Programs

The Reagan administration has discontinued the CDS program, granted ODS and CCF for foreign-built ships, and cancelled Title XI. [8] These actions are

intended to boost the U.S. shipping industry and its participation in world trade. With no direct subsidies and few orders, the U.S. shipbuilding

industry is undergoing a major shake-out period. The

shipyards that still survive are those which have been

able to secure Navy contracts and position themselves to best compete for Navy ships.

The Naval ship construction program has expanded during the Reagan administration. The Five Year Defense Plan (FYDP) for 1984-1988 had an allocated budget in 1984 of more than $12 billion, and the FYDP for 1985-1989 has only slightly been lowered from the

1984 level. [9] However, there are two major problems with the Navy business, and those are:

a. Orders are not distributed evenly across the major shipyards, and therefore are not sufficient to support all of those yards;

-28- b. Navy projects are somewhat volatile.

It is estimated that 75% of Navy construction work (in terms of budget) goes to the few major yards that have successfully positioned themselves to handle the sophisticated technological requirements of Navy work. Among these stand Newport News Shipbuilding in

Virginia, Bath Iron Works in Maine, and Ingalls in Mississippi. The remaining 25% of the Navy budget includes construction of auxiliary ships or the conversion of existing ships. The number of Navy vessels under construction at private shipyards is shown in Exhibit 6. Many of the major shipyards have not been able to position themselves for the bulk of Navy work. They must compete for the remaining portion of it and experience conditions of chronic overcapacity.

The reliance on a single buyer (the Navy) in the shipbuilding industry represents a monopsony situation, with substantial bargaining power in the hands of the buyer. This creates an unstable situation for many commercial shipyards since not only can the Navy's FYDP change substantially from one year

-29- EXHIBIT 6

The @QoDG of 9M @[pbOiDOin i

------I ------Number of vessels under construction • or on order at private shipyards

Todd Shipyards Bell Aeroespace, Textron Litter (Ingalls) Galveston, TX , . New Orleans. LA . Pascagouia, MS SIthip I..1 ship . 11 shltps

Soum: US Navy. March 1985 ~ I- - -- _1 ------· 111~--

-30- to the next, but also there are limited alternative sources of work for the major shipyards.

5. Proposed Solutions to Revitalize the U.S. Shipbuilding Industry

The future of the U.S. shipbuilding industry can derive little from the present situation, and many different groups have proposed solutions to help the industry overcome its current problems. A brief description of some proposals to revitalize the U.S. shipbuilding industry follows hereafter.

In general, all proposed solutions affect commercial shipping and shipbuilding since the two industries are tightly connected. There are two broad categories of solutions: those implying federal support - direct, indirect or political; and those advocating the benefits of free market competition.

Exhibit 7 lists the different types of proposals according to the two categories and their effects on the shipping or shipbuilding industries.

Solutions implying federal support are based on assumptions that the U.S. shipbuilding industry cannot

-31- EXHIBIT 7

° ...• ...... • .. .•......

Shi ppjng Shi pbuildi ng

Shipbuilder Shipbuilder direct Council of Council of America ,L Rice America, L.Rice

Federal Cargo Preference Cargo Preference suRPort policies

Navy John Lehman John Lehman

Free market NACOA report -authors" opinion-

Source - authors

'. * ......

-32- compete under free market conditions and that the maritime industry in general should be treated as an integral part of the economic and defense policies of the U.S. government. The resurrection of the CDS program and the build-and-charter program

(constructing from the government's account and then chartering to private operators) are examples of direct federal support and intervention. The cargo preference regime is another example of a supportive policy that allocates a fixed percentage of U.S. traded cargo to U.S. ships.

Finally, the Navy (listed under federal support because its FYDP budget is approved by the government) is considered a solution to survival of the shipping industry. The rationale behind supporting shipbuilding through Navy contracts has recently been explained by John Lehman, Secretary of the Navy. [10] Lehman claims that the Navy, with its system of competitive bidding, helps to keep the shipbuilding industry alive by creating a competitive environment.

Whether this view is legitimate or not, the point remains that some rationalization of the industry may in fact be undertaken through Navy contracts.

-33- Among advocates of free market conditions to help revitalize U.S. shipping and shipbuilding industries is the National Advisory Committee on Oceans and Atmosphere (NACOA). NACOA recommendations include: a co-production ten year plan under the Jones Act to relax domestic building provisions; and liberalization of CCF provisions to allow reinvestment of the tax deferral of U.S. flag shipping profits in foreign ship construction.

The authors of these proposals think that one way to save the productive capacities of shipbuilding facilities is to diversify the activities of shipyards into related products and to support technological innovation in the production process. By broadening their product lines, shipyards can lower the risks associated with the widely fluctuating demand pattern for new ships and can potentially disentangle the fate of their business from that of the shipping industry. Diversification would also mitigate the effects of dependence on a single buyer in shipbuilding.

Further, through support of technological innovation, shipyards can maintain a competitive position by offering products that are differentiated in terms of their technological content.

-34- The Quincy Shipbuilding Division of General

Dynamics, aka "the Quincy shipyard," is an example of

a major U.S. shipyard forced to close as a result of both the slump in the shipping industry and the effects of international competition among shipyards.

The issue of shipyard conversion in the U.S., given the reality of shipbuilding overcapacity, and the roles played by both the public and private sectors in deciding the fate of individual yards are discussed in this thesis. The controversy surrounding the Quincy shipyard is seen as representative of that which other U.S. shipyards potentially face or are currently facing. Quincy is therefore used to outline issues and to introduce an analytical framework for definition of public interest in shipyard conversion.

-35- B. THE QUINCY SHIPYARD AND GENERAL DYNAMICS

1. History of the Quincy Shipyard

The Quincy Shipyard was founded in 1884 as The Fore River Engine Company by Thomas A. Watson, a machinist reknown for his association with Alexander

Graham Bell, in East Braintree. Watson moved the yard downstream to its present location, as shown on Exhibit 8, in 1900. The initial business at the yard was in farm engines, but later expanded to include first marine engines and then construction of marine vessels. In 1913, Watson sold the yard to Bethlehem

Steel Corporation, under whose auspices it was renamed the Fore River Shipbuilding Corporation. Fifty years later in early 1963, Bethlehem Steel closed the yard due to a lack of Navy contracts. In December, 1963, it was sold to General Dynamics Corporation for $5 million.

Throughout the yard's 101-year history, more than six hundred vessels have been designed and built there, with output levels closely paralleling U.S. war activities. [11] Production peaks have occurred during the Spanish-American War in 1898, later during

-36- EXHIBIT 8

QiwMUE B@jhciPtf Latioo

RAINSFORD i.

SHUZC£ AVA

SHEEP .1' 1U2Jy'c V NA V (1NIEK *r

35' TURNING LATEI 8' STATE :RAPE 1.

QUINCY

RPS OF ENGINEER

-37- World Wars I and II, and finally in the late 1960s, reflecting American involvement in Vietnam.

2. General Dynamics' Tenure

General Dynamics has pursued both commercial and government contracts in an effort to maintain production activities at the shipyard. Although the relative proportion of government to commercial contracts has oscillated over time, 7% of all merchant ships produced in the U.S. in the last 22 years were built at Quincy. [121

Commercial business has primarily been in the construction of tankers and barge carriers. Quincy was the world's leading producer of liquified natural gas (LNG) tankers, until demand for those ships disappeared. Its "LNG program" was a response to the disappearance of Navy work in the early 1970s. The program lasted from 1972, when the first LNG contracts were negotiated, to 1981, when the last tanker was delivered. In total, 10 LNG tankers were constructed. [13]

As part of the LNG program, General Dynamics

-38- invested heavily (more than $75 million) in new equipment specific to LNG tanker production. The

result of that investment is that Quincy is one of the

most modern shipyard facilities in the U.S. with a very high steel throughput capacity. The major improvement which were made include:

a. conversion of two conventional sliding ways ways to large construction basins;

b. new steel fabrication process line with a a substantial amount of updated equipment;

c. 1,200-ton Goliath bridge crane which is the largest in the Western hemisphere;

d. new materials handling equipment including two 200-ton transporters and robotics equipment;

e. new facility at Charlestown, South Carolina,

for the fabrication of spherical tanks. [14]

This investment program reflected management's prediction that the LNG business would expand and their consequent strategic decision to create a niche

-39- for Quincy in that market. Demand for LNG tankers eventually waned, however, due to a number of factors, which included: the softening of oil prices, an increase in concerns about the safety of storing LNG tankers in urban harbors, and the failure of the U.S. and Algerian governments to reach contract agreement regarding LNG transport.

The demise of the LNG program dealt a severe blow to the Quincy yard. Because LNG tankers require substantial steel work and throughput, while Navy construction contains a high proportion of outfitting, investments made under the LNG program equipped the yard for a market which no longer exists. In the end, much of the new equipment purchased was barely used, and, having been built into the facility through concrete foundation for specific shipbuilding uses, cannot be resold except to a new shipbuilder operator with similar steel work requirements.

The LNG program represented Quincy's largest investment in commercial shipbuilding. Because they sustained substantial losses, management was hesitant to pursue commercial work requiring any significant initial investment the'reafter. The commercial

-40- shipbuilding industry in the U.S. has since dried up almost completely, as discussed in the previous section, and Quincy is predominantly dependent on government contracts for shipbuilding.

General Dynamics is a major military contractor, and owns two shipyards: its Quincy Shipbuilding Division and its Electric Boat Division in Groton,

Connecticut. The two yards have focused on different ends of the Naval shipbuilding industry: Quincy builds smaller, less complex support ships including auxiliary, amphibious and merchant hulls; and Electric Boat builds submarines. Quincy's market is more competitive, as many other shipyards have the capacity for support ship construction, but not for submarine construction. In addition, Quincy's contracts are individually less valuable and of shorter duration.

Specifically, the estimated total value of support ship contracts should be $17 billion during the

1986-1995 period, while those of submarine contracts only will be approximately $15.5 billion [15]; and the production period for support ships averages 2 to 3 years, while that of submarines is 4 to 6 years [16].

The demand for support ship construction has

-41- steadily diminished over the last 30 years, as the Navy has chosen to overhaul old support ships or convert commercial ships, rather than commission new orders. [17] The trend has intensified competition among the numerous shipyards geared towards this market. Quincy won its last contract for two Marine Prepositioning Ships (MPS) on August 18, 1982; the contract was expanded to include three more ships the following year. Four MPS vessels have been delivered: the "2nd Lt. John P. Bobo" on January 19, 1985, the "Pfc. Dewayne T. Williams" on May 18, 1985, the "Ist Lt. Baldomero Lopez" on October 26, 1985, and the "Ist Lt. Jack Lummus" on February 22, 1986. The fifth MPS, the "Sgt. William R. Button" is scheduled for delivery in May, 1986. [18]

3. The Decision to Close the Shipyard

On July 24, 1985, General Dynamics announced that it would close the Quincy shipyard after the last MPS vessel is delivered. Gary Grimes, the yard's vice president and general manager, stated that the decision to close was made "after assessing upcoming Navy contracts and deciding Quincy had little if any chance of winning them." [19] Another probable reason

-42- behind the decision is that the shipyard does not meet General Dynamics' expected return on investment. According to the company, of the 21 years to 1985 that

General Dynamics owned the shipyard, 9 years were profitable and 11 unprofitable. [20]

Prior to the decision to close, General Dynamics lost three bids for contracts. The first was for a

$341 million commercial contract to build container ships; that contract was lost to a foreign bidder in October, 1984. [21] The second bid for a $525 million Navy contract to build three fleet oil tankers was awarded to Avondale Shipyards Inc. of Avondale, La., and Pennsylvania Shipbuilding Co. of Chester, Pa.

[22] The third bid for a $130 million Navy contract to construct two TAGS surveillance ships went to

Bethlehem Steel of Sparrows Point, Md.

Loss of the third bid was a particular blow to the

Quincy yard. The contract was expected to generate

1,000 jobs per year into 1988. [23] Industry sources affirm that Bethlehem's bid, which was substantially below the Navy's cost estimates, will not support completion of the ships. They also claim that because Bethlehem does not have sufficient cash from

-43-

-'I operations to cover cost "overruns" (which will obstensibly be due to design alterations), the Navy will be obliged to provide further financing to ensure the ships' completion in the future. [24]

The government charged General Dynamics with using the same strategy in the past, i.e. bidding under cost and later overcharging for design alterations in order to win contracts. That and other charges have resulted in law suits which are still pending against General Dynamics may have contributed to the company's recent lack of success in obtaining contracts for Quincy. Increased public scrutiny and credibility problems ensure that the company's bidding will remain conservative for the duration of legal proceedings.

4. The Impact on Labor

Employment at the shipyard has fluctuated widely with production levels: from 812 workers during the Depression to 32,000 during World War II, and from 0 in 1963, when the yard was closed by Bethlehem, to over 11,000 in the late 1960s. [25] During General Dynamics' recent tenure, the shipyard employed, on average, 6,000 to 7,000 workers in the 1970s, and

-44- 4,000 to 5,000 workers in the 1980s. [26] In 1984, employment grew to 6,300 when work on the MPS vessels was at its peak. [27]

On April 30, 1985, General Dynamics announced that because it had not secured any contracts for future work, 3,100 of the 5,267 workers on payroll would be laid off by the end of the year. [28] Layoffs had already been occuring as MPS work decreased, but the announcment in April served to formalize management's expectations regarding future contract opportunities.

By July 24, 1985 when the company announced that the yard would be closed, there were 4,203 workers left on the payroll. [291 About one-quarter of those are salaried white-collar workers who are expected to keep their jobs but transfer to new locations. [30] The remaining 3,300 hourly workers have been laid off in stages to be completed in May, 1986 when the final MPS vessel is delivered. Thereafter, a skeleton crew will be maintained until December, 1986.

Of the 3,300 hourly workers scheduled for layoff,

800 are from Quincy, 1,000 from Boston, and the remainder from other parts of the state. Of that same number, 1,000 have worked at the shipyard for 15 years

-45- or longer, 1,200 for 5 to 15 years, and 1,100 five years or less. [31]

The majority of hourly workers scheduled for layoff fall predominantly into the following type of skill categories: shipfitters, riggers, loftsmen, welders/flamecutters, machinists, electricians, pipefitters, sheetmetal workers, boilermakers and electronics mechanics, rigger-erectors, production laborers, carpenters, chippers and burners. Only the first three categories are unique to shipbuilding; the others are in general use in equipment manufacture and construction industries. [32]

Demand for these labor categories is relatively elastic, except when demands for the products of industries competing for labor are rising. Since rising demand does not typify the current economic condition of most competing industries, demand for

Quincy's labor force is at present relatively elastic. The economy may be unable to absorb the highly-paid, skilled workforce from Quincy at wages to which they are accustomed, and the expected hardship to those workers is of major concern to the state government. In particular, workers from the first three skill

-46- categories and those who are least mobile will be hardest hit.

