Response to the Regulatory Impact Statement on Proposed Children's Services Regulations 1997 (Victoria)

Submission

SUMMARY

Contrary to the Government's intentions, in the provision of child care services, we favours allowing parents to choose the standards of child care for their children.

The Government's proposed regulations are premised on it displacing parents in the determining how to care for children.  The proposals reject the notion that it is parents who are the most efficient custodians of their children's interests and interpose a bureaucracy and a credentialism where none is needed.  In doing so they will ensure that prices are increased, to the detriment of the parent-consumer and to the taxpayer who pays an increasing proportion of the costs.

The existing and proposed regulatory arrangements, are founded on a paternalism that says, "The gentlemen and gentlewomen in Spring Street know the citizen's true needs better than the citizen".  The Regulatory Impact Statement disguises such sentiments by making claims on the behalf of "the community", which is said to require services of a higher quality.  People in general always want higher quality.  Most would prefer to drive a BMW rather than a Holden, opt for a fine restaurant rather than Macdonald's, and buy designer clothing rather than ready-to-wear.  Few people actually choose the highest quality because they either cannot afford it or prefer to settle for something less and save money.

In the case of child care, the fact is that the customers need to be coerced into using services deemed by the sponsors of the regulation to be those they truly prefer.  Other standards of service, many of which have long been in operation, are to be declared illegal.  The sponsors do not want to leave it to chance that those responsible for the upbringing of children, the parents, might not share their expert opinion of what is sound practice.  They want instead to impose a plethora of requirements on those offering child care services.  These requirements are said to improve the quality of the services.  Whether or not they do, they will undoubtedly increase the price.  The regulatory denial of choice in the quality of services citizens may select is contrary to the concepts of economic and political freedom that the Government claims to espouse.

Our preferred approach to the provision of goods and services allows the free interplay of demand and supply.  Such an approach has long been demonstrated to offer the lowest cost goods and services and the diversity of supply that the market commonly requires.  Our view is not founded on some ideological prejudice, but on vast experience of how goods and services are provided most efficiently.

DIFFERING OVERALL APPROACHES

The approaches to the provision of child care can follow one of two routes.  The first is having government specify in considerable detail:

• who may provide the service,
• the facilities in which it may be provided
• the staff who may support the provider
• the times that the facility may be open
• the age profile of each facility's group of children
• the proportion of staff to children and the nature of that proportion as between staff of different levels of credentialled expertise
• the prices at which the service should be provided.

The alternative is to insist on rigorous publication of information on the centre so that parents can choose the quality they consider appropriate to their needs, preferences and resources.

Child care is an important matter for parents.  Choice of centre is not a decision that will be undertaken without major consideration.  By its nature, it is a "repeat purchase" and dissatisfaction will lead to changing the supplier.  This places pressure on the centre to perform in order to gain and retain its customer base.  With open access to the provision of child care services, each centre must continuously strive to provide value.  This market based approach allows needs and offerings to be matched without the intercession of a bureaucracy.

The usurping by the State of the need for the parent to exercise control may also lead to a form of "moral hazard".  Where a bureaucracy is vested with responsibility to ensure a standard is maintained, it is likely that users will be less vigilant in undertaking these tasks themselves.  Users will assume that others are undertaking the scrutiny role that they themselves would previously have performed.  This may lead to reduced resources being applied to the scrutiny.  It also may mean a less effective scrutiny where those undertaking it are focused on a rule.

MEASURING THE NEED FOR THE PROPOSED STANDARDS

Impact of Credentialism

The increase in the costs that the new regulations will cause is comprehensively demonstrated than in the credentialism that is being specified.  Rearing and caring for the young is something that requires no qualifications.  It is a natural function of all creatures.  Millions of generations have demonstrated that it requires no scholastic preparation.

What is proposed is an extension of present requirements of having qualified staff employed in the Class 2 centres which cater for children in care no more than 10 hours per week and for no more than 10 hours per week.  The qualified staff will also have to be in attendance at all times that children are present in the Class 1 centres.  A minimum of two staff will need to be in attendance at all times children are present.

Some may argued that child care is part of education and that qualified staff are equally important in this service as in schools themselves.  If this is the case, the preferred approach is act directly and to lower the school attendance age.

The adverse impacts of the proposals can be crystalised under three headings:

• First, they deny some of the least privileged members of society an opportunity to use their skills.  Although standards for acceptance to obtain the qualifications are not high, they will prove too onerous for many willing carers.  For others the need to obtain the credentials and forego paid employment will prove to be financially forbidding.  The impact is likely to be on people, especially women, from poor backgrounds, including aboriginals, and migrants.  Denying perfectly competent women from such backgrounds opportunities to use their skills to the fullest extent is a cruel and shameful strike by the educated classes who are devising and policing the regulations.
• Secondly, there is the needless cost of services foregone while the qualifications are being acquired.  If two years are taken to obtain the diploma, and the normal working period is twenty years, society incurs a cost increase of 10%.  Inexplicably, while it draws attention to the cost of HECS, the RIS fails to recognise the deferral of payed employment as a cost.  Of course, the cost is retrieved by the credentialled people in terms of their increased remuneration.  But that increased remuneration is paid for by the hapless consumer/taxpayer.  In the regulations being put forward, the voices of these people are not heard.  Most would not have the degree of interest to seek modification of the system, for, unlike those seeking the intensification of the regulations, they are not paid from the public purse to devise new ways of imposing their preferences.
• Thirdly, the regulations will directly increase wage costs.  According to the RIS (p.31) credentialled workers are paid 29-50% more than other workers.  This must be reflected in fees.

The higher costs will in all likelihood be picked up by governments.  But this means foisting the costs onto other taxpayers.  There is a case for some modest subsidy to those who would be otherwise be impoverished by not being able to work, but at present arrangements extend some sort of subsidy to the vast bulk of parents.

