INTRODUCING AUSTRALIA INFRASTRUCTURE
Australia’s infrastructure policy and the COAG National Reform Agenda
Luke McInerney, Chris Nadarajah, Frances Perkins1
In the last 15 years, Australian governments’ infrastructure policy has shifted systematically from directly providing virtually all infrastructure to creating competitive markets where competing public and private suppliers can provide infrastructure efficiently. Wide ranging competition and structural reforms, particularly under National Competition Policy, have underpinned this policy shift. The Productivity Commission (2005) estimated these reforms added about 2.5 per cent to GDP, or about $7,000 to household income each year.
However, significant opportunities remain to enhance infrastructure markets’ performance and hence raise national productivity and wellbeing. Outstanding policy reforms broadly involve making markets more fully competitive where competitive supply is possible and resolving regulatory and planning failings where natural monopolies remain. All governments took an important step forward to address some of these issues, when in February 2006, the Council of Australian Governments agreed to a wide ranging National Reform Agenda (NRA) to build on National Competition Policy. The competition stream of the NRA focuses on reform initiatives in energy, transport and infrastructure regulation and planning; it tackles many, but not all, of these outstanding infrastructure policy issues. Fully implemented, the NRA and other reforms canvassed in this paper would make a significant contribution to ensuring Australian households and businesses receive the most efficient and cost effective infrastructure services possible.
1 The authors are from Competition and Consumer Policy Division, the Australian Treasury. This article has benefited from comments and suggestions provided by Brad Archer, Steve French and Jim Murphy. The views in this article are those of the authors and not necessarily those of the Australian Treasury or the Australian Government.
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Australia’s infrastructure policy
Introduction
After 15 years of continuous growth, in the midst of a resources boom and a major drought, some Australian infrastructure sectors are showing signs of strain. Communities are suffering water shortages, bulk commodity ships are queuing off some ports, on hot summer days electricity capacity reserves can be quite low in several States and the cost of urban traffic congestion is rising in major cities. While the Fisher Taskforces report, Australias Export Infrastructure (2005), concluded Australia did not have an infrastructure crisis, it found some parts of the nations export infrastructure faced immediate capacity constraints and, if not dealt with, some underlying weaknesses in the infrastructure investment environment threatened to make these problems more widespread, compromising Australias export potential in the next five to ten years. The OECD (2006) and International Monetary Fund (2006) outlined similar concerns about infrastructure market constraints in their recent reviews of the Australian economy. This paper examines best practice policy for infrastructure, analyses many of the major challenges facing Australias infrastructure sectors and suggests potential policy solutions. It then examines the contribution the Council of Australian Governments (COAGs) new National Reform Agenda (NRA) should make to resolve a number of these problems when fully implemented.
Because infrastructure is an essential input to virtually all economic activities and contributes directly to peoples wellbeing, economically efficient infrastructure policy is crucial to Australias economic performance. State governments retain constitutional responsibility for most energy and transport infrastructure policies while the Commonwealth Government is responsible for telecommunications policy and some economic regulation of infrastructure through the Trade Practices Act. The basic objective of Australian governments infrastructure policy is to ensure households and businesses can access high quality, competitively priced infrastructure services in an efficient and sustainable way. However, ensuring infrastructure policies maximise community wellbeing is a challenging task. This is because most infrastructure activities including electricity, gas, water, telecommunications and land, air and sea transport have distinctive public good, externality and/or natural monopoly characteristics. However, if public policy ensures infrastructure markets function effectively, governments usually can allow competing suppliers to provide infrastructure services. Where competition is not possible, governments often need to regulate to ensure monopoly power is not abused or may decide to provide such services themselves. (See Appendix for more discussion of monopoly power issues.)
Over the past 15 years, Australian governments, like many others in the OECD, have reformed their infrastructure policies. As part of their broader microeconomic reform agenda to boost productivity and growth, governments have shifted systematically from directly providing virtually all infrastructure to creating markets where competing public and private suppliers can efficiently provide infrastructure services.