The traditionally cyclical nature of work in shipbuilding is similar to that of the construction industry, which has in fact provided the most direct competition for shipbuilding labor in the past. Construction work could eventually offer the single most significant source of comparable work to Quincy's labor force. Construction pays more on average than shipyards for the same skills, even though shipbuilders work under dirtier, more cramped, and noisier conditions; this wage differential is due to the fact that shipyards offer more stable employment in a fixed location. Workers have been willing to trade off those benefits for lower wages. [33] The possibility that a sizable percentage of workers will be employed, within Massachusetts or nearby states, in construction activities is important in that, under this scenario, remobilization of the workforce at

Quincy would be possible sometime in the future. Remobilization potential is an important factor to shipbuilders or other industrial operators who consider purchasing the yard.

-47- 5. Potential Buyers of the Shipyard

When General Dynamics publicly announced that the

Quincy yard would be closed, the company indicated that it "would consider conversion of the yard to other uses and sale of the yard to another shipyard, to employees, or to developers seeking to use the yard for an industrial park or condominiums." [34]

Initially General Dynamics focused on other shipbuilders as the major pool of potential buyers.

The company's sales effort included a mass mailing of brochures to all major U.S. defense contractors and shipyard owners. However, due to the present condition of the U.S. shipbuilding industry, as previously discussed, most large shipbuilders are unwilling at this time to acquire new capacity.

The possibility that a smaller, entrepreneurial shipbuilder with experience in Naval contracting could run a profitable business at the shipyard, either now or sometime in the medium-term future, can not be dismissed. General Dynamics has not specifically targeted this type of shipbuilder in its marketing activities as the company prefers to sell the entire

-48- yard to a single buyer. A shipbuilder could use only a portion of the yard's capacity because of the current scarcity in large Naval contracts, but such a buyer could eventually complement other industrial buyers if the yard is diversified.

General Dynamics did enter into negotiations with one entrepreneurial buyer, Frank Rack. Rack had worked with General Dynamics for 17 years, but left his position as deputy operations manager at Quincy in 1973. In December 1985, Rack founded Genesis Shipbuilding and signed a tentative agreement with General Dynamics to purchase the shipyard. Rack intended to produce four $200 million luxery liner cruise ships, which could be converted to military uses during wartime, at Quincy. The success of his plan depended, however, on the provision of $75 million per ship in subsidies by the federal government. The tentative agreement with General

Dynamics expired in January 1986, when Rack failed to gain the cooperation of Congress or the Armed Services Committee. [35] Since that time, General Dynamics has not reported any other solicitations from shipbuilder entrepreneurs.

-49-

~,QLclSZ~;~.-d~4~M1S118;4i~jF~748~(~WI~* rrmmr In examining industrial conversion of the yard, General Dynamics has focused on large single buyers. Large manufacturing companies, specifically those involved in industries which require heavy lift, heavy machining and ocean access, are viewed as the second most-likely target buyer group. The main problems General Dynamics has encountered in attracting these types of companies have included the relatively high wage rates, expensive real estate, low unemployment rate, and lack of state-sponsored business incentives in Massachusetts. Large manufacturing companies easily locate, or relocate, wherever costs are lowest, as they usually are not dependent on retaining skilled labor.

Other constraints are that the yard has limited highway and rail access. The yard is located at a distance from main highway arteries. And, although one Conrail spur services the Braintree end of the shipyard, its overhead bridge allowances are low. The flat railcars used for steel transport are of an acceptable height, but most container-type cars, particularly those used for shipping, are too tall for the overpasses. Large U.S.-based manufacturers often rely on highway and rail access for receipt of

-50- supplies and product distribution, rather than on ocean transport. For this reason, shipyard conversion or diversification in nations like Japan, Taiwan and South Korea would be less problematic in that many of their industries are water-dependent.

Advocates of diversification believe that smaller industrial businesses or projects could be found to utilize the shipyard's productive capacity. Such projects would ideally be water-dependent, need some proportion of skilled labor, and require geographic location either within the region or in the state of Massachusetts. The last characteristic would typify, for example, small manufacturers with local suppliers/ buyers or public works projects. Coordination of this type of many-project or many-buyer diversification requires creativity, a long-term perspective and dedication to the conversion plan. A large, private military contractor such as General Dynamics, using its own industry-specific requirement for return on investment, would generally show little interest in directing such an effort.

Groups, such as the South Shore Conversion

Committee (SSCC), believe that the failure of General

-51- Dynamics to find a successful means of converting the shipyard to other industrial uses is due to management inflexibility. They believe that a large enough number of projects could have been found to generate

the company's required return on investment. Further, the SSCC charges that General Dynamics did not

seriously pursue conversion because the community

support for that alternative made it a political issue. They have proposed that the yard be used to produce "plant ships" that could generate electricity or process timber at sea (designed by the Applied Physics Lab of John Hopkins University). However, neither private investors nor public utilities have as yet shown an interest in plant ship investment. [36]

Leaders of the shipbuilders union in Quincy have steadfastly opposed conversion of the shipyard. They believe that their members would, in all probability, be forced to accept lower wages for any other type of work which could be done at the shipyard. They believe that either General Dynamics or another large shipbuilder operator could make the yard profitable through employment of more modern shipbuilding methods, such as pre-outfitting or modular construction, methods currently used in Japan. They

-52- accuse General Dynamics of failure to make the appropriate capital investments and lack of managerial know-how. [37]

In fact, General Dynamics would be the first to admit that it made a strategic error in its massive LNG investment program during the 1970s. Whether or not they should have foreseen that the LNG business would wane is arguable. Although the union's accusations may be true, the fact that no private investor is now willing to invest in modernizing the shipyard reflects: the decreased demand in the shipbuilding industry, as previously discussed; and the unlikelihood that a large shipbuilder under current economic conditions will be able to obtain an acceptable return on investment.

There has been a recent proposal that former workers buy the shipyard with state financing. Despite potential assistance from the state, the receipt of federal support, in the form of loan guarantees, would also be needed to ensure the idea's success. The plan is to obtain small shipbuilding contracts, and to supplement those revenues with temporary diversification projects, until shipbuilding

-53-

,~X1Pr*-~~~~n~.4.p*~,~·tBlrNi-~~~k- -~BDB*ll~r~YII~1I~YPYiT~j5fir~~~~B1~M~ ~~UY '~p~-e~~U~Wlls~·~~rrr~Ul~(i41CUI~~~ becomes economically feasible at some point in the future. The union is thus far divided on the issue, because the plan's success will depend on the

acceptance of lower wages by the small portion of workers who are allowed to remain. The state is tentatively interested in this particular alternative,

and may request a $100,000 ($75,000 from the state and $25,000 from the union) study on the feasibility of an employee buyout. [38] Factors which influence the state's concern and degree of potential participation

are discussed in both section C of this chapter and in Chapter 5.

General Dynamics requests that all bids and

proposals be submitted by August, 1986. The company has expressed a willingness to cooperate with state

and union representatives in selling the site for a price lower than that optimally obtainable from the market [39]; whether they will actually take such

action remains to be seen. A number of private developers have contacted both General Dynamics and the Quincy Planning Department to express interest in purchasing the yard for commercial and residential development. The yard would have to be rezoned for those types of uses, as described in Chapter 5,

-54- however the booming South Shore economy may enable a developer to offer a price which is higher than that currently obtainable from the industrial sector.

In conclusion, the authors of this thesis hold the view that if industrial diversification is undertaken, particularly with the participation of a shipbuilder entrepreneur and/or former shipyard workers, the shipyard could survive profitably, while maintaining a sizable number of blue-collar jobs and its industrial water-dependent setting. Without diversification, the shipyard may remain idle, may eventually be sold to a large industrial manufacturer with no need for skilled labor, or may be rezoned for residential uses.

Given this range of potential outcomes, various government agencies and representatives are concerned about sale of the yard and its impact on the public.

Due to the fact that no single shipbuilder, or industrial buyer similar to General Dynamics, has been found, a smooth transition (from the public's perspective) to a new owner is less likely. The government bears the responsiblity of ensuring that public interests are protected in the decision-making process. Major public entities currently involved in

-55- resolution of this situation, and their respective mandates, are described in the next section.

-56- C. PUBLIC SECTOR INTEREST IN THE FUTURE OF QUINCY SHIPYARD

1. The Task Force of the Reuse of the Quincy Shipyard

When General Dynamics announced that the Quincy shipyard would be closed, the Massachusetts state

Governor, Michael S. Dukakis, established a task force to investigate possible alternatives for use of the shipyard. That group met for the first time on August

13, 1985 in Boston. A representative of the state's

Department of Industrial Services, an agency designed to help companies facing economic troubles, chairs the task force. The other seventeen members include state Labor Secretary Paul Eustace, Secretary of Economic Development Evelyn Murphy, the economic advisor to Governor Dukakis, state legislators from Quincy,

Boston, Weymouth, and other South Shore communities,

Local 5 of the Marine and Shipbuilding Workers Union at Quincy, General Dynamics, and representatives from a variety of other state agencies.

The state is interested in outcome of the sale because of the potential direct impacts on the local

-57- economy, which include: loss of state tax revenue, state expense for unemployment benefits, loss of property tax to the cities of Quincy and Braintree,

and loss of income to businesses which supply or

service the shipyard. Government agents are also concerned about the personal hardship to former

shipyard employees, most of whom are state residents,

and about any potential less tangible effect on the community and on the local environment.

Finally, the shipyard is a "designated port area"

(DPA), a state classification usually given to developed areas with port facilities, often used for heavy industry, where few or no natural land forms or vegetation remain. [40] The state is concerned that maintenance of Quincy as a DPA may be of sufficient value to the public that an alternative which uses its industrial and port capacities should be enforced. Each of the government's concerns regarding direct and indirect effects of closure of the shipyard are discussed in Chapter 5 in greater detail.

Two state agencies were interviewed by the authors: the Department of Industrial Services and the Office of Coastal Zone Management. The opinions

-58- of each of those offices are described below.

The Department of Industrial Services favors that alternative industrial use which promises to support the maximum number of former shipyard workers. They are strongly opposed to any use which would not employ blue-collar workers. In particular, the agency believes that a shipyard should be maintained on the site, whether it uses all of the yard's capacity, or part of it in conjuction with other diversified industrial activities. The Executive Director of

Industrial Services hired Booz-Allen & Hamilton, a management consulting firm, on behalf of the task force to prepare a $100,000 report on reuse of the shipyard; that firm concluded that the U.S. shipbuilding industry will be revitalized in the medium to long-term future, and that other industrial diversification opportunities will not fully utilize the yard's capacity. [41]

The office of Coastal Zone Management (MCZM) is a policy and planning branch of the Executive Office of Environmental Affairs. Its policies are implemented by the Department of Environmental Quality Engineering (DEQE) and various other agencies. The MCZM is

-59- primarily concerned with the fact that the shipyard site is a designated port area, and as such, must be used in accordance with waterways regulations which give preference to marine-related industrial uses at port areas. In other words, if there is a viable water-dependent industrial use for the shipyard, the MCZM is obliged to give priority to that use through the DEQE licensing procedure and, when necessary, to enforce it. The MCZM's general guidelines are clear; its problem in this case is to ascertain whether a viable water-dependent industrial use for Quincy actually exists and, if one does, how to steer the private sector toward that preferred use. [42]

Each government player has slightly different jurisdiction in the protection of public interest, but a general consensus exists among state representatives on the optimality of continued shipbuilding and/or alternative water-dependent industrial uses at the

Quincy site. Of course, the latter use is qualified to exclude industrial uses which cause excessive environmental pollution or disruption as detailed in the Environmental Impact Report (explained below).

If one or more buyers appear that fit the optimal

-60- use profile, the state can facilitate the transaction.

However, if shipbuilder or industrial buyers fail to appear, the state will have to decide whether or not to intervene in the situation. The state's various alternatives to influence the outcome of the sale are described in the next section.

2. Intervention Options Held by the State of Massachusetts

Although the state usually prefers not to intervene in private sector transactions, it is empowered to take whatever action is needed to enforce public interest. Government agencies are responsible for protection of the environment and certain limited resources, the economy (if possible), and the "quality of life" of persons living under their jurisdiction.

For these purposes, the state of Massachusetts has regulations, ownership of specified public lands "ad infinitum," and income from taxes, from which the following options for intervention stem:

a. exercise of licensing powers

Any new owner of the shipyard property will have

-61- to go through an elaborate licensing process to gain permission to use or in any way alter facilities under the state's control, which include all facilities

located seaward from the historical mean high water mark. [43] These lands are owned by the state of Massachusetts "ad infinitum" and are protected by laws which regulate their usage. The historical mean high water mark at Quincy is landward from all drydocks,

and in some areas may include a substantial proportion of the industrial facilities. In fact, a considerable

amount of land fill has been licensed over the last one hundred years since the shipyard was first developed. [44]

The state's licensing process is based on three major programs or legislation:

o Massachusetts Environmental Policy Act

Any new owner who wishes to physically alter or re-use the land and/or facilities located seaward from the mean high water mark, for any purpose other than that exactly matching the previous owner's, must apply for a license from the MCZM as the first step in the licensing procedure. An Environmental Impact Report

-62- (EIR) would then have to be filed with the Massachusetts Environmental Policy Act (MEPA) unit of the Executive Office of Environmental Affairs. The

MEPA unit evaluates and attempts to minimize the environmental impact of projects by requiring that a study on those impacts, and also on those of project alternatives, be submitted for their review. Issuance of all other types of licenses is subject to gaining MEPA approval on the EIR. [45]

o The Wetlands Protection Program

Under the Wetlands Protection Act (Massachusetts

General Laws Chapter 131, Section 40), a new owner must obtain a permit before removing, dredging or filling of wetlands, which at Quincy is defined as land under the ocean. This permit must be granted by the Quincy Conservation Commission, which is charged with the responsibility of protecting the wetlands as a natural resource. [46]1

o The Waterways License and Permit Program

Under Chapter 91 of the Massachusetts General Laws, a license much be obtained from the DEQE for any

-63- structural alteration or proposed re-use of the shipyard facilities, which include all buildings, drydocks, and other permanent structures located from the mean high water mark seaward. Licenses can only be issued for uses or projects which are water- dependent and deemed to serve proper public service.