A revolt of taxpayers is currently underway throughout the western world and it seems likely that the subsidies will come under pressure in future years.  At that time it will prove very difficult to dismantle edifice of the excessive qualifications -- people will, in all good faith, have denied themselves income by undertaking unnecessary training.  They will resist the opening up of their positions to competitive labour supplies which have had not had to make the sacrifices.

Check on criminal records

If there are 10,000 workers in the industry in Victoria the checks, at $34 each, will cost $340,000.  This would be increased if volunteers are also to be checked ­ as they logically should be.  Moreover, these checks will not be effective in revealing a record of someone who was intent on hiding their past, as would surely be the case with people who might pose a danger to the children under their care.  The checks would therefore be a waste of money.

The regulatory impact statement contemplates, but rejects on the grounds of cost, a fingerprint test.  The mere consideration of this option is disturbing from the perspective of civil liberties.  While it is appropriate to take stringent care to avoid recruiting criminals in such occupations as the police, fingerprint checks are not the practice elsewhere.  Would those who are devising the regulations, those in the inspectorate and those in the Department also agree to be fingerprinted as a condition of their continued employment?

Staff:Child Ratios

The proposals are to increase staffing in the Class 2 centres, bringing them in line with the more stringent requirements in Class 1 centres.  Contrary to this approach, we considers that mandatory staffing levels ought to be abandoned.  Instead they should be replaced by a requirement that all centres prominently display up to date information on the numbers of children and numbers (and qualifications) of all staff and their hours of operations.  This will give parents the opportunity to select the services that suit their situations.

The absurdity of the proposed arrangements is demonstrated in the provisions that will prevent any flexibility in operations even where staff are not available.  There are, at present, five centres where staff cannot be recruited due to their geographic isolation and other centres where most of the children are aboriginal and no suitably qualified staff are available.  Those centres would be forced to close and the parents denied suitable child care.

While some totalitarian regimes have taken over children at a very early age, our preferred way of rearing children under 6 is for the State to intervene only in circumstances where the child is being abused or neglected.  The present arrangements assume the parent is unable to make the correct decisions about their children's well being.  The approach is irreconcilable with our notions of democracy and individual responsibility.  It will almost certainly engender costs additional to those seeking the services require.

Facilities

The Regulations cover the facilities in great detail.  These specify space per child, require natural light outdoor areas, child-specific toilets and wash basins and an ability of staff to observe children at all times.  While these requirements are doubtless inspired by well meaning considerations, a moment's reflection leads one to realize that a great many homes fall far short of these standards of appointment.

Should we not, therefore, require such facilities as a pre-condition of people having and bringing up their own children?  The logic of requiring such standards in child care standards is that they should be extended to all facilities where children are cared for.  Indeed, they are all the more necessary where the child is living in premises for 24 hours per day rather than the 40 hours per week in a centre.

This logic could dictate:

• that children should not be brought up in tall apartment blocks, especially where there is little natural light;
• that nobody should be allowed to have children unless they have first completed the required tertiary qualification;
• that there should be at least two people present to supervise children at all times, especially where there are more than three infants in the family;
• that homes in which children reside should be remodelled to ensure the wash basins and toilets are appropriate for those of small stature and that those using the facilities can be observed at all times.

CONCLUDING COMMENTs

The regulations as proposed represent a solution in search of a problem.  They are more exacting in many respects than are those governing the care of sick people.

The excessive costs of the proposed standards are most readily seen once they are compared with those required to bring up children in other situations.  The two most obvious comparisons are with the home and schools catering for 6 or 7 year old children.

School records do not require the considerable detail specified in the regulations for child care centres.  Nor do schools see the need to keep such exacting details of parents, court orders, languages spoken etc.

Clearly, all these requirements will call forth a policing system.  This will offer valuable career opportunities to public servants, many of whom are hostile to private sector provision of child care services.  The thousands of regulatory requirements will ensure that no centre could guarantee an unblemished outcome from inspection.  This may result in an inspectorate that will apply standards in a discriminatory fashion and pose a constant threat to the livelihood of many entrepreneurs.

If the proposed provisions are in line with the wishes of parents, the Government could set a standard and allow those centres that meet it to promote this to users.  Where parents choose not to send their children to these "accredited" centres, this should be their right.  If the "accredited" centres are what parents really wish to use, they will displace from the market those that do not meet the standard.

South Australia: Energy Situation and Policy Approach

Energy Forum Papers

EXECUTIVE SUMMARY

THE POLICY BACKGROUND

Almost a decade ago the South Australian Government embarked on reducing the staffing levels of its electricity businesses.  In this it was ahead of other governments in Australia.  South Australia, if only in recognition of cost realities, also avoided "State chauvinism" in not pursuing self-sufficiency in power generation where imports were cheaper.

More recently the Government has been slow to see and pursue reform in energy:

• It has adopted the minimum degree of disaggregation of ETSA acceptable to other jurisdictions leaving its generator with market power, creating the potential for its transmission business to favour its sister distributor and providing insufficient competitive tension in distribution/retailing.
• It has been slow to open electricity retail markets to competition -- both in announcing a timetable for customers becoming contestable and in issuing licences to new providers.
• It has been slow to open the market for gas and has favoured electricity over gas in its welfare-subsidy policy.

POLICY PROPOSALS FOR THE FUTURE

The Government should move to further disaggregate its businesses by splitting the generation facilities into two separate firms and the existing ETSA into a transmission business and two retailer/distributors.

The Government should exercise leadership in promoting privatisation of its electricity assets.  Privatisation is likely to bring improved efficiencies and to offer greater assurances of a continued stream of income similar to that presently obtained from its electricity assets.  With a likely sale price in excess of $4 billion, privatisation would more than halve State debt.