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Australia’s infrastructure policy
Indeed, as shown in the article Trends in Infrastructure in this edition of the Treasury Economic Roundup, the share of private sector investment in infrastructure has markedly increased since the mid-1990s, to more than off-set a moderate decline in total public sector infrastructure investment during this period. As a result of rising private investment, the ratio of total Australian infrastructure investment to GDP rose from an average of around 3 per cent from 1987 to 2000 to almost 4.5 per cent by 2006 (Coombs and Roberts 2007).
However, Australias infrastructure policy reforms are incomplete. This paper examines a range of factors constraining completive infrastructure markets and efficient infrastructure regulation. These policy issues can contribute to uncertainty that may discourage timely new investment and can generate actual or potential infrastructure bottlenecks and raise infrastructure prices for users.
Pressures to provide infrastructure in the most efficient way are increasing. Lower barriers to international trade and foreign investment, along with financial sector and other microeconomic reforms have increased the trade intensity of the economy. Technological advances also increase the importance of innovation in infrastructure provision and provide opportunities to recover costs through user charges.
Best practice infrastructure policies
Understanding why, when and how governments and the private sector can participate effectively in infrastructure provision is essential to delivering an efficient policy environment and maximising community gains from infrastructure policy. Given that most infrastructure sectors exhibit special characteristics, government infrastructure policy needs to:
• understand the monopoly nature of much infrastructure;
• prevent exploitation of monopoly power by, wherever possible, introducing competition in and for infrastructure service markets, or, if competition is not possible, appropriately regulating these markets; and
• recognise and allow for public good characteristics and externalities of some infrastructure services.2
Public or private ownership?
The ownership of infrastructure assets is a sensitive community issue in many countries and Australia is no exception. This is due primarily to public sector employees concerns about job losses and consumers fears of reduced service levels and higher prices from privatised suppliers, particularly where public utilities prices have been held artificially low or are used to subsidise certain groups. However, in all but a few centrally planned economies, privately owned businesses operating in competitive markets supply most goods and services. Because private firms profits and management incomes typically are more closely linked to their performance, they generally respond better to customer demands and price signals.3 Hence, most consumers accept that, at least in sectors without significant public good, externality or natural monopoly characteristics, competing providers are more likely to supply high quality and competitively priced goods and services, compared to public sector monopolies using non-market resource allocation mechanisms. The economic efficiency losses from underpricing infrastructure services and the significant fiscal burden and risks imposed on taxpayers from developing new infrastructure create further incentives for governments to recoup fully the cost of infrastructure services and seek private involvement where appropriate.
One argument advanced for government ownership is that infrastructure supplies essential services, or merit goods, with benefits extending beyond direct users to the community more broadly. However, while water supply, sewage treatment, transport, energy and telecommunications certainly are essential services, this does not in itself justify public sector provision.4 Food is at least as essential as these services, but given the agricultural failures of centrally planned economies, few would argue that public sector provision increases food security.
Without public ownership, governments can ensure healthy competition in infrastructure industries and monitor reliability and safety standards as they do in
3 They also are more likely to minimise costs and innovate in technology and service provision than are state owned entities. Effective public sector managers are less likely to be rewarded than their private sector counterparts for cutting costs or increasing revenue because public enterprises do not keep their profits. As a consequence, public managers often can invest in excessively secure systems or gold plated investments to ensure they never fail, rather than implementing more cost-effective risk management strategies. The very negative public and political reaction to public infrastructure failures such as Aucklands power supply breakdown in 1998 and the failure of Sydneys water treatment plants and possible outer-catchments containment in 1998 show why public authorities often adopt such risk averse strategies.
4 While minimum quantities of water and acceptable levels of sanitation prevent the outbreak of disease, generating considerable community benefits, direct government provision is not the only, or necessarily the most efficient way, to ensure even these most essential services are supplied.
other industries such as food and hospitality. In fact, governments arguably can regulate standards more effectively when they do not own and operate firms in the regulated industry; remaining an impartial umpire is difficult when you are also playing in the game.