[47]

Other types of licenses may be required from state and local governments if a new owner wishes to substantially alter the site, again depending on the degree of environmental impact. In addition, a permit must be obtained from the U.S. Army Corps of Engineers to either dredge or fill the dry docks or waterways. The U.S. Army Corps of Engineers, however, has recently changed its wetlands policy nationwide by instructing its regional offices to "allow development on wetlands unless another site is available that meets the developer's criteria." [48] The new guidelines imply that a buyer, who wishes to develop or alter the shipyard property, will encounter less resistance from the federal government than from the state government.

In exercising its licensing powers, the government

-64- can either completely refuse to grant licenses for purposes which clearly violate the intents of protective regulations, or it can suggest that the licensing applications may take years to adjudicate in the case of a use not considered optimal.

b. participation in purchase of the Quincy shipyard

The government can purchase the shipyard, directly or indirectly, and either: let it remain idle until the preferred buyer appears, or manage a diversification effort. The first alternative may be the only means, at present, to ensure that the shipyard is available in the future for uses which will serve public interests. The latter alternative could entail either selling the land in parcels for diversified, water-dependent industrial uses, or managing a consortium of contractors engaged in temporary diversified projects of the same nature.

Clearly, the government's preferred action will depend upon its internal consensus regarding public interest and regarding the existence of projects/ buyers which fit its perceived optimal use profile.

-65-

~~x.ir~.~i·~*re~·XL~.~.~I*dr~UR1&IUUJJIIU9~hrl xU·X~-~~f"~C***I~"C-~D1I~~Um~lrNn*5· rrTi~~LT In the next Chapter, we will discuss one of the many potential industrial projects which would be viewed as appropriate by the government.

-66- CHAPTER 3: THE THIRD HARBOR TUNNEL PROJECT

One of the alternatives proposed to diversify the activities of shipyards is the construction of steel structures. This alternative offers the advantage of using the steel manufacturing equipment of a shipyard for the production of a wide range of durable goods. Modules, bridge structures, rail vehicles, turbines, and components have been successfully produced at several shipyards worldwide.

Recently, three U.S. shipyards have successfully diversified in these products. The Swan Island shipyard in Portland, Oregon, began to construct modules for the Alaska northslope oil exploration program in 1984. Newport News Shipbuilding in Virginia manufactured rail cars, hydroelectric turbines and highway bridge structures in the early 1970s; however the shipyard's new orders for Navy ships later became so large that it was able to discontinue diversification activity. Finally, Avondale shipyards of New Orleans began a diversification program in the early 1980s to fabricate steel modules and processing plant

-67- components. [1]

In this thesis, the authors focus on an industrial water-dependent project that may present a real opportunity to diversify the Quincy shipyard's product line. The project chosen is the construction of sunken steel tubes for the proposed Third Harbor Tunnel, a four-lane, two-way tunnel connecting South Boston to Logan Airport. The technical requirements of the project and assessment of the Quincy shipyard as a feasible construction site are analyzed in the this chapter.

After evaluating the feasibility of the project, the authors address the issue of calculating the project's cash flows and the net present value at the date the project begins, which is estimated to be in April, 1990. The value of the project at Quincy shipyard will be used in the Chapter 4 to assess the potential value to a private investor of purchasing the Quincy shipyard now as an option for future investment.

The Third Harbor Tunnel represents one of numerous diversification alternatives that can be undertaken at

-68- Quincy. The authors chose this project, one real opportunity, to establish a methodology that can be adopted for other potential projects (or for a series of projects).

-69- A. DESCRIPTION OF ALTERNATIVES

The Commonwealth of Massachusetts is studying the construction of a four-lane, two-way Third Harbor Tunnel, approximately 3.9 miles in length, which directly connects with the Massachusetts Turnpike to the west and Logan Airport to the north. [2] The probable layout of the tunnel is shown in Exhibit 9. The construction of a Third Harbor Tunnel will provide increased cross-harbor capacity currently available through the Mystic-Tobin Bridge and Callahan/Summer

Tunnels, and will improve the present traffic congestion that severely affects the operation of

Boston's transportation network.

1. Bored Tunnel versus Sunken Tube Tunnel

The Massachusetts Department of Public Works has evaluated two alternative methods for constructing the tunnel below Boston Harbor. These methods consist of a bored tunnel and a sunken tube tunnel. The bored or driven tunnel is constructed by driving a circular-

shaped tunnel underground by soil excavation. The sunken tube tunnel is constructed by sinking and joining together large units of concrete or steel in a

-70- EXHIBIT 9

-71- dredged trench, which is then backfilled. A pontoon, moored to the harbor bed, is used to sink and align the tubes in the sand foundation. Exhibit 10 shows the sunken tube method of construction. After careful evaluation of the two alternatives, the Department of Public Works has concluded that the tunnel should be constructed by the sunken tube method since the bored tunnel method does not appear feasible for the project, due to major problems associated with excavation and dewatering. [3]

2. Concrete versus Steel

The sunken tube tunnel can be constructed using two different materials: concrete or steel. These two materials require different construction techniques and fabricating sites. The concrete elements are usually constructed in large commercial drydocks and towed to the tunnel site. The steel tubes are fabricated in a steel manufacturing plant before being outfitted and towed to the tunnel site. The outfitting site does not need to be adjacent to the construction site, but it does have to be as close as possible to the pontoon for sinking. In fact, outfitting consists of placing structural and ballast

-72- EXHIBIT 10

Dm T~alVanm mmB imSItmii nCtm

-73- concrete to prepare the tube for placement, and after outfitting the tubes can reach a draft of 25 feet, making their transportation very difficult and costly. [4]

The U.S. has no previous experience in concrete sunken tube construction. All three tunnels recently built in the U.S. were made from steel, as shown in Exhibit 11. Also, according to experts in the field, the cost of the concrete tube alternative is higher than the cost of the steel tube alternative. [51 There are therefore good reasons to believe that the Third Harbor Tunnel will be made of steel, and for the purpose of this study, we concentrate on the steel tube alternative and its construction requirements.

B. STEEL TUBE CONSTRUCTION AND SITE REQUIREMENTS

In this section, we focus on the fabrication of steel sunken tube sections and the fabrication site requirements. Our goal is to show that a shipyard can be a feasible construction site if it satisfies some specific requirements and that the Quincy shipyard is not only a feasible construction site but also one of the best sites.

-74- EXHIBIT 11

......

August,85,vol3 .... * * * .• .- .•...... p62 •.• .. . .-. . . •.*..-. . •. .• . . .- . . -. -. -...... •...... • • • ...... • • • • • ° • ....•

Tunnel Location Year built Material

Hampton Roads Norfolk, Va 1976 steel

Society Hill Philadelphia,Pa 1978 steel

Ft. McHenry Baltimore, Md 1980 steel

Sore.!idHro unl Itrtt9/eta rey

.ae93 I t niomna Ipc ttmn

an ia ecin4f Source: ThirdEvlainFeea"ihaiAmn~ain Harbor Tunnel, Iaterstate90/Central Arterq, Auut8!vl 6 -- "--- Interstate 93, ---Environmental Impact Statement ...... * ' ' ...... --.!. * .* ...... and . .Final .. Section ...... * ...... , ..ource Th.. .r ...... 4(f)el i...... tery.. ', * ...... Evaluation, ...... Federal "En.....ment.l.mp.ct..t.temen ... Highvay* Administration, ...... ) ...... -, ...... E...... gh ......

-75- Steel tube construction is very similar to the construction of a ship. It requires a steel fabrication process line, stiffening and welding equipment, large building basins, cranes and lifting equipment, and piers or wet basins. In fact, a steel sunken tube tunnel is formed by a number of units which are fabricated by welding a steel panel to form a steel plate, and by stiffening and wrapping a shell plate around a special wheel. When the wheel is collapsed from inside, the module is ready to be joined to other modules. Ten to twelve modules are welded on a shipway to form a unit. Once the unit has all its structural pieces and its structural concrete, dam plates are attached to seal each end, and the drydock is flooded. The unit is then outfitted at a wet basin or pier and towed to the catamaran barge anchored above the tunnel line. Exhibit 12 shows the sequence of operations for the construction of Ft. McHenry Tunnel in Baltimore.

The Third Harbor Tunnel will measure approximately 2,400 feet. It will be made of 10 units, 240 feet in length, each unit having a diameter of 80-90 feet. A typical binocular section is shown in Exhibit 13.

-76- EXHIBIT 12

WewoItn ona @vtcmioOme

I l l ' ,Ib /l lll, nt lr ' iIs it111I , 's t hh'dl 'ell I'o 2 Illgifuldl/ l ~lill t.i ,i udhl'd /ot slI .1.l /o/n iinl hr'lul 1tlh

.?. Slhpilllla uIlodllh il htItIi Plipigl fluh' lit'hi/rfd 'hrl p/il, ',uiilld .l I lit' wt ,uul/ t'l 'lull atu' It is'ittIt , a fp dlt'~l i "I hII tlit'h1 lltitwlIftj l Iit a'It l ittu ' fll t luff I fi l t u'n, lit' ,J/dh'tI

1 I flit it'i s (I',u/l, l/ ll ill1 / In' illh it•'inl//' ' midf Olwt llt/du th I . l\IlW itf I// If IfIlIIt I1 1/ I tI l IfI IIl ,ll,ll?If /I,d I,ill,~ IttIt'l]l tI ,II . t/Ihb ntr/I' w Im f)/)Itttl /]Ilt-- ,lilt tl ! ItIha mt P , I .)It". ,, f Ituiitt' /10Hl .1 /uu1 1 ..lu Ill 11 l , ItI Ii-IIIf I IIllI I ,l(' II , I w]hlh .,i I / l ' fil''ate-- 'u/ lu / - -- - ______l___ --

-77- EXHIBIT 13

Ghl[Dml9 Tunnot G1ag001 @Emmm Tuai

-78- The total steel content of the tunnel will be approximately 30,000 gross tons, the equivalent of one and one-half LNG tanker. [6]

The basic requirements for the construction site are the following:

a. steel throughput greater than 30,000 tons per year;

b. plate stiffeners;

c. crane capacity in excess of 20 tons (18 metric tons);

d. building basins that can accommodate ships with a minimum length of 300 feet and a minimum width of 90 feet.

The Quincy shipyard easily satisfies all of the above requirements. In fact, its steel throughput has reached 2,000 tons/week on a full shift (approximately 100,000 tons/year). The shipyard has two plate stiffeners and two 40-ton cranes. The five building basins can all accommodate ships with a minimum length

-79- of 850 feet and a beam of 118 feet. [7] Since there are five basins feasible for construction, Quincy offers the possibility of working on five units of tunnel at a time. The current layout of the Quincy facility is shown in Exhibit 14.

In addition to satisfying all critical requirements for the construction of sunken steel tubes, the Quincy shipyard offers the following advantages over other sites:

a. outfitting piers to complete outfitting at the yard;

b. sea access through the Fore River channel

whose draft of 35 feet allows outfitted tubes, which draw in excess of 25 feet prior to placing, to be towed to the tunnel site.

c. proximity to the tunnel location.

The possibility of completing the outfitting phase at the yard permits an immediate coordination of the construction and the outfitting activity since both are carried on in the same location. Also, the

-80- EXHIBIT 14

-81- proximity to the tunnel location reduces the cost and risk of towing semi-finished tubes from a distant shipyard to the outfitting site. The cost of transportation alone is significant. We estimate, based on data obtained from an interview with Paul

Crowley of Boston Tow Boat Company, that the cost of transporting one tube can reach $8,000 per day. Since on average a tow boat can cover 100 miles per day, the cost is approximately $80 per mile per tube.

The risks of towing tubes 300 feet in length along the coast include collision, heavy weather accidents and even sinking; such risks affect the cost of the project and may delay its schedule. "Insurance against the perils of the sea, free of particular average" may cost up to $1 million for steel tube transportation. [81

Quincy shipyard is a feasible and optimal alternative for the fabrication and outfitting of the Third Harbor Tunnel steel tubes. There are no other sites in Massachusetts capable of performing this work, as the other possible steel fabricating locations are out-of-state. The Third Harbor Tunnel project represents a real opportunity to diversify the

-82- shipyard product line into related industrial water-dependent products. Therefore, the construction of steel tubes for the tunnel is chosen as the best example to outline the methodology by which the shipyard can be valued. The first step in this direction is to value the steel-tube construction and outfitting project in 1990, the year it is assumed to begin. The computations are described in the next section.

C. VALUE OF THE STEEL TUBE CONSTRUCTION AND

OUTFITTING PROJECT AT THE QUINCY SHIPYARD

The valuation of the steel tube construction and outfitting (STCO) project is performed using capital budgeting methodology. Forecasted cash flows over the 2-year life of the project are discounted to assess the net present value in 1990.

Cash flows are estimated from data obtained during personal interviews and adapted to the STCO project by the authors. The discount rate used to actualize cash flows is the rate suitable for the particular industrial sector in which the project belongs.

-83- 1. Cash Flows

We assume that the STCO project begins in April, 1990, and lasts two years. As shown in Exhibit 15, the construction phase starts immediately and ends after 18 months, while the outfitting phase starts in month 6 and ends at the beginning of year 2. [9] The components of cash flows are analyzed every six months to take into consideration the correct timing of each project phase. Cash flows are stated in 1990 real terms by using the approximation shown in Exhibit 16.

o revenues

We assume that a margin of 10% after taxes is charged over total costs and that revenues are evenly distributed across the project's lifetime. [10]

o costs

The cost of labor is computed assuming the following number of workers are employed by the project: 500 workers (400 skilled and 100 unskilled) for steel tube construction; and 200 workers (150 skilled and 50 unskilled) for concrete outfitting. Typical hourly wages for the construction sector in Massachusetts are $12/hour for skilled workers and

-84- EXHIBIT 15

.. iui......

steel construction •.

. 0 6 12 18 (months) 1990 1991 outfitting . I . I I I 6 12 18 24 1992 source: authors

Il\ii~.)r~ijrvr~r.~*~py~rS~;~(~;h~~\*SL ~~~ EXHIBIT 16

°°.°......