As an interim stage the Government should:

• enlist private equity to install gas turbines at the Optima gas-fired generator at Torrens Island;
• disaggregate the dominant generation business, Optima, into two competing businesses and allow a competitive provision of generation to develop based on these two units, the new co-generation plant at Osborne and the Victorian interconnector

The Government would also be well advised to take advantage of the proposed Riverlink interconnect with NSW which offers power from NSW subsidised by NSW consumers.  Other agencies may wish to review the consistency of that proposal with national competition policy.

1. THE SOUTH AUSTRALIAN ECONOMY AND GOVERNMENT

The South Australian economy has been growing more slowly than those of all States other than Tasmania over the past decade.  Although the State covers a vast area and has a well developed infrastructure in Adelaide, it is generally expected to continue to experience lower growth than in the rest of Australia.

The State has long been characterised by a high degree of government intervention in business and prominence within the economy in general.  In overall terms, South Australia presently spends 12% more per head than the average of the other States in supplying government services and its relative extravagance has tended to increase.  The following Figure shows the estimates by State.

Figure 1:  Relative Size of Australian Governments' ExpendituresSource:  Commonwealth Grants Commission

At least since the days of the Playford administration (1938-1965), Government has sought to play a major role in the directions of industry growth and in social matters.  Thus, the South Australian Housing Trust owns some 12% of the state's housing stock.  In renting out this property, the Trust fails to cover even its on-going expenses, while the very low rents tend to lock people into locations where there are fewer job opportunities.

Governments have also assumed a major role in energy policy, as illustrated in the history of the Electricity Trust of South Australia (ETSA). ⁽¹⁾, ⁽²⁾  As with its counterparts in other States, ETSA has been placed on a commercialised footing.  However, government policy has sought to resist disaggregating the electricity business.

In this respect, the Government has adopted a different position from those of Victoria, Queensland and to a lesser extent NSW, where the priority has been on reforming the industry to drive down prices by bringing increased competition.  An Industry Commission report ⁽³⁾ was the catalyst to bring some disaggregation but the report's recommendations did not go far in this direction and the Government's response further watered these down.  Generation remains subject to a degree of monopoly control by the main generation business (Optima Energy), while retail and transmission has been retained in a single organisation leaving some potential for monopoly abuse downstream.

The Government expenditures, together with the failure of the State Bank, have led to the State carrying a great deal of debt.  This totals some $7.7 billion, which, at $5,200 per capita, is twice the Australian average and exceeded only by Tasmania and the Northern Territory.

2. ENERGY GROWTH

Petroleum products remain the most important energy fuel and have been growing in line with the gradual increase in overall energy consumption.

The State's energy resources include the vast Roxby Downs uranium mine and the Cooper Basin gas reserves.  The State is a net importer of electricity and is expected to remain so as its coal reserves are poor quality and relatively distant from major loads while gas is likely to remain expensive for base-load generation.  Nuclear energy would probably be competitive but carries political risk.  The regulatory framework would itself be labyrinthine and it is doubtful that Australian Governments would be willing to offer a private developer the confidence needed to proceed in the face of minority group protests. ⁽⁴⁾

Over the past decade, average annual total energy consumption growth in South Australia has been a little over 1%.  Within this total, electricity consumption has been rising at just under 3_%.  Consumption of natural gas, having increased rapidly in the decade to 1985, was actually on a declining trend in the decade to 1996.  To some degree this was caused by the increased imports of electricity from Victoria that displaced gas-generated electricity.

Projections of growth by the Australian Bureau of Agricultural and Resource Economics (ABARE) are for total energy to increase at an annual rate of a little over 1%, with petroleum products increasing in line with this but gas and electricity increasing at average annual rates of 3.1% and 3.7% respectively.

These trends are illustrated in Figure 2 below.

Figure 2Source:  Energy 1997 Projections, ABARE.

3. THE ELECTRICITY INDUSTRY

MARKET SIZE AND TRENDS

The South Australian electricity market is a little over 9,000 Gigawatt hours (GWh) per year, about one-third of the Queensland load and less than one-fifth of that of NSW.  Demand growth has been around 3% per annum over the past decade, with annual growth having slowed to just over 2% during the 1990s.  The industrial sector has tended to show the fastest rate of growth.

Figure 3 illustrates the trends.

Figure 3Source:  ESAA

South Australia, like Victoria and Western Australia, has a larger share of its energy accounted for by gas than by electricity.  However such statements need to be qualified by the different efficiencies of the fuels.  In this respect, for most purposes electricity is a far more convenient fuel to use than gas and its effective output per unit of input is much higher.  In South Australia, as in Western Australia, gas is used as a major source of fuel for electricity.

The relative importance of gas in South Australia reduces the share of electricity in the State's total reticulated energy to less than 30%.  This compares with over 40% for Australia as a whole.  The respective shares of electricity in total reticulated energy in South Australia and Australia as a whole are illustrated below.

Figure 4Source:  Gas Statistics, AGA

ELECTRICITY SUPPLY SOURCES

A key feature in the South Australian supply system is the interconnect with Victoria.  Established in 1990, the interconnect provided 3,777 GWh of electricity or over a third of the total of 10,576 GWh supplied.  The increased share of imported electricity has largely displaced electricity generated from gas.  The trends in generation are shown in Figure 5 below.

Figure 5Source:  ETSA Annual Report

SYSTEM EFFICIENCY

The South Australian system has shown strong productivity growth over the past decade.  Employee numbers have more than halved, sales per employee have increased threefold and real prices have been reduced by a quarter.

Even so, South Australia has major weaknesses in generation, where its labour productivity is considerably below that of other State systems and the availability of its stations lags that of the better performing systems.  Figure 6 illustrates these comparisons.

Figure 6Source:  ESAA

PRICES TO END-USERS

ETSA set itself a major goal in 1988 to improve price competitiveness by 1995.  In the years since 1991/92, the differential between South Australian prices and those of the eastern States have tended to narrow.  Figure 7 illustrates this with regard to Victoria.