While public ownership may reduce efficiency, it also can generate benefits. As discussed in the following sections, public ownership of infrastructure assets, regulatory control or government subsidies are more likely to deliver net benefits for the community if infrastructure exhibits significant public good, externality or natural monopoly characteristics. Other motivations for government ownership include providing a source of information for regulators, thereby making regulation easier and cheaper, and achieving social objectives that cannot be secured readily by other means.5 To determine whether the public sector should invest in infrastructure assets decision makers need to assess competing projects using robust and transparent cost benefit analysis.6
Alternatively, governments can recognise some infrastructures public good and externality characteristics or achieve social objectives by offering subsidies to private operators, preferably in the form of contestable community service obligations.7 For example, rather than owning airlines that operate financially unviable services to isolated areas as they did in the past, Australian governments now provide contestable subsidies to private airlines to operate such services.
Public goods and externalities
Public ownership is likely to be necessary if the infrastructure is a pure public good. (See Appendix for a discussion of the characteristics of public goods.) For example, governments around the world typically supply public roads and urban infrastructure like footpaths and street lighting, which have strong public good characteristics.
5 Sometimes governments decide that maintaining public ownership is the best way to provide subsidies to targeted groups in the community. The relative costs of public ownership may be low when production processes are simple, the asset has substantial monopoly power and the information costs of regulating a private monopoly are high.
6 If private operation of an infrastructure service is not financially viable but the service is expected to generate positive net economic benefits for the community, due to externality or public good characteristics, the government could justify providing the service itself. The net economic benefits of selected projects should have the highest present value among all alternative uses of public funds.
7 Transparent, on-budget subsidies to competing suppliers to meet specified community service obligations should not exceed the net economic benefits (including positive externalities) derived from the infrastructure. If a government offers subsidies, the best approach is to ask market participants to bid to provide the service through a competitive tender process, with the bidder requiring the lowest subsidy to provide the service winning the contract.
Without subsidies, private sector providers cannot provide such pure public goods because they cannot efficiently charge people for using them.8 However, even public ownership of infrastructure services does not preclude private sector participation as the construction of infrastructure can involve private contractors, leaving the operation and ownership of the assets in public hands.
Governments also often play an important role in funding and providing infrastructure that generates significant externality, or spillover, benefits to the community. For example road, rail and public transport networks typically generate benefits beyond those immediately enjoyed by direct users that can increase land values in surrounding areas. Infrastructure generating significant positive externalities may be underprovided if governments do not subsidise it in some way.9 Hence, governments may decide to install such infrastructure itself and tax those, like landowners, receiving external benefits from it.
Similarly, infrastructure assets and services which produce negative externalities, such as noise, traffic accidents or pollution, may be overprovided if governments do not tax or regulate their provision. Congestion charges in urban areas, regulations requiring trucks to install quieter braking systems and prohibitions on heavy vehicles entering certain urban areas are some methods of discouraging activities or technologies which create negative externalities.
Monopoly networks and market power
The most critical difference between most infrastructure sectors and other industries is that many infrastructure industries have at their core networks that are natural monopolies (monopoly networks are discussed more in the Appendix). These include high voltage electricity transmission wires, fixed telephone lines, water and gas pipe networks, road and railway networks or regulated connections between transport nodes such as air routes. Inter-modal facilities like ports, rail hubs and airports also can possess monopoly power if suitable sites are not available to reproduce facilities or the current market is only large enough to justify one efficient facility in a particular location. As new entrants usually cannot threaten owners of such electricity, water or gas networks the owners could exploit their monopoly power without regulatory
8 Public provision of most roads is likely to remain unless it is technically feasible to charge for access. However, in many markets overseas, on toll roads and in some cities, telematic and related technologies now often charge vehicles directly for their actual use of roads.
9 This is because potential private sector investors will only value the revenue they can generate from charging the infrastructures direct users, not any external benefits it may generate for the community. Thus if externalities are sufficiently large, a commercially unviable project still could have positive net economic benefits for the community.
oversight.10 Unregulated monopolies can earn excessive profits in the long term by constraining their output below, and pushing their prices above, levels that normally would hold in fully competitive markets.
However, not all infrastructure assets are pure natural monopolies and some can be duplicated efficiently and compete with each other even when they possess a level of market power. Such assets include ports, airports or rail hub inter-modal facilities in reasonable proximity to each other.11 Road, rail, sea and air transport networks also can compete with each other to provide many but not all services. Similarly, mobile phone services, cable and Voice-over Internet Protocol now compete with fixed line telephony, reducing the monopoly power of telecom incumbents and allowing new players to enter these markets.