S 1990.. .91,92,91,92 cash novf wn year 19901986 dollars = CF90CF 90 ,CF1mCF990 1 .CF92,CF.90

86 86 86 1990 091092 cash flov in year 1986 dollars = CF OCF 9 CF 9

. 0 41 90 86 03 qU0 or CF =CF ED 9j 91,92 91,92

annual inflation rate =i assumed to be constant over the period 1986-1990

source: authors

...... °.

.. ... °...... I .... .-...... ° .... °.

-86- $10/hour for unskilled workers. [11]

Overhead administrative costs are assumed to be equivalent to 30% of the labor cost.

The material costs for steel construction include steel, bulkheads, and joints, while those for concrete outfitting include structural and ballast concrete. Material costs are given as dollars per pound or dollars per foot, and the total amount is computed by knowing the weight and the dimension of the work in progress. [12]

The figure for utility costs is not available separately, but is included in the material cost figure.

"Start-up costs," i.e. the initial investment which must be made to start the project, include the purchase of two reels, automatic welders to stiffen the shell plates, and miscellaneous tools, and total $3 million. [13]

The initial working capital is estimated to be 10% of the downpayment made to the contractor, and is

-87-

r.,l ~I-r- *·1.4* I:.rlc~rrr,~;-?·~,fr-,;·~,~~*·~fi*~i;,~sl urru·tkr~r;;~a4h~~au;W~'P~i~i~wax*u.m4M ~'"'~-x'--^"-~-`~~" ~~~ ~`~~~-~II-^ released at the end of the project.

Depreciation costs are computed only on the equipment that needs to be added to the actual shipyard. The equipment considered for depreciation purposes is:

a. 2 reels or "spiders" worth $100,000;

b. automatic welders worth $2/3 million;

c. miscellaneous equipment worth $1 million.

We assume that the project is fully equity financed and that the applicable tax rate is 40%.

The computation of the project's cash flows is shown in Exhibit 17.

2. Discount Rate

The cost of capital used to discount the cash flows depends on the risk of the project. To compute the discount rate, we use the Capital Asset Pricing Model (CAPM). The CAPM asserts that investors expect

-88- EXHIBIT 17 .... PI-c ------:lL ------JcOxicom-tI :Sk h-E:- :- ...... • m O ...... I ' 'D U' ' ` `e Q` • ' a ' ` .... Tube Fabrication Tube outfitting COSTS ( million $/6months) ( million $/6months)

4W~i gi~B 4.98 OW am 91 1.8

1.00 .5

5.98 2.3

A20 1 8.3 rsm Aam~Ca,ae MaMS

1grOaga~gF & 1 .79 $ .69-0f

~a~a~

AM 167.67~i o m1

29.44 11.30

REVENUES

10% net 35.33 13.56 mar1gi n

EARNINGS AFTER TAX note: all figures are in 1986 dollars equipment is fully depreciated 40%tax rate 3.53 during the first three years 1.35

-89- . . . . ,.,.,.,...... '.'. .. .'......

gear 1990 1991 1 992(start) month 0 6 12 18 24 net income after tax (million$) (b) steel construction - 3.53 3.53 3.53 - outfitting - 1 .35 1 35 1 .35

*depreciation -1.67 ,-1.67 (million$)

start up costs (a) (million ) - 3.00

Cvworking cital S(million3 - 53 3.53

CASH FLOVS - 6.53 5.2 4.88 6.55 4.88 in 1986 $ CASH FLOVS - 7.93 6.32 5.93 7.96 5.93 in 1990 $ (inflation rate=59) DISCOUNTED CASH FLOWS 7.93 5.97 5.29 6.72 4.73 (6 month rate = 5.8%)

I ~ETIIFJW -imII41go.¶t oifmixian 0

a 1. c M. cEDaD00nMUo= 0 sourn : authors (a) start up costs in 1990 dollars are 3.6 millions (b) income for steel construction is distributed evenly over the first three semesters and the first earnings are received at month 6 (c) income for outfitting is distributed evenly over the 2nd, 3rd and 4th semester and the first earnings are received at month 12 (d) depreciation over a three year period is recorded at mid gyear (e) inflation is assumed to be constant over the period 1986-1990 ...... a...... -90- a risk premium above that of a riskless investment in government bonds that is proportional to the beta of the project or industry. Beta is a coefficient that measures the sensitivity of a stock to overall market movements. The beta of a project can be estimated by using as proxy the beta of the business sector the project belongs to.

Industry betas are recorded every year by investment banks and other financial institutions.

Although these betas reflect historical stock movements, they represent the best estimates of future events. The Merrill Lynch beta-book of 1985 reported a beta equal to 1.2 for construction contractors, the industry sector with characteristics most similar to those of our project.

The computation of the discount rate for the STCO project is shown in Exhibit 18. The market risk-premium is assumed to be 8.8%, since this has been the average over the past 50 years. [14] The rate on Treasury bonds is 7.47%. This figure represents, in nominal terms, the one year riskless rate investors expect in 1990. It is obtained by looking at long-term Treasury bonds and computing

-91-

·U-~r~YF~.XNV..~(r*P~·r~Lli~"li*~U~b~.~i'~*-~(7·idlF~XC~~~IRIIlOCLI·CiQl~ff~~ EXHIBIT 18

r =r +8 (r -r ) project risk free project market risk free

r = rate of return on government bonds in 1990 risk free

r - r = 8.8%= market risk premium market risk free

B prject = average response of the project value to hisorical moves in the market.= 1.2

r calculation r1st free

Average r.ates on Government Bonds in the month of April 1996 (Finan••~1 Tirnmes )

year of maturity rate r t 1987 6.56% 6.56%1 r is obtained from the formula: t 1988 6.84% 7.12% t t-1 1989 7.07% 7.53% ( 1 +rate ) = (1+r) (1+r ) 1990 7.17% t-1 t 1991 7.26% 7.62%

r proect = 7.47% + 1.2 ( 8.8% ) = 18 % (nominal terms)

-18 - 1 = 12% (real terms) 1.05

source: authors ......

--· ..... 1

-92- expected future rates. The calculations are shown in Exhibit 18.

Since the cash flows considered in Exhibit 17 are

in real terms (1990 dollars), the discount rate should

also be converted into real terms. For this purpose,

we assume an inflation rate of 5%. The real discount rate becomes 12%.

3. Calculation of Project Value

Using the 12% discount rate, we can discount our projected cash flows and determine the net present value (NPV) of the project in 1990. This value is $14.78 million. The present value of the project,

excluding start-up costs, is therefore $18.42 million.

The STCO project is just one example of

alternative industrial water-dependent projects that can be conducted at the Quincy shipyard. Industrial sources have assessed that the STCO project will tie up only 20-30% of the shipyard's total capacity (measured as steel throughput in tons per year). Consequently, we can estimate that a capacity utilization of 80% can be valued for similar projects

-93- from a minimum of $49.12 million to a maximum of $73.7 million, excluding initial investment. These values are somewhat conservative since we assume that the lifetime of the project is only two years, and we disregard the resale value at the end of the project's life.

Our purpose in assuming an average value of $61.4 million [(49.5 + 73.7)/2] for a large scale project at Quincy is to have a realistic estimate of what an industrial activity for water-dependent uses could be worth if conducted in the Quincy shipyard. We now use this figure in the next chapter to value a call option for a potential buyer of the yard.

-94- CHAPTER 4: VALUATION OF A CALL OPTION

This chapter uses the binomial options pricing model to determine the implied value of a call option

on future use of the shipyard. The purpose of this calculation is to understand if the value obtained is consistent with the current sale price asked by General Dynamics.

The first two sections discuss the applicability of options pricing theory to the Quincy shipyard

situation. Section A identifies the different

variables which enter into the calculations of private versus public buyers in determining the shipyard's

value. The sequential nature of the decisions faced by potential buyers is discussed in section B, where we assert that the existence of a time delay between

the two decisions provides an option on the second decision to the buyer.

In section C, call options and their valuation using the binomial options pricing model are described. The model is applied to the Quincy

shipyard, using the Third Harbor Tunnel project as

-95-

---.-n .r-~irr, ,r-xrr*rrr-~,~t-..,c~~*·Jrur.lp&~.,iv,~n -·lr·rr~r;w- ·r~-..,.. x -~.~..- -~.r · rslrrr~u~nrr~:Msn~,~~P~zt~i~E(rasK·~r.~sr LYc~~a*B~unr; proxy to determine the value of future investment. Finally, the value of the option is calculated in section D. The option value is used in Chapter 5 to discuss the actions of private and public investors.

-96- A. VARIABLES DETERMINING THE POTENTIAL VALUE OF THE SHIPYARD TO PRIVATE AND PUBLIC BUYERS

Both public and private sectors must calculate the value of the shipyard's potential future opportunities for their own purposes, in order to decide whether or not the property should be purchased. Both sectors are capable of buying the property now and will do so if the present value of those future opportunities is determined to be greater than the sales price.

The private sector will purchase the property based on the net present value of known or predicted cash flows. A private buyer may also consider purchase of the property at this time to secure an option on use of the yard for future projects.

The public sector may be interested in buying the shipyard to insure that if water-dependent industrial projects are viable in the future, the shipyard will be available for those activities. The government, for reasons in addition to realization of currently expected cash flows, would like to have an option then to use the shipyard facilities. Further, the government may want such an option to insure that uses

-97- not deemed in the public interest will not be imposed on the shipyard before viable industrial projects become evident.

B. APPLICATION OF OPTIONS PRICING THEORY

The decisions faced by the buyer are sequential in nature. The first stage decision is: purchase the property or don't purchase the property. That decision must be made now. If a decision in favor of purchasing the property is made, another decision point will be available at a second stage. That second decision will be: invest in a viable project, or do not invest and resell the property. The decision not to invest may result from a nonexistence or insufficient number of feasible projects. The separate decision points can be illustrated using a decision tree, as shown in Exhibit 19.

Of course, any potential buyer could also decide to wait, in hopes that no one else will buy the property between now and the time at which the second decision is reached. The second decision could then be made without having to make a first decision, i.e. without requiring an initial investment. However, we

-98- EXHIBIT 19

I::::::::::::::....S..... ·i~:S8:t~~i~~'tf~m:::: :: :: ::::.....:::::::::::::::::: ...... ::::::::::::::...... ::::::::::::...... °..... °......

INVEST FOR 809 CAPACITY PRODUCTION

DON'T INVEST and sell property 1

D% IC lfCl on lPuT STOP O PROBABILITY NODE source: authors

i~l~-·----·IC-·l -·· I ~------·-- ·II------·-·I -- · IIIC-·ZIC --~-·I - Ci

-99- assume here that any buyer who determines that the shipyard has a positive net present value, including

the option value, will be willing to purchase the

property now at a price equal to or less than that net present value. The buyer cannot wait and risk losing the net present value because the Quincy shipyard is a unique asset.

Any buyer who purchases the Quincy shipyard now

will have an option to invest in a viable project in

the future, or to abandon that project, without having

made any project-specific investment. The value of

this option can be approximated using options pricing theory. The net present value of the project's potential cash flows alone would not attribute any value to the buyer's option.

C. DESCRIPTION OF OPTIONS AND THEIR VALUATION

A call option gives its owner the right to buy an asset at a specified exercise (or purchase) price. The call price is the amount paid now to buy the

option. When the call must be exercised on a given

date, it is known as a European call; and when it can be exercised on or before that date, it is known as an

-100- American call.

One method used to value a call is the "binomial options pricing model." The binomial model considers two asset states -- the upper value of the asset (uS) and the lower value of the asset (dS); and two call states -- the upper value of the call (uC) and the lower value of the call (dC). The asset states correspond to the call states such that uC will result from uS, and dC from dS. The payoffs from purchasing a call on this asset can be replicated in a stock and bond portfolio providing the identical payoffs to the buyer. The present value of that replicating stock and bond portfolio represents the value of the call option. [1]

The binomial options pricing model is appropriate to valuation of the option implicit in purchase of the shipyard. In order to generalize the shipyard's future investment opportunities, we refer to the Third

Harbor Tunnel project as a typical example which we have studied in depth. We assume that there will be two states of the world as of April, 1990: one in which the project is undertaken and one in which it is not.

-101- We can consider that the buyer of the shipyard is purchasing a European call option on the project, with a striking price equal to the project's start-up costs, and an expiration date of April, 1990. If the property is purchased now, the buyer will have an option to invest in a potentially viable project in 1990.

D. CALCULATION OF THE CALL OPTION VALUE

The value of this option is calculated by using a 1-period binomial model. That one period spans the 4-year gap between the decision to buy now and the decision to invest in April, 1990, when the project is expected to begin. Further, we assume, as described in Chapter 3, that the Third Harbor Tunnel project can serve as a proxy for a potentially viable project which will use 80% of the shipyard's capacity.

The asset and call payoffs on the Quincy shipyard are shown in Exhibit 20. We define the variables used in the calculation of call option value as follows:

L = the value of the land at Quincy shipyard in 1986

-102- EXHIBIT 20

uS = uP + at PAYOFFS ON ASSET

dS = dP + aL

T=4 years

aL + uC = aL + max(O, uP-K) PAYOFFS on CALL and LAND aL + dC = aL + max(O, IP-K) source: authors

-103- a = 1 + the annual appreciation rate on land in Quincy to the fourth power

P = the present value of project opportunities in 1990 dollars

r = 1 + the annual risk-free rate to the fourth power

S = current value of the asset which is equal to the value of the land (L) plus the expected

present value of future project opportunities in 1986 dollars

K = the option striking price = the project start-up costs in 1990 dollars

The present value of future project opportunities in 1990 dollars, the risk-free rate, and the start-up costs have already been determined in Chapter 3. We assume that the upper value on P is the full present value of the project, and the lower value on P is zero because the project is not viable.

The values used for land and its annual appreciation rate are estimated to be $16 million and 16% respectively. (The appreciation rate was

-104- determined by taking the lower of a range provided to us by the Quincy Assessor's office for land in

Quincy. According to that office, 1.25%-1.5% monthly

appreciation is a conservative appreciation estimate.

[2]) We use the value of land in our analysis, rather than the value of land plus an assumed value for plant

and equipment (P&E), because the present value of P&E is assumed to be zero. This assumption is legitimate because no uses for the shipyard currently exist, and

four years from now the equipment will have lost most of its value.

The upper and lower asset states, uS and dS,

include the upper and lower values of project

opportunities, and the appreciated value of the land,

since the land will have to be purchased. The appreciated land value is shown as a constant in addition to the upper and lower call values because

the buyer will realize a gain on the appreciation at

maturity in either state. The payoff on the call option is the maximum of upper and lower project values, uP and dP, minus the striking price, or zero.