Figure 7

4. THE GAS INDUSTRY

Reticulated gas is well established in South Australia.  Some 80% of households have access to the mains (compared with 88% in Victoria and 60% in NSW).

The South Australian gas industry is wholly privatised.  Production is by a consortium, the South Australian Cooper Basin Unit Producers, led by Santos with Esso and SAGASCO (Boral) as partners.  The gas is transported along a 1,989 km pipeline owned by Epic Energy (including 781 km Moomba to Adelaide) and distributed through a 6,425 km reticulation network by Envestra (controlled and serviced by Boral).

The significance of gas stems from the Cooper Basin discoveries some 30 years ago.  Gas has assumed considerable importance in the State, both as a commodity reticulated to end-users and as a source of electricity -- where it generates the equivalent amount of electricity as that produced locally from coal.

The State Government has tended to discriminate against reticulated gas in terms of subsidies to consumers -- the pensioner rebate covers electricity but not gas.  However, the industry has developed to be highly competitive and its private ownership has shielded it somewhat from the politically inspired cross-subsidies that have excessively compressed price differentials between industrial and domestic users in Victoria.

Gas prices on average in South Australia are the lowest within Australia.  In 1995/96, South Australian prices, at an average of $5.74/GJ, were 10-15 % below those of Victoria and NSW, and almost 40% below those of Queensland.  The gas price for industry in South Australia is lower than in all OECD countries other than USA and Canada.

This outcome has been achieved without squeezing earnings.  Some indicators of the operations in South Australia and other States are given in Table 1.

Table 1:  Comparative Gas Industry Data

	Gas Share of Non Transport Energy (%)	Earnings before Interest and Tax /Total earnings (%)	Mains (km) per Employee
South Australia	37.5	14.8	8.1
Victoria	43.5	14	12.7
NSW	17	12.6	13.4
Queensland	11.2	n.a.	6.8
Western Australia	41.7	10.9	16.7

5. THE ELECTRICITY BUSINESSES

INDUSTRY STRUCTURE

South Australia, like most other jurisdictions, has built up a vertically-integrated electricity business.  The State sought to maintain its business as a single entity, notwithstanding its agreement to structural reform in the Hilmer report and subsequent legislation.

Facing criticism from other jurisdictions as a result of its electricity business remaining integrated, the Government commissioned the Industry Commission (IC) to advise on the appropriate industry structure.  The IC's report ⁽⁵⁾ concluded that as well as repealing laws that prevent competition, the integration of generation, transmission, distribution and retailing should be replaced by a generation business and two to three retailer/distribution businesses.

The Government of South Australia rejected the split of the transmission and distribution from retailing.  Instead it created two separate businesses, ETSA Corporation and Optima Energy.

The Government also invited capital to build the Osborne co-generation facility owned by CUBE.  That plant's 180 MW capacity is fully contracted to ETSA, which is obliged to treat 130 MW as "must-run", with discretionary bidding for the remaining capacity.  Osborne is likely to provide 10% of the State's electricity.

The businesses are profiled below.

Table 2:  South Australian Electricity Businesses

	ETSA	Optima	Osborne	Other
Number of Customers (000s)	705
Total Sales (GWh)	9184
Lines in Service (km)	81531			n.a.
Generation (GWh)	291	6753	-	n.a.
Generation Capacity (MW)	84	2166	180	158
Sales Revenue ($M)	913	338
Profit before Tax and Interest ($M)	203	52
Total Assets ($M)	3176	457
Number of Employees	1663	881

Source:  ETSA Annual Report, ESAA and Office of Energy Policy.  Figures are for the year to June 1996.  The profit figures for Optima are extracted from the consolidated ETSA accounts.  Those same accounts indicate that $54 million out of the total $203 million earned by ETSA was earned by the transmission business.  Some employees and assets in ETSA also service Optima.

ETSA CORPORATION

ETSA Corporation has three subsidiaries.  ETSA Power is responsible for retailing and distribution;  ETSA Transmission for transmission and system control;  and ETSA Energy is responsible for gas trading.  ETSA Corporation owns virtually all of the State's assets in transmission and distribution.

As a retailer, ETSA has a larger home base than any of the Victorian businesses and ranks number two or three in the country in terms of customers and sales.  The size of ETSA in relation to other retailer/distributors is illustrated in Table 3. ⁽⁶⁾

Table 3:  The Size of Australian Retailers

Retail business	Number of customers (000s)	Sales (GWh)
Victoria
Powercor	537	7.3
Solaris	234	3.5
CitiPower	233	4.4
United Energy	527	6.4
Eastern Energy	470	5.1
New South Wales
Energy Australia	1306	20
Integral Energy	681	11.8
NorthPower	336	3.4
Advance Energy	113	1.77
Energy South	218	3.4
Australian Inland Energy	21	0.3
ETSA	700	9.2
Queensland
SEQUEB	874	11.7
Capricornia	87	1.4
Far North	92	0.7
Mackay	48	0.7
North Queensland	93	1
South West	91	0.5
Wide Bay	85	0.5
HEC	239	8

Source:  ESAA 1996

Comparative data on transmission are not readily available, partly because jurisdictions use different definitions of transmission.  In terms of the data available, ETSA is considerably smaller than the NSW, Victorian and Queensland grids.  From the data available it is difficult to determine whether or not it is a higher- or lower-cost system than those of Victoria and NSW.

Reflecting the nature of the system, equipment utilisation is relatively low, particularly in transmission.  Table 4 provides some comparisons with other State systems.

Table 4:  Comparisons Between Different State Transmission Systems

	Line length (over 66kV)	Losses (% of Energy Sent Out)	Labour Productivity	O&M Costs (exc. fixed costs) $/MWh	O&M Costs (inc. fixed costs) $/circ. km
ETSA	7,098	1.2	79.9	2.1	11,659
Transgrid	24,846	2.7	51	1.8	21,799
PowerNet	20,842	2.5	96	1.24	21,617
Powerlink	20,378	5.3	54.4	1.5	12,795
Western Power	6,624	3	64.6	2.4	15,870
HEC	3,491	4.9	57.8	1.12	8,838

Source:  ESAA

OPTIMA ENERGY

The generation assets, the Leigh Creek coal mine, the Northern Power Station, the Torrens Island Power Station and two gas turbine stations, constitute Optima Energy.