Governments also can play an important role in facilitating competition between infrastructure assets that are not pure monopolies but have some market power, thereby expanding service levels and/or reducing prices for users. Where it is economically viable to do so, governments can help reduce the monopoly power of incumbents by providing opportunities for investors to establish competing infrastructure assets and services. They also can prevent dominant incumbent infrastructure owners from bidding for limited sites or market niches for potentially competing facilities. For example, if an entity owns the main inter-modal (rail head) facility or airport in a city and the government decides to release land suitable for a competing facility, the inter-modal facility or airport owner incumbent could be proscribed from bidding to establish the new facility.12 The two separately owned rail heads or airports could then create competitive pressures on each other, potentially reducing user charges and improving service quality. Similarly, if a port has a dominant position in a particular region and the government decides to open up a new port site, the private or public owners of the existing port or facility preferably should not be permitted to bid for the new potentially competing site.13
In the past, many governments addressed infrastructure networks market power by publicly owning and operating integrated utilities that included these networks.
10 Replicating electricity transmission lines, water pipe networks and reticulated gas pipelines typically is not efficient as these networks are a major component of industry costs.
11 Typically infrastructure service providers like air, sea, road or rail transport service providers, loading facilities or stevedoring services within such transport hubs do not have any natural monopoly power and can compete in open entry markets.
12 In the case of rail heads, to remove incentives to restrict access to the new facility, such inter-modal facilities would be better developed by unbundled track owners or third parties, rather than integrated track and rail service providers.
13 Finally, if a port has only two stevedores and the government decides to develop a third berth which could compete with incumbents, the existing players should not be permitted to bid to provide this service.
However, they now increasingly recognise that competing suppliers often can provide lower cost and higher quality services than public utilities. Hence governments have sought alternative ways of addressing monopoly network power issues to reap the benefits of competing operators delivering infrastructure services.
Unbundle or integrate?
The most important first step in this process is for governments to consider vertically and horizontally separating, or unbundling, integrated infrastructure monopolies into their competitive and natural monopoly elements. While most integrated infrastructure utilities have natural monopoly network components at the centre of their operations they also include activities that smaller competing firms could supply more efficiently. Examples of unbundled infrastructure facilities and activities that can be supplied competitively include electricity generating plants, electricity retailing, water and sewage treatment plants, telephone exchanges and telephony retailing, rail passenger and freight services and gas wells, treatment plants, compressors and retailing. Unbundling is particularly important if the infrastructure is going to be privatised. Owners of vertically integrated networks and service activities have a commercial incentive to restrict access to their network to advantage their service supplying activities over other suppliers.
Benefits and costs of unbundling
Once competitive business segments are unbundled from monopoly networks, the competitive elements of the industry can be fully privatised without needing significant regulation. So long as they operate in a competitive market environment, privatisation will help pass on the gains from commercial efficiencies to customers, without government intervening with heavy handed pricing or rate of return regulation. Infrastructure networks also can be privatised after unbundling, but typically will require ongoing access and price regulation.14
If an infrastructure network is separated from the industrys competitive components, and network access is assured by legislation, potential new entrants need not duplicate expensive network investments to compete. Instead, as in normal industries, new competitors can enter merely by investing in production capacity. Even major investments like power stations will not deter new entrants so long as they are guaranteed access to the network at economically efficient prices. The costs and decision delays associated with managing and operating large firms often provide
14 Owners of vertically separated infrastructure networks will have an incentive to provide competing suppliers access to their network, but if they have market power, may seek to charge excessive tariffs for such access.opportunities for nimble competitors to exploit new technologies and gain market footholds.
The main potential cost of vertically separating infrastructure and regulating to mandate access to monopoly networks is that network owners who also provide services in competition with other access seekers may be unwilling to invest in new networks if they cannot have exclusive access.15 Even if potential network investors are not also competing with service providers, mandatory access and regulated prices may cap the upside of returns from new investments while network investors carry the risk of losses from the investment. Hence, some investors seek access holidays for new network investments so they can capture more of the up-side from their investment.