The numerical values assumed for each variable, as well as the values calculated for the upper and lower

-105-

, ''.,''. " -1 -- IIý-·- % r~S4~-~~~.~Il~~ T~**l*~ ~ 1-0JI~ I.~E:·C~~~~C.C-*~rX 1~~~~~C~rl~-~ ~ --W 1~1 ~ -"-PY~~F·~dTUl~P-~~)~·SiiIj~jVi3&~~n EXHIBIT 21

...... • . ° . . . o ...... •...... • . .... -.. ..

all figures are in millions: r = ( .0747)4 k= 14.4 L = 16 uP = 61.4 4 a= (1.16) dP = 0 therefore , 4 uS = uP + aL = 61.4 +16 (1.16 ) = 90.4 dS =dP + aL = 0 + 16 (1.16) =29 and , uC = max ( 0, uP-K) = ( 61.4-14.4)= 47 dC = max ( 0, dP-K) = 0

source: authors

-106- asset and call states, are shown in Exhibit 21. In order to obtain S, which includes the expected present value of the project opportunity in 1986 dollars, we must assume a probability (q) that the project will in fact be viable in 1990. We initially assume that q = 20%. Using that probability, we calculate expected present value of the project opportunity as follows:

[(.20 * uP) + (.80 * dP)]/(1.0747)A4 = [(.20 * 61.4) + (.80 * 0)1/(1.0747)^4 = 9.2

Thus, assuming q = .20, S = L + 9.2 = 25.2.

The call value is calculated in Exhibit 22, using the value for S at q = .20. The replicating stock and bond portfolio is long (buys) .765 on the underlying asset and is short (lends) 16.74 in bonds at the risk-free rate. The value of that portfolio, and therefore the value of the call (C), is $2.638 million.

Because the call value is sensitive to the value assumed for q, we have calculated alternative values for S and C, as shown in Exhibit 23, under a range of

-107- Exhibit 5.1 here

Source : author EXHIBIT 23

q S C

.5 39.1 1 3.2

.4 34.4 9.68

.3 29.84 6.16

.2 25.2 2.64

.12 21.52 0.00

. ..o source:.. . auth......

...... •.•. o • • . • o .o .• .• .o . , • .. . o • • • • .•..• • . . .o ...• o . .•• •.. ...

...... • • • • • o . o • ...... o , • o • • , • o • o .• .• • .o . o o ...° • ... . • o......

-109-

·· ·I··-· ··=jr·;·-;···;·-r ~: -r··q ·iYII-~ ILI~ITitr~i*l )-N-·.I-~)Y-l*~-~iilSt~iC.~o 6L~3L1S~CXIL_(~.X~C3~_r~C-l-~al~br ii)i~.U1-L·XL·_·r ~ r -.L)~. )*.^Y ~-~-r---I -···-~*I (L~5)*~~i*~-1;6·liei~lf ~~*SJ~*;nr~rT~^~X~L-~-.i~;lfli).~,,~..~*ilZrrUI~·L~l~.nlllPILhl hlUV-rUI*^~i*l~X~nl·I·L·^--CI~- probabilities. We will use the call value obtained assuming q = .20 in further discussion, as we believe that it represents a realistic and conservative estimate of probability in this situation.

Our result is that the call value implicit in purchase of the shipyard now for an option on future project opportunities is 2.638 million (4.3% of the the project value in 1990, but 28.7% of the project's present value, assuming q = .20).

A buyer should therefore be willing to purchase the shipyard for $18.638 million, a figure which represents the present value of the land plus the value of the call option. In the next section, we will compare this result with the price being asked by General Dynamics and discuss other factors influencing the buyer's decision.

-110- CHAPTER 5: EXTERNALITIES

In the last chapter, we concluded that a private industrial investor should be willing to purchase the shipyard for approximately $18.64 million, a figure that includes an option value of $2.64 on future project opportunities. Despite our assessment of the shipyard's value, to date no buyer has managed to close a deal with General Dynamics. Furthermore, although the public sector has expressed consistent concern with the fate of the shipyard, no public buyer has as yet taken steps toward its purchase.

This paradoxical situation is characterized by both an apparent lack of private interest and substantial public concern, and can only be interpreted through consideration of the economic factors that cause "market failure." Market failures are defined as situations that lead to a misfunctioning of the competitive market. They normally involve two kinds of economic goods: public goods and externalities. The first are generally goods that cannot be distributed to specific individuals. The latter are costs and benefits that

-111- impact the community, but are caused by a private transaction.

The fact that no private buyer is willing to purchase the Quincy shipyard can be explained as follows. The price asked by General Dynamics is too high for the assessment of future opportunities that private industrial investors have made. In other words, the two parties to the transaction do not seem to be able to reach a "fair valuation" for the shipyard. If we assume that there is adequate market information on the value of the asset in question, then some other effects cause this deviation from free market conditions. One reason General Dynamics may ask for a price higher than that offered by the market is the existence of externalities, or spillovers effects, which interfere with the valuation of the shipyard.

It is possible that the constant and extraordinary public pressure on General Dynamics to influence the shipyard's fate may cause this discrepancy. Driven by concern about social costs and benefits related to the shipyard operation, public representatives may have forced General Dynamics to focus on buyers in an

-112-

ri~ill^i·~~L~n~CVd(lIV~-Li'?31CnlUM~·~CI~d ~R~n_*1~LI~T~I*·I~~*"iX~Yr~lBF~i~I~*mli~ 1 economic sector that cannot meet the company's optimal price, i.e. that which is the maximum obtainable from the market. Even though General Dynamics states that it is willing to accept a lower price, it is not clear that the company will in fact accept a price affordable to private industrial buyers. Because no sale has yet been made, General Dynamics seems to be asking a price that is misplaced for the economic sector which is targeted by public representatives.

The company's preferred optimal price reflects an avoidable loss that General Dynamics may not be willing to incur. For this reason, we may say that if pressured into selling to an industrial buyer, General Dynamics may be forced to internalize some externalities through acceptance of a lower price.

The public sector's explicit interest in the outcome of the sale, and its concurrent reluctance to purchase the yard, can be interpreted as follows. The public sector has reasons to believe that important spillover effects are included in the sale of the shipyard, but the amount of these effects does not justify public purchase of the yard at the price asked by General Dynamics. While the first statement supports our previous observation on the misplacement

-113- of price for the private investor, the second statement seems to contradict it.

The price asked by General Dynamics should match the price that the public sector is willing to pay for the property, if that price reflects the effects of externalities. But, the public sector also has to overcome an internal barrier, when looking at the transaction, which is potential "bureaucratic failure." The complex decision process that normally characterizes a large, political organization may constitute a substantial obstacle in the decision to buy the shipyard.

The purpose of this chapter is to explore the nature and the impact, where possible, of externalities which may be involved in sale of the shipyard. Its contents develop around two bases for public interest: (i) financial concerns, including return on public investment and potential deadweight loss of tax revenues; and (ii) externalities. In discussing each of these issues, we try to understand how and why these factors could affect the sale outcome.

-114- The discussion on public investments analyzes three investments that may have benefitted the shipyard in the past. If benefits can actually be attributed to the shipyard, the public sector may claim a residual return on these investments. The

Weymouth-Fore River dredging project, the Fore-River Bridge project, and the Conrail spur construction are analyzed separately in detail. Then, the discussion proceeds to study the impact of the shipyard closure on federal, state and city tax revenues.

The discussion of externalities covers possible impacts that closure of the shipyard might have on third parties. After a general definition of externalities, the section explores issues related to the following: the local economy, education of the workforce, commercial navigation activities, other industrial activities around the Weymouth-Fore River basin, potential loss of the port facility for future uses, pollution, change in the character of Quincy, and loss of defense mobilization capacity. An effort is made to assess the relative importance of each of the aforementioned effects.

Finally, the conclusion to this chapter assesses

-115- the validity of public claims on the outcome of the shipyard sale. The discussion is supported by our findings.

-116- A. RETURN ON PUBLIC INVESTMENTS

1. General Issues

One reason the public sector may be interested in a private business transaction is the potential loss of tax revenues that may result from its outcome. This is especially true if the loss is substantial. However, if this statement is considered in light of economic theory, one could argue that in an efficient market, the private sector will allocate its resources in the most efficient manner. More precisely, the outcome of the private transaction will be the most profitable activity given the resources invested. Thus, the public sector can benefit from the maximization of tax revenues without interfering in the private transaction.

As a consequence of the argument above, public concern about the loss of tax revenues may exist for only two reasons:

a. some public investment made in the past has specific characteristics related to the private business in question;

-117- b. the loss of tax revenues is a deadweight loss since no other party is willing to carry on any profitable business activity.

The first issue can be explained as follows. A public project is usually undertaken when a divergence between private and social costs (and benefits) would lead the private sector to make choices, based on its own profitability requirements, that are not optimal from the public's perspective. The allocation of resources to public projects, and the expected return on those projects, is analyzed by comparing the benefits promised and the costs incurred over time. Most of the benefits are difficult to quantify since they are related to goods and services not traded in the market. Costs are more easily measured by observing the market prices of resources used in the project. However, when some of the benefits of a public project accrue specifically to a private business, the public sector may consider the tax revenues from that business as a return on its expenditures.

The second issue is more immediate. The public

-118- may have a vested interest in the decision to close a business when no subsequent alternative profit-making activity is expected to use that business' resources.

The public's concern will be more pronounced when tax

revenues from that activity are substantial.

Given this framework, it is important to

understand if the public sector (including the City of Quincy, the Commonwealth of Massachusetts, and the

federal government) has the right to claim a return on previous investments whose benefits might have directly affected the shipyard's activities.

In the next section, we will attempt to ascertain

the major public expenditures related to the shipyard and the return obtained from those investments in the

form of tax revenues. Where possible, we divide the funds and returns between the state and federal

governments. The purpose of our analysis is to understand if the public sector has a legitimate claim on the shipyard's future returns, and thus on the

outcome of the sale, based on the public's expected return on investment.

-119- 2. Analysis of Three Types of Investments

Three different investments have been made or proposed which might be seen as benefitting the Quincy shipyard: the Weymouth-Fore and Town Rivers dredging projects, the Fore River Bridge reconstruction, and the construction of the Conrail spur. These three investments are discussed below.

o the Weymouth-Fore and Town Rivers dredging

projects

Between 1905 and 1976 when the last project was completed, four major dredging works were undertaken in the Weymouth-Fore River channel. Exhibit 24 lists the first three projects together with the public funds allocated to them. The most interesting project for our purposes is the fourth, the 35-foot channel project, which is described here in more detail.

In 1964, two years after General Dynamics acquired the Quincy shipyard, plans to deepen the Weymouth-Fore and Town Rivers' entire waterway to 35 feet, to enlarge the turning basin in the Town River, and to increase the 550 foot maneuvering area at the mouth of

-120- EXHIBIT 24

Channel depth Year Local contribution Federal funds (approved) ($ in year approval) ($ gear approval)

1 8-foot 1905 58,300 NA

b 24-foot 1916 100,000 NA

* 27-foot 1935 69,000 658,500

- funds allocated to dredge and maintain the depth Chab.funds centributeionto the projct

ources: River and Harbor Act 3/3/1905 Letter from Secretary Armyj 24-footRiver an Harbor Act 7271916 'Letter from Secretary Army" River and Harbor Act 8/30/1 935 SLetter from Secretary Army'

•...... • . , ...... • . .. . • ...... • . • ...... , ,, ,

-121- King Cove and Town River, were approved by Congress under the Harbor and River Act of 1964. [1] The reasons given for deepening and widening the channel were that: (i) shipping was subject to numerous tidal delays; and (ii) prospective commercial navigation was restrained by the existing 27-foot channel.

In 1964 it was estimated that 2.35 million tons of cargo were carried in and out of the Weymouth-Fore River channel. The cargo was received and shipped by industrial facilities with waterfronts on Town River

Bay, Fore River Bay and King Cove. Exhibit 25 shows the location of these facilities at the time the project was evaluated.

The major increase in cargo movement was expected to come from coal transported to a new electric power station on Town River, the Quincy Electric Light &

Power Company. The power plant required 2 million tons of coal per year. In considering the benefits to commercial navigation on the waterway, the River and

Harbor Act of 1964 estimated a figure of $1.59 million per year in 1964 dollars. [2]

The project cost was estimated to be $14.04

-122- EXHIBIT 25 wcmultotal t with WOU2eilateufugyw on TCUID IeZI3ne @0093o ftGsMZ BGD OW MOED @MG

CRAINSFORD 1.

SHEEP -- •I~I'C V &AV -1'*/

35' TURNING S)'8' STATE GRAPE LATE I

OUINCY

OF ENGINEERS

-123- million in 1964 dollars. The division of costs between the Weymouth Fore River and the Town River, and between federal and non-federal funds, is shown in

Exhibit 26. In 1980, seven years after the project began and four years after it was completed, its total cost was assessed at $28.64 million in 1976 dollars, including a $0.5 million local cash contribution. [3]

There are reasons to believe that the project might have benefitted the Quincy shipyard. The

35-foot channel facilitated the launching of ships for the LNG program. These ships had a loaded draft of 36 feet and a light draft of 17 feet. [4] Also, the channel permitted easier maneuvering and access for ships that needed to be repaired and converted. For these reasons, we can say that part of the dredging project benefitted to the shipyard. However, the main purpose of the project was to support the procurement of coal at the Quincy power plant. Therefore, only a small fraction of project cost, if any, can be related to the shipyard.

The observation that a small amount of federal funds in the channel project might be associated with a direct benefit to the Quincy shipyard is only part

-124- EXHIBIT 26

- site to dredge Ia~E tiOr~r~i ~ Ssource of funds ($million as of 1964) ...... B...... r... .d~ ...... ·:...... 5.65 ...... 5.85...... ·:·:· ......

1.,5 .04

.:sou:rceo Wgozh: j 0

-125-

--- ~·· -·-·-···m)Y·Liy ~~X.,Xlli(Cc~.~.:---t~i~.IC~Cl/f~lT~j~l~T24~* ~WY~·~1RIIVlmp.~~~~Tjr*t~s~l~i~..li--~J of the issue. Even if this small amount is considered, the federal taxes paid by General Dynamics on revenues generated by the Quincy shipyard over the 1973-85 period provided a substantial return to the public sector, as described in the section on local tax revenue below. For this reason, we assert that a claim on future tax revenues by federal and state government, based on an expected return from the channel project, should be discredited. Moreover, since local funds for that project were minimal, and only a small percentage of those were related to the shipyard, return on local investment cannot be considered an issue.

o the Fore River Bridge reconstruction

The Fore River bridge, separating the cities of Quincy and Weymouth, is downstream from the Quincy shipyard. The bridge has a 175-foot drawspan, and it was constructed in 1936. The location of the bridge is shown in Exhibit 27.