Optima Energy has a capacity of 2166 MW.  This is largely held in two major plants as indicated in Table 5.

Table 5:  Power Station Details

Power Station	Owner	Capacity (MW)	Units	Energy sent out 1996 (GWh)	Type	Location	Year of commissioning
Torrens Island	Optima Energy	800 480	200x4 120x4	3372	Steam/gas	16km north-west of Adelaide	1977 1967
Northern	Optima Energy	520	260x2	3372	Steam/coal	5km south of Port Augusta	1985
Thomas Playford `BÕ	Optima Energy	120	60x2	3	Steam/coal	5km south of Port Augusta	1960
Dry Creek	Optima Energy	156	52x3	4	Gas turbine/gas	9km north of Adelaide	1973
Mintaro	Optima Energy	90	90x1		Gas turbine/gas	110km north of Adelaide	1984
Snuggery	ETSA Corp	75	25x3	3	Gas turbine/gas	400km south-east of Adelaide	1978
Port Lincoln	ETSA Corp	9			Steam/diesel	Port Lincoln	1934

Source:  ESAA, ETSA Annual Report

In anticipation of shortages in the coming year, the Thomas Playford station has been overhauled and prepared for operation.

COMPETITIVE ARRANGEMENTS

South Australia is to be a participant in the national market from its commencement at the end March 1998.  Its progression to opening its markets to new competition is slower than that of the three eastern States as illustrated in the following table:

Table 6

Threshold	Type examples	NSW	Vic	Qld	SA
40 GWh	vast sites	1996	1994	1998	3/98 (20 GWh)
4 GWh	large office blocks	1997	1995	1999	7/98 (4 GWh)
750 MWh	supermarkets	1997	1996	2000	1/99
160 MWh	small office blocks	1998	1988	2000	1/2000
remainder		1999	2001	2001

South Australia, like the other jurisdictions, intends to phase in contestability of markets from the top down.  There is now considerable experience around Australia about the effects of these phase-ins and general satisfaction about their workability.  New Zealand, however, introduced contestability to all customers from the outset of its deregulation without adverse effects.  In South Australia, as in other jurisdictions, it is likely that the interpretation of load size for a customer seeking contestability will be liberal, as the Government would wish to avoid a firm taking action against it.  In this respect, Adelaide Brighton Cement, the State's largest gas consumer, has been free to seek electricity supplies from suppliers other than ETSA for two years.

While it is sometimes thought that a gradual phase-in offers incumbents opportunities to adjust to the new market situation, the corollary of this is that in shielding the incumbent supplier from competition the customers are paying more.

Except for some special areas, ⁽⁷⁾ ETSA currently holds the only retail, distribution and transmission licences.  There are no details about the licensing conditions for new retailers, a matter that lends concern to potential competitors to ETSA who are constrained from signing up customers in the State.  Queensland, unlike both NSW and Victoria, has adopted "mutual recognition" principles under which there is automatic acceptance of retailers who are licenced in another jurisdiction.  Such a measure offers cost savings both to governments and participants, while avoiding the appearance of creating barriers to new suppliers.

OPTIONS FOR AUGMENTING THE ELECTRICITY POWER SUPPLY

Current peak summer demand is 2300MW and although demand is only growing slowly, some new power reserves will be necessary.  As an interim step, one vintage station has been made ready;  and the cogeneration project at Osborne with a capacity of 180 MW is to come on line in July 1998.  Other supplies or supply options include:

• Augmenting the 500 MW interconnect with Victoria, possibly by 100 MW;
• Further cogeneration plants;
• A possible conversion of, and expansion to, the Torrens Island Power Station through combined-cycle gas investment;
• A possible new interconnect, "Riverlink", between SA and NSW of 250 MW.

Interconnects

Some 35% of South Australia's electricity is provided through the interconnect with Victoria.  For the most part, the increased supply from Victoria has displaced supplies from the gas powered Torrens Island plant -- gas usage was only two thirds of its 1987 level in 1996, whereas coal usage had increased somewhat.

The national market rules have provision for both entrepreneurial interlinks and those constructed at the behest of NEMMCO, the market manager.  Where non-entrepreneurial links are constructed there is no comparable market test to that present where businesses risk their own capital.  "Regulated" interconnects have a guaranteed return.

Moreover, the structure of the financing for transmission businesses places the overwhelming cost onto existing customers.  In terms of drivers for Riverlink, the cost would be incurred roughly 50/50 by ETSA Transmission and Transgrid of New South Wales.  These costs are passed on to consumers in the two jurisdictions.  Yet, Riverlink would mean an ability of New South Wales generators to seek higher priced markets in South Australia.  In supplying those markets, the price in New South Wales would be likely to rise.  Ironically, the consumers in Sydney would be paying for a facility that would also lead them to pay a higher price for their electricity.

Of course, there are other advantages to an increased number of links, including system security and greater competitive variety.  The increased supply availability brings much greater stability in prices, as is illustrated in the price trends in the Victorian, and to a lesser degree the NSW, market after the competitive interstate trading regime was introduced in May 1997.  The reduced price volatility is readily observed in the chart below.

Chart 1:  Pool Prices in NSW and Victoria January to August 1997

However, as the main benefit is obtained by New South Wales generators and South Australian consumers, the present payment arrangements offer perverse incentives.  Having half of the cost paid by NSW consumers may well result in a benefit for the South Australian consumer.  But a cynical view of the proposal is that it is a means by which the NSW Government subsidises power sales to South Australia to support the jobs of NSW power workers and coal miners.  Such subsidies are anti-competitive and lead to inefficiencies in the sourcing of production.