In 1974, the construction company Parsons, Brinckerhoff, Quade & Douglas was asked by the Bureau of Transportation of the Commonwealth of Massachusetts

-126- EXHIBIT 27

-127- to evaluate reconstruction of the Fore River bridge. The bridge was to be lengthened to a 300-foot span.

The main objectives of the study were: (i) to assess the constraints posed by the present bridge on the maximum beam of ships constructed at the Quincy shipyard; and (ii) to analyze the benefits offered by a wider bridge for future ship construction programs.

In 1974, when the dredging program was already underway, the Weymouth-Fore River channel could handle very large crude carriers (or tankers) of up to

400,000 dwt. However, the bridge constrained the area available for maneuvering ships in front of the building basins and outfitting piers. A 300,000 dwt tanker was the largest vessel which could be handled within this constraint. [5]

At that time, the LNG ships under construction at Quincy had a beam of 143 feet, and they represented the largest ships which could safely navigate the bridge. The shipyard was also considering a bid for construction of LNG liquification and regasification terminals with a possible beam of 285 feet. Bridge restrictions could have seriously affected the prospects of such a program.

-128- The Fore River bridge reconstruction project was specifically proposed to meet the shipyard's needs. In fact, there were no reasons for increasing the highway capacity in the corridor served by Route 3A. Given this scenario, the cost of bridge replacement was directly weighed against the benefits which would result from an expansion of the shipyard's activities. A preliminary estimate of the reconstruction cost was $30 million in 1974. A more detailed breakdown of the total cost is shown in Exhibit 28. [6] The bridge reconstruction project was never undertaken, and other than the construction study, no state funds were allocated to it.

o construction of the Conrail spur

The Conrail spur branches off the Y line into Braintree and serves the General Dynamics, Procter & Gamble, and Cities Service facilities located around the Weymouth-Fore River Bay. The rail spur was built in 1885, after land purchases, which began in 1845 to procure right of way, were completed.

The benefits of investment in the spur were

-129- EXHIBIT 28

*: ::: : intr :OmW:rn8: T 0 lia: *::

...... : .. *..••......

type of construction total cost (MILLION OF $) structural steel 8.1

concrete and site work 14.1

equipment 7.8

TOTAL 30.00

source: adapted from "Fore-River Bridge Reconstruction Evaluation," progress report Parsons, Brinckeroff, Quade&Douglas, Inc-., Commonwealth of Massachusetts Department of Public Works, 1974

.. • °.. •...... • • . .. ° ....• ...... • ..•...... • .... • • . °. •....

-130- assumed by the public along with the company, upon its acquisition. It does not seem relevant, however, to address the issue of tax revenues as return on investment in a project which was undertaken such a long time ago. We discuss the Conrail spur investment in this thesis because it was mentioned, along with the federal dredging investment, by former Senator Paul Harold (D-Quincy) as justification for the public's "moral right to go in there [shipyard] and free up the facility for alternate use." [7] We do not believe that this statement can be supported in light of our findings.

3. Deadweight Loss of Tax Revenues

The second major reason for public concern in a private transaction arises when the outcome of that transaction may produce a deadweight loss in taxes.

If the Quincy shipyard remains idle for a substantial period of time, the federal, state and city taxes paid by General Dynamics will diminish. With no earnings from shipyard production and the possible tax abatement from the city of Braintree, aggregate tax revenues will be reduced.

-131- o local tax revenues

In 1984, the shipyard paid approximately 4.5% ($2.25 million) of the total property tax bill collected by the city of Quincy. [8] The shipyard is in fact the largest taxpayer in Quincy. However, the city pays General Dynamics $2.8 million per year in tax abatements for overassessing the shipyard property in the years from 1977 to 1983. Those payments more than offset the company's tax bill, and will continue until 1993. [9]

Closure of the shipyard could potentially reduce the property tax revenues collected by the city of

Braintree; General Dynamics will be eligible to apply for abatement of taxes paid to that city when the yard closes. Slightly more than 27% (2,115,278 out of 7,820,995 square feet) of the shipyard's property is located in Braintree, [10] and the property tax bill should be approximately, but not exactly, proportional to that levied by Quincy. The amount of property tax paid to Braintree is determined using a different method of property valuation, and the base property value used in the calculation is probably lower than that used in Quincy, because a higher concentration of

-132- production facilities is located in Quincy.

Although concern regarding the loss of property taxes has been stated repeatedly in the press, the outcome may be different. Not only does the city of Quincy end up paying more in tax abatement than it receives from General Dynamics, but also Massachusetts tax laws should allow Braintree to recoup its losses by slightly raising the taxes of that city's other property owners. [11]

o state and federal tax revenues

In 1984, the shipyard paid $8.1 million in state income taxes [12], and $18.0 in federal income taxes. [13] Based on the size of the tax bills, we conclude that there could be justified concern on the part of state and federal governments; if the shipyard's facilities remain idle in the future, a deadweight loss in tax revenues will occur.

If in fact, the market is assumed to be efficient, the public should expect to obtain the highest possible tax bill through the private sector's maximization of return on investment. If a deadweight

-133- loss does actually occur, despite the private sector's motivation to maximize return, market failure could be responsible. In this situation, market failure would most likely occur as a result of imperfect information. For example, all potential buyers may not have knowledge about the sale of the shipyard, the value of the shipyard's assets, or demand for the shipyard's products, when such knowledge may be essential to their investment decision.

The state government does in fact believe that market failure may have occurred in this case; its representatives argue that the shipyard has not been sold to any industrial buyer because General Dynamics has not marketed the yard correctly, and potential buyers are therefore unaware of its availability. [141

4. Conclusion

In summary, we do not believe that public concern for the loss of future tax revenues as an expected return on past public investment is justifiable in this case. The Weymouth-Fore and Town Rivers dredging projects were not specifically undertaken to benefit the shipyard; the only project which would have been

-134- undertaken for that purpose, the Fore River Bridge reconstruction project, was never actualized.

The net deadweight tax loss appears to be a justifiable concern only to federal and state governments, and only if market failure is assumed.

Public interest in the future of the shipyard may, however, be justified by the existence of externalities, which are costs and benefits incurred by the public, but not included in the purchase price. In the next section, we will discuss externalities in the context of the Quincy shipyard.

-135- B. THE EXISTENCE OF EXTERNALITIES

1. A General Definition of Externalities

In a market system, prices do not always reflect all of the costs or benefits incurred in the use or production of a good. Both costs and benefits may therefore accrue outside of the market transaction; in such cases, those costs or benefits incurred by individuals other than the buyer or seller are called

"externalities" or "spillover effects." A capitalist market does not account for externalities. In a competitive economy, profit-seeking entities are not motivated to include hidden costs in the prices of their goods; and buyers will not agree to pay for benefits accruing to others.

2. Externalities and the Quincy Shipyard

Externalities will occur in the sale of the Quincy shipyard in that certain costs and benefits to individuals other than the buyer and seller will not be accounted for in the selling price. We will discuss the nature and impact of these externalities in the following section by assuming that the shipyard

-136-

-~CX-~3UVrl-ri~C1~~rxrl~~iY*~-ltCiUI~DC~ZI~L~7JXUOKIJI~B~*~ )i is simply closed down, and potential buyers are unknown. There are two main reasons for making this assumption.

First, the nature of the buyer's business

(industrial, commercial or residential) will affect the degree to which externalities occuring in connection with the shipyard's activities change. For example, another industrial use may provide a balance between public costs and benefits which is similar to the one maintained by the shipyard. An analysis of externalities affected by the shipyard's closure may therefore be applicable to those which would occur through purchase, in that the externalities connected with the buyer's business could fully offset, mitigate or have no effect on the public impact of closure.

Second, further externalities related to the buyer's business will accrue. For example, another industrial use could produce more pollution than shipbuilding does, or a residential use could change the local capacity for industrial water-dependent activity.

In sum, the externalities which result from sale

-137-

I-··- .--- ovrU~siuW')-"4":~·Sn-rXW~I"*·hhn~.L~d-~' ".'~... . . ~..`..~-` *I.rv..Y-~~*"'z~a_·~-g;*-,:~I~WV·2*r.r*: ~ of the property could dramatically change, mitigate, or offset those which occurred from operation of the shipyard by General Dynamics. We will not attempt to analyze the myriad of externalities which could result in each type of sale. This thesis focuses instead on externalities which are affected by the shipyard's closure. By doing that, we provide a framework for evaluating externalities under different buyer scenarios.

3. Discussion of Potential Externalities

We identify and discuss specific externalities which could potentially result from the shipyard's closure hereafter. Valuation of externalities is generally problematic, but cost or benefit estimates are given wherever possible.

a. Impacts on the Local Economy

There are both direct and indirect impacts on the local economy which could result from the shipyard's closure. First, the loss in government revenues (state and local income taxes paid by General Dynamics and its workers, as discussed above) directly affects

-138-

'r4~-·rSCIWi.?~·)Er~~lri*1LJ-M~W·~~dulJB~l~iF~I*) the local economy by reducing the source of funds available for public spending. In addition to the reduction in sources of funds, the government must use funds to support shipyard workers who are eligible for unemployment insurance and who have been unable to secure new employment. Unemployment laws guarantee workers at least 30 weeks of benefits, and do not require proof of ongoing job search. (15]

Second, indirect impacts result from a "multiplier effect" on the loss of demand for goods and services by the company and its employees. The multiplier effect means that any change in aggregate demand in an economy has a series of effects on total spending.

Thus, the shipyard generates not only tax revenue, but also jobs and sales revenues in local businesses where the company and its employees purchase goods and services. In 1984, company expenditures within the state totalled $24.3 million; and employee payroll was $114 million. Estimates of the resultant multiplier value lost to local businesses as a result of the closure range from $353 to $500 million annually. [16]

Closure of the shipyard will have the greatest economic impact on small businesses in its immediate

-139-

'IlI C' ~^"r~l · ' 'r·` ,~.~r~r..-nr..r~r- r~,~~·al~,·~l;x~r.~r~I-*·L~*YCh~L·~~SP·H -. L'**~Y~*YII~C~-nrrr~·a_~~-~V~~n~*lf~- I~ vicinity, mostly restaurants, with sales which are solely dependent on the spending of shipyard workers. Specifically, owners of the Mae-fare coffee shop,

Joe's Lunch, and Ma's Lunch, all located on South

Street across from the entrance to the yard, have been extensively interviewed in the press. Some are planning to close and move elsewhere, while others will attempt to survive through targeting a different customer group, or through waiting out the closure.

[17]

In summary, we conclude that while closure of the shipyard will have some negative effect on aggregate spending in the local economy, it will be difficult to measure that effect. The change in workers' personal spending levels is difficult to ascertain for a number of reasons. First, most workers residences are dispersed geographically throughout the state, and a change in their spending habits will thus have a minimal effect within their own communities. Second, many workers receive unemployment compensation to supplement their income in the short-term, and may be collecting that benefit without reporting wages being earned in Quincy's booming underground economy. This hypothesis has been forwarded by Barbara Opaki, who

-140- runs the retraining and placement center in Braintree, based on her observation of the frequency in workers' refusals of highly paid job offers. [18] Third, many workers have or will have found jobs within a relatively short period of time. General Dynamics estimates that 70% of its workers have found new jobs or are in retraining programs; state officials have lower estimates but some "are nevertheless optimistic that the healthy economy will absorb the laid off workers." [19]

In conclusion, the factors presented above serve to mitigate the economic impact of the shipyard's closure resulting from the multiplier effect, and make estimation of that impact difficult. Finally, the most measurable and definite economic impact will be that on businesses located in the shipyard's immediate vicinity.

b. Education of the Workforce

There are three costs involving education of the workforce which the public might incur due to the closing of the shipyard: the cost of training current workers for reemployment; the potential cost of

-141- remobilizing the labor force at sometime in the future when a need arises for skills specific to shipbuilding; and the cost of losing the shipyard as a long-term source of education for the workforce.

o training displaced workers for reemployment

Both General Dynamics and the state government have invested in retraining Quincy's displaced workers. The company budgeted $10 million for both job placement services and severance pay. This amount includes a severance bonus based on seniority for workers who remain on the job until their scheduled dismissals and the partial funding of the job placement center in Braintree. [20] In addition,

General Dynamics has hired psychological consultants, Troy Associates, to help workers who suffer from depression, frustration, confusion and fear. [21]

These costs have been incurred by the company and do not represent externalities.

*The government, however, has also invested funds in retraining workers. Both the state and federal governments provide the remaining portion of funds used for the placement office in Braintree. The state

-142- government has a total budget of $810,000 for retraining purposes. This amount has also covered the payment of $1,800 in tuition for workers who attend a 28-week intensive retraining program at Massasoit

Community College in Canton. The purpose of the classroom program is to prepare workers for entry-level occupations in "economically stable and growing sectors of the economy," such as computer programming, heating and air conditioning, diesel technology, construction, and electrical technology. To date, 69 out of 79 enrollees have graduated from this program. [22]

o Potential Cost of Remobilization

When workers with skills specific to shipbuilding are forced to move to other industries, their skills are essentially lost from the labor pool. Such workers will learn new skills applicable to their new jobs, and they will not necessarily reappear in the future if and when skills specific to shipbuilding are needed. There may thus be a cost to remobilizing the work force in the future; that cost would include the training of new workers or the hiring back of former workers, at wages high enough to compensate them for

-143- leaving their interim occupations.

The maximum cost for remobilization of workers with skills specific to shipbuilding would then be that of training new workers. If it were more expensive to hire back former workers, new ones would always be trained. The potential maximum cost can therefore be estimated as equivalent to the training costs for those displaced workers. The three job categories considered specific to shipbuilding are shipfitter, rigger-erector, and loftsmen, representing approximately 17% of Quincy's former workforce. [23]

Therefore, of the 4,203 workers employed when the closure was announced in July, 1985, about 714 fell into these categories. Available statistics on the duration of on-the-job training for selected metalworkers is on average 3,915 hours [24]; assuming that only 10% of those 714 workers would have to be retrained while receiving a beginning wage of $6 per hour, the total cost incurred in remobilization would be $1,677,186. If the percentage of workers needing to be retrained or the beginning wage were higher, both conservatively assumed in this calculation, the cost could be substantially higher.