Doubtless, as in the case of the review by London Economics ⁽⁸⁾ of the Queensland/New South Wales interconnect, there could be studies undertaken to demonstrate an aggregate gain from the link.  But such studies will often find gains to consumers and producers from new ventures in excess of the price actually paid.  If such proposals go forward, they are likely to reduce the availability of investment funds for projects that do not rely upon annexing gains from other parties.  The real test is whether private operators would undertake the investment without having recourse to levying a regulated charge on third parties.

In this respect, a new interlink has similarities with a new generator.  It could be considered to be arbitraging the price between two markets -- buying in the market with the lower price and selling in the other market.  Some means of permitting this to occur needs to be devised if we are to avoid centrally-planned systems driven by non-commercial considerations.

6. POSSIBLE REFORM AGENDAS

FURTHER DISAGGREGATION OF OPTIMA

The minimum required by other jurisdictions if South Australia was to become part of the national market was to split ETSA into a retail/transmission/distribution business, which retained the name ETSA, and a generation business, Optima.  This leaves both components with considerable market power.

The interlink with Victoria provides the lowest cost power.  But once this is fully loaded, Optima's dominance offers it a strong incentive to ramp up the price.  Such "gaming" activity is not illegal under the Trade Practices Act.  Although impediments to "gaming" activity can be put in place by way of administrative oversight, the directors of corporatised businesses are required to seek to maximise their shareholder's wealth in any legal way.

In creating Optima, the Government was persuaded that there were advantages in having a portfolio generation business that could offer two availability types of electricity.  These claims have some merit and have formed the basis of incumbent managements' resistances to creating competitive units throughout Australia and other parts of the world.  It is unlikely, however, that the advantages of having a single portfolio outweigh the increased surveillance and loss of competitive pressure that dividing Optima into two entities would bring.

A viable market could operate with two separate Optima businesses bidding, a fully contracted Osborne generator, the Victorian interlink and a possible Riverlink combined with existing and possible future cogeneration plants.  This would reduce the risk of excessive prices resulting from the key position held by Optima and allow some greater flexibility by retailers to seek supply deals.

RETAIL, DISTRIBUTION AND TRANSMISSION

Although ETSA is ring-fenced into a transmission business and a retail/distribution business, further reform would appear to offer benefits.  The transmission business in other jurisdictions is split from distribution to prevent future enlargements favouring the sister business over others wishing to develop rival or by-pass distribution systems.  Such a split would not present serious difficulties, as transmission is relatively autonomous already and is a business with over $600 million of assets.

There are also calls to disaggregate the retail and distribution systems in electricity along lines being developed for gas in Victoria.  This entails the retail and distribution arms being structurally separated.  A full disaggregation would prevent retail arms of a distributor having a competitive advantage over rival firms through access to information.

These issues have been addressed in a previous paper, ⁽⁹⁾ which concluded that requiring a corporate split would offer few benefits.  The degree of customer churning without such a split testifies to the effectiveness of internal ring fencing.  Imposing a requirement on consumers to select an energy supplier in addition to a service supplier would inconvenience those who wish to avoid making such a choice.

As already discussed, ETSA as a retailer/distributor is quite large by Australian standards.  Previous papers ⁽¹⁰⁾ have reasoned that there is little to be gained by having very large units.  In Victoria one of the businesses, Solaris, is less than one-third the size of ETSA's retail/distribution arm and does not face an apparent lack of scale economies.

It is unlikely to be of major importance to have two South Australian domiciled retailer/distributors in the early rounds of contestability (though it is important to have the market opened up well in advance of the market opening if retailers are to be certain they may supply).  This is because those rounds are confined to making offers to well-informed major users.  For subsequent rounds, a second major State-based retailer would offer more choice to customers and the intra-State rivalry may lead to improved service and greater attention to costs.

For these reasons, it would be preferable to split ETSA into two roughly equal distributor/retailers.

PRIVATISATION

ETSA first began to reinvent itself as a business with the appointment of new management in 1988.  At that time there were over 6,000 employees.  Since then the workforce has been halved and corporatisation in 1994 stiffened the commercial approach.  The reductions in staffing have mirrored those of the two major States.  In terms of price, Figure 7 indicated how the premium South Australian customers faced compared to those in Victoria has reduced in recent years, especially for industrial users.

The logical step to consolidate and expand upon these gains is privatisation.

The Government made strong but not totally unambiguous pre-election statements that it would not privatise the businesses.  In this respect, the statements were stronger for ETSA than for Optima.  Both Labor and the Democrats are resolutely opposed to privatisation and control the Upper House.

While there is often a knee-jerk reaction against any privatisation (and nearly every candidate for privatisation is claimed to be especially sensitive), the outcome of privatisations in Australia and the rest of the world has been universally beneficial.  Politicians need to provide leadership, if necessary, like the NSW Treasurer, incurring some political risk, to press for reforms that take businesses out of public ownership and present the business risks to entrepreneurs and not taxpayers.  Businesses in government ownership will always be vulnerable to political patronage and arm-twisting to promote some short-term political advantage to the party in power.

The Victorian Government has demonstrated that its privatisations bring a stream of additional income to the State in the form of an annuity equivalent to over $500 million per year.  This will be increased as a result of the sale of PowerNet and the subsequent sales of the gas assets.  The Auditor-General estimated the savings at $622 million in 1997/98.