-144- The potential remobilization of the shipbuilding workforce may not be an externality, in that any business which mobilizes a workforce for the purpose

of making a profit will pay training costs as part of its investment. On the other hand, should the public have to finance remobilization for a public purpose, such as a national defense effort, then the loss of those skills would represent an externality.

o Loss of the Shipyard as a Long-Term Source of Education

A large proportion of general metalworking skills are learned in on-the-job training programs, provided either directly by the employer or through union- registered apprenticeships. The percentages of on-the-job training versus off-site training received in preparation for the various metalworking occupations used at Quincy are shown in Exhibit 29.

As discussed in Chapter 2, demand for labor at the Quincy shipyard has fluctuated widely over the years. During demand upswings, a certain number of workers were trained in order to remobilize the workforce, and conversely during demand downswings, a certain number

-145- EXHIBIT 29

° ::::ts:Yetsini o ::gadom~thiegets::n: me:a::::inadainisia M ::::::::::

: w rNOWSn OmdMMIter 38.5 61.5

. ...:.: s e.t . .0*. .ti.p...... i g I l t d ...... i. l i

* * * 1:-:-:-:-i:-: i:t-: :-: A :- . : :* *

-

-146-

~-~·~ -~- · ··. ~~·n··.~,~~.,!.. s i·~ra,r·r.:~lrrlspl,~.rl7=,~,~~U;~~~~~*I(FUWr 1~~~·~lJ~lJ~lJ~lJ~lJ~IJ~Sr~L~-~-~-~.Sf~~ 1~5C·.~I*I·rI~L-~fl of workers were released to seek employment in other industries. Thus, the shipyard has provided a source of skilled labor to the surrounding economy over time, and closure of the shipyard represents a decrease in the aggregate source of education available to the public. This education effect is most important with respect to workers trained in general metalworking, and other non-specific skills, because those skills can most easily be transferred to other industries.

In summary, there are externalities associated with education of the workforce. Current public expenditures on the retraining of displaced workers is directly observable. In addition, the potential need to remobilize a labor pool with skills specific to shipbuilding and the loss of the shipyard as a long-term source of education are both legitimate public concerns.

c. Commercial Navigation Activity

Another possible externality resulting from the shipyard closure can be identified with a reduction in commercial navigation activity on the Weymouth-Fore River channel. Commercial navigation provides

-147- earnings to shipowners and income to crews and to handling facility personnel. The shipyard might be a source of commercial navigation, and it is important to establish the impact of its closure on that activity.

The Army Corps of Engineers annually records a detailed breakdown of waterborne commerce in the U.S. by location and type of freight. Exhibit 30 shows the freight traffic in the Weymouth-Fore River channel as reported in 1983 [25]; Exhibit 31 shows the type of activities conducted, and the purpose for which the waterfront is used in each setting. From the these two types of information, one can estimate the allocation of freight traffic to the different industries located on the waterfront in the Town or

Fore River basins, based on the type of activities they conduct.

Our estimates of traffic volume attributable to the Quincy shipyard are highlighted in Exhibit 30. Assuming that all fabricated metal products and machinery are received at or shipped from General Dynamics, the shipyard's traffic volume in 1983, during full-scale MPS vessel production, was 905

-148- EXHIBIT 30

:..: . :..:.:.:-:-:-: .. sh ri.ioh•) ......

commodity total tons

vegetable oil 11,110 sodium hydroxide 2,108 basic chemicals 3,316 gasoli ne 796,128 dlstillate fuel oii1 267,829 i' residual fuel oil 77,080

'' petroleum&coal products 137 Sabriicaited -metal: prirducts :.: - -.-•--•.--..·- - :.·-. . :::-.-.668. !·

''

'' '' :::::: :: *De:::::::partent fr:the .Arn o rps.f-.~agi:ners: .1 985:

-149-

I**-r·r,·u·r.i~..i~·~,rsur*~*-r4Sr~p~BXn ......

EXHIBIT 31

I i I

i. ?ICý -cftr 012 ~~ .

1· i I com-pC ari name Operated by Purpsse for' which

j· pie~rs ,vharv es and r I; docks are useed j JIt-,t: -j Nano?Wr Co.OinJD sC.. I1.a r, a! orIng, i·:·:1 1i

-4 i i iFcfllE~:

iu~idiJi -e I . i· · i i arnd i i · QuslrioY r.AduV a4wst NO~ pif:Y&I IrimKuzrgqaws C:-:za RS*#lf ·r ep:;h,,~ 'Cry·fi inn ·;

,~-L1C.J,

s~i·3);1 · i

i.'. i • :.- C.-.·- ".''-•'% : •.t &."".4 fieF, 't'.,.. . -1 . IT I : t f(-I- ar,~

. i I i · -,I~ . 1E u - · I . Ctiteg C,-r i-e1re I

I · r i t I · r ·i 1 I i &-fst" E-3isori.. C~ic onEfT! Ea ii r C o r - I 1 i Fore IEt.r-Wh.arf

I. : i source: "The Port of Boston, Ma," US Army Corps of [ ' Engineers, Port Series no.3, 1983 - i· --·..

-150-

-, -.z. tons. This amount represented 0.1% of the total volume transported that year. Obviously, for a more detailed and accurate analysis, we would need more information regarding the value of cargo and the size of the ships used. Nonetheless, it appears evident that the shipyard has not had a very significant role in the commercial navigation activities at the Weymouth-Fore River basin.

In summary, we conclude that the closure of the Quincy shipyard will not have any major effect on freight traffic in the channel.

d. Impact on Other Industrial Activities Around the Weymouth-Fore River Basin

As previously stated, General Dynamics spent $24.3 million on goods and services in Massachusetts. The proportion of the amount which may have gone to other large industrial businesses located around the

Weymouth-Fore River basin is minimal. None of those businesses, as named in Exhibit 25, are directly, if at all, dependent on the shipyard for revenues. Because no significant economic exchanges between General Dynamics and those concerns occur, the direct

-151- impact of the closure on their businesses can be assumed to be negligible.

The only exception would perhaps be the Quincy Electric Light & Power Company which received $6.6

million in 1984 from General Dynamics. [26] If that company's margin is seriously affected over a long

period by a loss in revenue, compensation in the form of a rate increase will, in all probability, be granted, and the cost passed on to local residents.

An indirect impact on the industrial companies

located near the shipyard may result from a recent

proposal to rezone a large parcel of the shipyard

property, which is located within Quincy city limits. The proposal concerns a change in zoning class from

Industrial B to PU-D (Planned Unit Development), and is currently pending. A PU-D classification

designates land for mixed commercial and residential uses. The proposal was filed by Ted DeCristofaro, the Ward 2 Councillor representing the Quincy port area. A public hearing was held before the City Council and the city's Planning Board on April 7, 1986, at which time the hearing was recessed for further public comment. The zoning decision will ultimately be made

-152- by the City Council (2/3 vote) after the Planning Board has submitted its recommendation. [271

The outcome of this rezoning proposal could affect the future of the Weymouth-Fore River basin as an industrial waterfront area. Zoning decisions, like legal cases, have precedent implications. Other

Quincy-based industrial concerns may more easily gain PU-D classification if the shipyard is rezoned. In the South Shore area, where real estate prices and commercial businesses are booming, industrial businesses could be tempted to move if a precedent for PU-D rezoning is provided.

e. Potential Loss of the Port Facility for Future Uses

The Quincy shipyard is a port facility, which possesses drydocks, basins and piers. In addition, the Weymouth-Fore River channel, providing access to the facility, is a "stable" channel. That means that the channel's current activity is such that, once a dredging to widen or deepen the channel has been completed, there will be only a minimal need to redredge the channel in the future. [28]

-153- Because stable channels are a limited natural resource, which implies that port facilities located on such channels are also limited in number, the shipyard facility can be seen as a public asset. This asset can be used to support any number of water dependent activities.

We cannot predict all potential future needs for port facilities on stable channels. Destruction of the Quincy port capacity will diminish the limited pool of such assets. If, at some time in the future, public need for a port facility with stable channel access unexpectedly arises, and none are available, the public could incur significant cost. This cost may be that of foregoing opportunities or that of attempting to rebuild suitable port facilities which have been used for other purposes. Therefore, if

Quincy is sold for commercial or residential uses, the loss of its port facility may represent an externality.

f. Pollution

Pollution is one of the most common externalities.

-154- Its costs are inflicted on a community by private industrial entities, having no economic reason to bear those costs. Extensive debate on the subject has been centered on how to design effective regulations that can shift spillover costs to the sources of pollution. In this section, we are interested in problems that may arise when an industrial activity ceases its operations. More specifically, we want to address the issue of permanent pollution of the environment caused by closing an industrial plant.

The Quincy shipyard has been an industrial setting for 102 years. Early tenants operated the shipyard with no stringent rules on pollution control. Over time processes began to produce larger amounts of hazardous waste, and regulations became more stringent. Today, the shipyard is closing, and its land and waterfront show evident signs of an industrial activity carried on for over a century.

During the last 20 years, the largest source of hazardous waste at the Quincy shipyard have been coating and painting processes. [29] As a result, organic aromatics, solvents and volatile materials have polluted the nearby atmosphere and the land, and

-155- traces of solvents and organic compounds are left in the soil. The second major source of hazardous waste comes from the leakage of hydraulic and lubricating oils. Most of these oils, if contaminated, are burnt away in a specific industrial waste site, as required by the DEQE. However, leakages are inevitably absorbed by the soil and accumulate over time.

Finally, the "Hazardous Waste Manifest" of the

DEQE prohibits industrial plants from treating or storing solid materials, fluids and pieces of equipment, such as PCB transformers, for more than 90 days without a special permit. In order to comply, the Quincy shipyard has removed an average of six tons of hazardous waste per quarter in its last few years of operation. This figure does not include any treatment of soil consistently polluted by leakage of solvents, organic compounds and oils aforementioned.

Nor does it represent an estimate of the cost which would be incurred to clean up pollutants derived from past tenants.

Given this situation, one may argue that there are pollution spillover effects that the shipyard closure may provoke. General Dynamics is aware of, and

-156- attempting to deal with, its hazardous waste problem. Recently, a sum, specified as a "6-figure" amount by one of our contacts, was spent by the company for ground assessment. In the first quarter of 1986, 80 tons of hazardous waste, including an underground tank and some PCB transformers, were removed from the shipyard. At an average cost of $2,000/ton, approximately $160,000 has been spent in the last few months. And General Dynamics has expressed an intention to spend much more on the site, and in fact, claims that the land will be clean enough to "use as a playground." [30]

Of course, the liability problem that General Dynamics might incur as a result of its hazardous waste offers an incentive to clean up the land. On

the other hand, General Dynamics should not be respon-

sible for the pollution caused by past tenants. If it decides not to remove hazardous wastes attributable to

the activities of past tenants, it may leave them on site. While it may be difficult to ascertain

responsibility for hazardous material dumped, it is likely that potential pollution may be left at the shipyard after its closure. If this happens, there might be an incentive for the public sector to address

-157- the issue of pollution at Quincy shipyard.

g. Change in the Character of Quincy

Quincy city officials, including Mayor Francis X. McCaulley and city council President Jim Sheets, have expressed concern on behalf of residents that closure of the shipyard will change Quincy's character. [31] Two main reasons for this change are cited.

First, they argue that the shipyard represents a symbol of the town's waterfront tradition, and that removal of that symbol will, in some sense, irrevocably cut the city's ties with its history.

Second, they assert that closure of the shipyard will fuel the recent trend from a blue-collar to a white-collar environment in Quincy. They claim that such change is not welcomed by many residents, and further that the changes will be perceived by those residents as causing deterioration in their quality of life.

We must conclude that this effect, if it is real, may represent an externality, because changes in the residents' quality of life will not be accounted for

-158- in selling price. However, assessment of the value of the externality, or even determination of its nature, i.e. whether the change will be a cost or a benefit, is beyond the scope of this thesis. We therefore merely state that the anticipated change in Quincy's environment may impact the public.

h. Loss of Defense Mobilization Capacity

Shipyard mobilization is defined as the construction, conversion, repair and maintenance activity that is required during war times. Under the assumption that a future war will be conventional, many advocate the need for preserving sufficient shipyard capacity in peacetime, so as to be ready to meet the demand-surge in war times. More precisely, government subsidies and supports to the shipbuilding industry are considered necessary to maintain national security.

From a theoretical point of view, if one accepts the basic assumption that a future war might be conventional, and if one has no particular disagreement with weapons construction and operations, there may be some spillover benefits in maintaining

-159- active shipyards. Under these assumptions, the private demand for ship construction may understate the benefits to society of keeping an active shipbuilding base. Resources to shipbuilding may subsequently be underallocated, if not monitored by the public sector. Without questioning the benefit of national defense, we discuss the effects of closing the Quincy shipyard on national security below.

This subject has been recently debated in different studies: the Shipyard Mobilization Base Study (SYMBA) [32] and the Nacoa Report [33]. By projecting different "war scenarios" and assessing the shipbuilding capacity required in each, the SYMBA study concludes that the shipyard facilities existing at the end of 1982 were sufficient for mobilization purposes. However, the report also concluded that the existing shortage of skilled shipyard workers might have delayed some of the requirements dictated by surges in demand.

Because shipbuilding capacity has been decreasing since 1982 as increasing numbers of shipyards close, one may expect that the current mobilization capacity of the shipbuilding industry is not sufficient for

-160-

(;"··I~1~.U*F~ sx·).~·r*~a~\~i~rN;LM(LM~a~'*LEI~ iC~I~I4IYl~a~i~JUi~7~i~'L·lr-r·n~n~~icrll(*Pxi~~f~%~Pr~YZl.aOl~li~· national defense purposes. However, the Nacoa Report shows that even with the reduced capacity of 1984, the nation could meet its mobilization requirements.

It is beyond the scope of our study to pronounce a judgement on this matter. The issue is very controversial. Opinions generally depend on political views, on assumptions about the types of future wars and probabilities of their occurence, on the degree of risk that a nation can support, and on war scenarios that can be imagined.

In summary, if we agree with the Nacoa report finding that there is no need to support an excess capacity in the industry for national security reasons, the closure of Quincy shipyard has no spillover effects on national defense. On the other hand, in evaluating the findings of the SYMBA report, one must engage in the delicate discussion of the validity of investment in national defense.