ASSET VALUATIONS OF THE ELECTRICITY BUSINESSES

A major revaluation took place in 1996, which raised the value of the assets by $1,248 million, placing the value of the equity at $2,581 million.  The revaluation shifted the relative value of ETSA's assets.  It led to the following changes:

Table 7

Asset	Previous Valuation	New Valuation
Power stations and Leigh Creek Coalfield	$1098 million	$387 million
Transmission system	$267 million	$628 million
Distribution system	$645 million	$2120 million

The revaluation has the effect of locking-in values at the new levels, a matter of some significance in view of the Commonwealth's recent stipulations on the asset valuations for government businesses that are to be privatised.  The Commonwealth, in an attempt to obtain for itself (at the expense of the State Governments) a greater share of the revenue from sale of assets, is to allow only the depreciation value specified at 30 June 1997 to be written-off for tax purposes.  The South Australian revaluations are likely to offset the effects of that action should the State wish to privatise its lines assets.  However, the power stations would appear to be capable of raising rather more than the $387 million book value if previous sales in Victoria are a guide.  Table 8 gives the value achieved for the Victorian generators.

Table 8:  Sale Proceeds and Earnings Multiples Achieved from the Sale of Power Stations ^(a)

	Loy Yang Power	Hazelwood and Energy Brix (b)	Yallourn Energy
Price:earnings multiples
1995-96	11.9	20.1	9.7
1996-97	13.1	24.1	9.3
Average 95/96-98/99	11.8	17.8	9
Sale proceeds ($m)	4594	2261	2146
Capacity (MW)	2000	1770	1450

^(a) The earnings multiples are based on projected earnings before depreciation, interest, tax and abnormal items (EBDIT), as per the Information Memorandum for each company (in nominal dollars).

^(b) The EBDIT for Energy Brix only represents 2 per cent of the total combined EBDIT for Hazelwood and Energy Brix for the period July 1995 to June 1999.

On the basis of Victorian sales and including the associated coal mine, the 520 MW Northern Power Station, which is the same vintage as Loy Yang, would be valued at between $900 million (based on the average receipts for the Victorian generators) and $1190 million (on Loy Yang multiples).  Even with a hefty discount for the higher costs, a valuation of $500 million seems possible.  The Torrens Island 1280 MW gas plant is between 20- and 30-years old and may have a low residual value in a nationally integrated market.

Transmission

The Victorian system PowerNet is the only example of privatisation of an Australian transmission system.  That business, which is a system more than twice the size of South Australia's, was sold for over $2.7 billion.

It is difficult to determine the value of other systems from this valuation, which exceeded expectations by a margin at least as high as previous electricity privatisations.  Some of the difficulties in determining a valuation include:

• the definition of transmission as opposed to distribution facilities;
• the age of the lines and their reliability;
• the South Australian system has a low level of transmission losses but experiences considerably more downtime and has a cost structure approximately double that of Victoria;
• the cost structures, where in O&M terms South Australia is twice that of Victoria;  and
• the charges allocated to the transmission business.

The written-down valuation of the transmission system was put at $628 million at June 1996, having been revalued from $267 million at June 1995.

Distribution and Retail

Distribution businesses provide a secure form of revenue.  In Victoria, they have sold on EBIT multiples of between 13 and 19 and between $3000 and $6000 per customer as illustrated in the following table:

Table 9:  Victorian Electricity Distribution Companies at Time of Sale, Financial Profile

Company	Owner	Sale price ($M) (excl. franchise fees)	Customers 1994/95	$/ Customer	Net Assets 1994/95 ($M)	Return on Assets %	EBIT ($M) 1994/95	EBIT Multiple 1994/95
United Energy	Utilicorp/AMP	1,550	520,000	2,980			120	12.92
Solaris Power	Energy Initiative/AGL	950	232,500	4,086	8.2	10.62	52	18.27
Eastern Energy	Texas Utilities	2,080	470,000	4,468	17.05	14.52	141	14.75
CitiPower	Entergy Corp	1,600	230,000	6,086	13.06	12.23	85	18.82
Powercor	Pacificorp	2,300	537,000	4,004	23.75	13.21	159	14.47
	Total/Average	1,696	1,989,500	4,325	15.515	12.645	111.4	15.85

Source:  Various

ETSA distribution and retail, on a sale price of $4000 per customer, would be worth $2.8 billion.

Overall Revenues from Privatisation

With generators raising some $600 million, the distribution system some $2.8 billion and the transmission business worth $700 million, a figure close to its book value, ETSA would return over $4 billion in a sale process.  This is equivalent to over half the State's net debt and invested at 6% would return $240 million per annum.

At the present time, the government earns a similar amount to this in tax and dividends from the ETSA businesses.  This income, however, is derived from firms operating as monopolies in a sheltered market.  Notwithstanding the advances ETSA has made in efficiency over recent years, there is certain to be some loss of market share and a marked reduction in prices and revenues as the market is opened to competition.  While this intensified competition will be of great benefit to the people and economy of South Australia, it will reduce the stream of funds to the Treasury.

These considerations suggest that early action by the State to divest its electricity assets would be to its advantage.

An Interim Approach

For the present, the South Australian Government has some options to implement a limited privatisation programme involving Optima.  Optima has two main generators, Torrens Island (gas) and Northern (using Leigh Creek coal).  Northern is cheaper and used for base power and Torrens has greater flexibility and is brought on-line when the lower cost supplies from the interlink and Northern need to be augmented or are unavailable.

The cheapest power is that supplied from Victoria which meets some 35% of the market.  A further 10% (fully contracted to ETSA) will be provided by the Osborne facility to come on stream in July 1998.  Other similar co-generation facilities are under consideration.  There is also the proposal for a link with NSW which will provide up to an additional 15% of the market.

One means to privatisation could be arranged through the Torrens Island plant.  This gas facility could profitably be re-powered by gas turbines at a cost of $150-200 million.  A feasibility study regarding this is presently nearing completion.  The re-powering could be undertaken by private ownership up to 49.9% without this requiring legislation.  Such a move, unlike any concerning the coal mine supplying the Northern power station, would not require legislation.  This changed ownership mix would also give the opportunity to introduce a new player into competition.

Gas Structural Reform

The deregulation timetable for the gas industry opens up to competition the 100 TJ customers (about 40 in the State) in April 1998.  A further 110 customers (those over 10 TJ per annum) will become contestable in July 1999.  The remaining business customers (about 8,000) will become contestable in July 2000 and present plans are to release households from their captive customer status in July 2001.