-161- C. CONCLUSION

The purpose of this chapter is to understand if the public sector has a valid claim on the sale of the Quincy shipyard. To study this problem, we have analyzed two major topics:

1. the financial interests of the government,

based on expected return on public investments

and potential deadweight loss of tax revenues;

2. social claims based on the existence of

externalities related to sale of the shipyard.

The conclusion we reached in discussing the first issue can be summarized in two points. First, the public sector has already realized its return on past public projects which might have benefitted the shipyard. Second, the potential deadweight loss of tax revenues will be a valid concern, if the public sector has compelling reasons to believe that market failure will occur. Therefore, financial claims cannot alone be considered a valid argument for sustaining public concern.

-162- The second issue is more difficult to address because it involves controversial issues which cannot be resolved or accurately quantified. However, we summarize our findings as follows.

First, the impact of the shipyard's closure on the local economy is difficult to measure. It seems evident that businesses located near the shipyard will suffer from its closure. But, local aggregate spending provided by the company and its employees may be replaced by alternative spending sources, due to a boom in the South Shore economy and to reabsorption of the workforce.

Second, the closure does present a social cost with respect to education of the workforce. The public sector is in fact allocating funds to retrain displaced workers, but more importantly, there is a potential cost related to losing a portion of the labor pool of workers with skills specific to shipbuilding, as those skills will not be immediately available in the future if needed.

Third, the impact of the closure on commercial

-163- navigation at Weymouth-Fore River is negligible.

Fourth, the change in Quincy's character, traditionally that of a blue-collar, waterfront community cannot easily be judged as a benefit or as a cost, and we do not consider it relevant.

Fifth, the impact of the shipyard's closure on other industrial activities around the Weymouth-Fore River basin could be reason for state and local public concern, in that success of current rezoning efforts may start a trend which could tempt those concerns to relocate to other areas.

Sixth, the loss of a port facility for future needs also justifies public concern. The shipyard has extensive facilities facing a designated port area. The loss of its port facility, a limited asset, can be considered a potential cost to society, if a need for such that facility arises in the future.

Seventh, pollution can be a matter of concern to the public, especially if health problems occur in the future due to the fact that General Dynamics did not remove all on-site hazardous waste. In particular, all liability for such problems for which private

-164-

~pr~~%~"r~Wa*~·i·UaF*pu~,~-~n~,*K~n~U~ar responsibility cannot be ascertained may eventually be covered by the government.

Eight, the impact of the shipyard closure on defense mobilization capacity is very difficult to assess and remains a controversial issue.

As a result of the points mentioned above, we conclude that there is a valid basis for public interest in the outcome of the shipyard sale. In

fact, the aggregate effect of externalities, which are described as being important in this conclusion, seems to result in a net benefit to the public, if either

the shipyard is maintained as such, or else it is used for other industrial water-dependent activities.

-165-

~· l·~--.··~·:-t ,·s.,·.· x-.~.~.o~~If- A-1rn -"4,.- x ~~pi~~ ;~~r2rsi~~ ----- CHAPTER 6: CONCLUSION

General Dynamic's recent decision to sell its

Quincy Shipbuilding Division has prompted strong reaction from the public sector. The difficulties encountered in finding another shipbuilder operator to buy the shipyard, together with the public pressure exerted on behalf of maintaining the property as an industrial facility, have created a controversial discussion, centered on the future of the shipyard. The interests of different parties are often highly subjective and are based on claims that may be difficult to interpret on purely economic grounds.

This thesis has identified the key issues characterizing sale of the shipyard. By applying financial and economic concepts in their analysis, the authors define fundamental factors which affect the transaction. A careful study of the price distortions shows how justifiable and conflicting interests can lead to a situation where it is not easy to determine a "fair market price" for an economic good. More importantly, this thesis suggests the need to recognize the misuse of economic concepts in public

-166-

~~~*^~~r~LI~~I1I*Zn*X~--~·UY-~~CWUI·X~il debate and ascertains the relevancy of the factors which support our findings.

The Quincy shipyard closure illustrates a case of market failure. Spillover costs and benefits characterize the sale transaction. As we concluded in

Chapter 5, the shipyard can be considered a source of net spillover benefits. Thus, the effects of externalities cause an "underallocation" of the asset. Private buyers are not willing to pay a price that includes the net spillover benefits to the community.

Under this circumstance, the public sector has a legitimate right to direct the outcome of the sale so as to maximize social welfare. More precisely, the public sector will participate in the purchase of the yard, if its assessment of the value of externalities exceeds the difference between the price sought by

General Dynamics and the price that a private investor is willing to pay. Exhibit 32 shows the actions undertaken by the public sector in the case of net spillover benefits.

There are two cases in which the public sector

-167- EXHIBIT 32

Private P P imnv. G.D.

E(Net Exter.) E(Net Exter.)

Pubic P -P P -P G.D. inv. G.D. inv. BUY NOT BUY

P D...-=Price asked by General ..Dynamics -.

P inv. =Price assessed by a private industrial i nvestor SE(Net Exter.)= expected value of net externalities to the public

source: authors

-168- will fail to intervene when net spillover benefits occur. The first case arises when the public assessment of externalities is less than the price differential between the private parties. This may happen if the seller and the public sector have asymmetric information on the effect of externalities. The second case arises when the public sector experiences bureaucratic failure. For this reason, a decision to participate in the asset's purchase may never occur, either because of conflicting interests or information among the various government agencies, or because of compromise behavior which leads to suboptimal decisions.

In summary, the public sector has a legitimate interest in determining the future use of the shipyard based on the existence and nature of externalities which will result from outcome of the sale.

Therefore, we expect that the government will participate in purchase of the shipyard if it determines that net spillover benefits exceed the price differential between private parties.

-169- FOOTNOTES

CHAPTER 2

1. "A Future for the Few," Far Eastern Economic Review, February 13, 1986. 2. "Potential Reuse Study of the Quincy Shipyard," Booz, Allen & Hamilton, Inc., February 25, 1986. 3. Far Eastern Economic Review, op. cit. 4. U.S. Shipping and Shipbuilding: Trends and Policy Choices, Congress of the United States, Congressional Budget Office, August, 1984.

5. "Too Many Yards Chasing After Too Little Work," The Boston Globe, May 5, 1985.

6. Far Eastern Economic Review, op. cit.

7. Merchant Marine Miscellaneous - Part 3: Hearing Before the Subcommittee on Merchant Marine of the

House Committee on Merchant Marine, 98th Congress 2d Session 218-224.

8. Booz, Allen & Hamilton, op. cit. 9. ibid.

10 Seapower, April 1985, Vol. 28, No. 4.

11. Report on Survey of U.S. Shipbuilding and Repair Facilities, U.S. Department of Tranportation, Maritime Administration, 1985. 12. Booz, Allen & Hamilton, op. cit. 13. U.S. Department of Transportation, op. cit. 14. ibid.

15. Booz, Allen & Hamilton, op. cit.

16. "Too Many Yards Chasing After Too Little Work," op. cit.

-170- 17. "Saga of the Dying U.S. Shipbuilding Industry," The Boston Globe, Thursday, July 25, 1985.

18. "Fourth Quincy-Built Supply Ship Christened in Honor of USMC Hero," General Dynamics World, Vol. 16, No. 3, March, 1986.

19. "Quincy Shipyard To Close," The Boston Globe, Thursday, July 25, 1985. 20. ibid.

21. ibid. 22. ibid.

"Contract to Lift Shipyard's Jobs," New York Times, July 25, 1985.

"Why the Shipyard Decided to Close," Patriot Ledger, July 25, 1985.

23. "Navy Contracts Key to Quincy," The Boston Globe, May 5, 1985.

24. "Quincy Shipyard to Close," op. cit.

25. Shipyard's Fortunes Kept in Step with America's Wars," The Boston Globe, Thursday, July 25, 1985. 26. "Leaders in Quincy, Mass., Weigh Impact of Closing Shipyard," The New York Times, July 27, 1985.

27. "3100 Quincy Shipbuilders to be Laid Off," The Boston Globe, Tuesday, April 30, 1985.

28. "Shipyard Workers Blame 'the Bigwigs'," The Boston Globe, Thursday, July 25, 1986.

29. "The Impact," The Boston Globe, Thursday, July 25, 1985.

30. "Shipyard Workers Blame 'the Bigwigs'," op. cit. 31. "Quincy Shipyard to Close," op. cit. 32. Congressional Budget Office, op. cit. 33. ibid.

-171- 34. "Quincy Shipyard to Close," op. cit. 35. "Union Says Donnelly not Helping with Shipyard," The Patriot Ledger, January 6, 1986. "Potential Yard Buyer's Record is Shipshape," The Patriot Ledger, January 17, 1986. "Shipyard Owners Talk to Others Besides Genesis About Sale," The Patriot Ledger, January 22, 1986. 36. "Quincy Shipyard Should Convert," The Boston Globe, Sunday, May 5, 1985. 37. "Rescuing U.S. Shipbuilding," The Boston Globe, April 13, 1983. Telephone interview with representative of the Local No. 5, Shipbuilders Union, AFL-CIO, in Quincy. 38. "Shipbuilding's Future Rides on Perfect Assembly of Pieces," The Boston Globe, May 13, 1986. 39. ibid. "City Hears Quickly From Possible Buyers," The Patriot Ledger, July 25, 1985. 40. Booz, Allen & Hamilton, op. cit. 41. ibid. 42. Massachusetts Wetlands and Waterways: A General Guide to the Massachusetts Regulatory Programs, Department of Environmental Quality Engineering (DEQE), November, 1984. 43. ibid. 44. Interview with Bert Ward, Chief Engineer, Commission of Public Works, Quincy, Massachusetts. 45. DEQE, op. cit. 46. ibid. 47. ibid.

-172- 48. "Wetland Fight: New U.S. Policy is Under Fire," The Boston Globe, May 11, 1986.

CHAPTER 3

1. Booz, Allen & Hamilton, op. cit.

2. Third Harbor Tunnel, Interstate 90/Central Artery, Interstate 93," Final Environmental Impact Statement and Final Section 4(f), Evaluation, Federal Highway Administration, Vol. 3, August, 1985. 3. ibid.

4. Interview with Peter Gwyn, President, Peter Gwyn & Associates, Inc., Management Consultants, Duxbury, Massachusetts.

5. Interviews with Peter Gwyn, op. cit., and Lou Salano, Senior Management Consultant at Bechtel, Parsons Company, New York, New York. 6. Peter Gwyn, op. cit.

7. U.S. Department of Transportation, Maritime Administration, op. cit.

8. Interview with Mr. London of John Alden Insurance Company, Boston, Massachusetts. 9. Federal Highway Administration, op. cit. 10. Peter Gwyn, op. cit.

11. Employment and Earnings, U.S. Department of Labor, Bureau of Labor Statistics, Vol. 33, No. 3 March, 1986.

12. Lou Salano, op. cit., and Peter Gwyn, op. cit. 13. ibid.

14. Principles of Corporate Finance, Second Edition, Richard Brealey and Stewart Myers, McGraw-Hill Book Company, Inc., 1984.

-173- Chapter 4

1. Options Markets, John C. Cox and Mark Rubenstein, Prentice-Hall, Inc., Englewood Cliffs, NJ, 1985. 2. Interview with staff assessor at the Assessor's Office, Quincy, Massachusetts.

Chapter 5

1. Weymouth-Fore and Town Rivers, Boston Harbor, Massachusetts. "Letter from the Secretary of the Army," House Document, No. 247, 88th Congress, 2nd Session, March 16, 1964. 2. ibid.

3. "River and Harbor Projects, Massachusetts," U.S. Army Corps of Engineering, New England Division, Vol. 2 and 3.

4. "Fore River Bridge Reconstruction Evaluation," Commonwealth of Massachusetts, Department of Public Works, 1974. 5. ibid. 6. ibid.

7. Telephone interview with Mike Hoye, Conrail, Area Engineer's Office, New York, NY.

"State Seeks to Keep Quincy Yard for Manufacturing," The Boston Globe, August 2, 1985. 8. "The Impact," op. cit.

9. General Dynamics Corp. v. Board of Assessors of Quincy, et al., Supreme Judicial Court of Massachusetts, Suffolk, 388 Mass. 24, January 21, 1983. "Quincy Coping with Changes," The Boston Globe, May 12, 1986.

-174- 10. General Dynamics Corp. v. Board of Assessors of Quincy, et al., op. cit. 11. "The Impact," op. cit. 12. "Leaders in Quincy, Mass., Weigh Impact of Closing Shipyard," op. cit. 13. "Why the Shipyard Decided to Close," op. cit. 14. Interview with officials at the Department of Industrial Services, Commonwealth of Mass. Booz, Allen & Hamilton, op. cit.

15. "Quincy Coping with Changes," op. cit. 16. ibid. "Shutdown Will Cut Deeply into South Shore Economy," The Patriot Ledger, July 24, 1985. "Why the Shipyard Decided to Close," op. cit. 17. "Shipyard Closing Casts Its Shadow," The Patriot Ledger, April 26, 1986. 18. "Quincy Coping with Changes," op. cit. 19. ibid.

20. "Closing Gives the City Much to Worry About," The Patriot Ledger, July 25, 1985.

"General Dynamics Will Spend $10 Million on its Displaced Workers," The Patriot Ledger, July 25, 1985.

21. "Approaching an Uncertain Future," The Boston Globe, May 11, 1986.

22. "Shipyard Workers Blame 'the Bigwigs'," op. cit. "69 From Shipyard Hope Retraining = Jobs," The Patriot Ledger, April 26, 1986. 23. Booz, Allen & Hamilton, op. cit. 24. "Occupation Training in Selected Metalworking Industries," U.S. Department of Labor, Bureau of Labor Statistics, Employment and Training Administration, 1974.

-175- 25. "Waterborne Commerce of the U.S.," Part 1, Waterways and Harbors, Atlantic Coast, Department of the Army Corps of Engineers, 1983. 26. "Quincy Coping With Changes," op. cit.

27. Telephone interview with Richard Meade, Planning Department, Quincy, Massachusetts.

28. Interview with Carl Boutilier, U.S. Army Corps of Engineers, Regional Office, Boston, Mass. 29. Anonymous source at General Dynamics Corporation. 30. ibid.

31. "Leaders in Quincy, Mass., Weigh Impact of Closing Shipyard," op. cit.

Closing Gives the City Much to Worry About," op. cit.

32. SYMBA Study, Department of the Navy, Office of the Assistant Secretary and Department of Transportation, February, 1984.

33. "Shipping, Shipyards and Sealift: Issues of National Security and Federal Support," Nacoa Report, preliminary draft, 1985.

-176-