The key impediment to competitive provision in South Australia, as in the eastern States is the monopoly supply.  The Industry Commission ⁽¹¹⁾ noted that competition requires either basin-on-basin rivalry or rival producers within the same basin and noted that such competition did not then exist in South Australia and Victoria.  The link between NSW and Victoria will be completed in 1998 allowing sales that are in effect basin on basin competition in both States and into South Australia.

Within the Cooper Basin, the Santos led consortium is obliged to surrender certain prospective leases in 1999 (PEL 5 and 6).  However, the consortium has recently been successful in taking control of a further highly prospective area, the Nappameri Trough.

The ability of third parties and for the incumbent suppliers, Optima and Boral to compete is limited by the capacity of the transmission pipeline.  At present this is fully booked as far as the 95 Petajoules of firm capacity is concerned.  Moreover, if either Boral or Optima were to win a customer from its rival, they would need to obtain the rival's permission for release of capacity.  Some of the monopoly may be broken by the allocation of 15 Petajoules to ETSA Gas Trading from July 1998.  Some 11 Petajoules is required by the Osborne facility leaving 4 Petajoules available to contest other customers.

To facilitate competition, the Government could consider having the capacity of the transmission pipeline allocated by customer rather than by retailer.

---

ENDNOTES

1.  Linn, R., "ETSA", ETSA Corporation 1996

2.  Technical regulation in energy is an area where there is arguably less regulation in South Australia than in other States.  The State's Office of Energy Policy takes pride in having between a third and one-seventh of the regulatory staff per customer compared with the other States.  See Office of Energy Policy, Annual Report 1996/97, p. 33.

3.  The Electricity Industry of South Australia, Industry Commission, 15 March 1996.

4.  In this respect, even in Victoria, nuclear power generation is illegal.

5.  The Electricity Industry of South Australia, Industry Commission, 15 March 1996.

6.  Data availability has made it difficult to determine the relative efficiency of distribution systems in Australia.  Since corporatisation, the ESAA cost estimates indicate a near doubling of Victorian businesses O&M costs, both including and excluding fixed costs.  This outcome doubtless reflects the different accountancy conventions used by the corporatised and privatised businesses, and may partly reflect redundancy packages which have been a major feature in the increased efficiency brought about in Victoria.

7.  These cover traditional supply of remote areas and the BHP and Western Mining supplies to their own facilities at Roxby Downs and Whyalla.

8.  Independent review of the economic costs and benefits of interconnections of the Queensland and New South Wales electricity grids, London Economics, August 1997.

9.  Wood, R.J., "Separation of Retail and Distribution in Electricity Supply", Energy Forum Paper No. 2, February 1997.

10.  For example, Wood, R.J., "Retail Competition in the NSW Electricity Market", Energy Forum Issues Paper No. 1, October 1996.

11.  Australian Gas Industry and Markets Study, Industry Commission, 1995.

ACCC zeal is distorting market-place

The ACCC is interfering with the competitive process to try to promote competition, complains Richard Wood.

Under Professor Fels, the Australian Competition and Consumer Commission is sacrificing the shareholders of Australis to promote the viability of Optus.

The blocking of the Australis-Foxtel proposals on the grounds that it will create excessive market power is one of a number of examples where the ACCC has sought to transform markets to accord with its views of the best competitive outcome.

In approving the recent merger between Wespac and the Bank of Melbourne, the ACCC insisted that Westpac maintain Saturday trading, not increase fees for particular current account holders and open up its ATMs to a wide range of financial institutions operating in Victoria.

In the laudable name of increasing competition and favouring consumers, the ACCC used its regulatory powers to require a bank to proffer the business services it thought should be provided.

In its inquiry into petroleum products, the ACCC extracted undertakings from Ampol and Caltex on oil storage terminals as a condition of the merger and claims to have been a catalyst for greater imports.  It is also pressuring the oil companies to provide new capacity in terminals, specifically in Darwin.

This sits uneasily with the Competition Policy Reform Act which stipulates that "the Commission must not make a determination that would require the provider to bear some or all of the costs of extending the facility or maintaining extensions of the facility".

Requiring the incumbents to undertake investments that are not in their corporate interests is inconsistent with prevailing notions of light handed regulation that pervade the present approach to competition in Australia.

These petroleum interventions cover an industry engaged in cut-throat competition.  With four major oil businesses having independent storage facilities, with non-affiliated facilities available at 17 locations around Australia and new facilities that can be constructed at modern cost, the industry is one of the least likely candidates for regulatory control.  The vulnerable nature of the majors to challenge is further demonstrated by the rapid development of competition from supermarkets.

The rival players in the pay TV market are incurring losses of $900 million a year.  This cannot persist and to prevent the financially strapped Australis from salvaging its position amounts to expropriating its shareholders.

Moreover, ongoing advances in technology have brought a fluidity in the pay-TV and the telephony market that will confound any attempts to establish a structural design.  What is required is a market that is free of government intervention not one that is plagued by regulators imposing their ideal model.

In its interventionist approach, the ACCC is departing from its sister bodies:  the National Competition Council (NCC) and the Industry Commission.  The NCC has curbed its power base to avoid intrusion into business affairs.

For example, the NCC has drawn the line at extending its powers over "essential facilities" into areas of manufacturing, even where these can be bottlenecks.  Thus, the NCC specifically excludes gas processing plant from within the territory it controls on the basis that this is a manufacturing facility which can be readily duplicated.

By contrast, in the context of water, Professor Fels speculates on filtration plants and associated equipment falling within the ambit of the Competition Reform Act.

It may seem that the consumer will benefit from having a watchdog to require providers of goods and services to offer greater convenience or lower prices.  However, unless there is monopoly, the outcome of such interference in the competitive process usually backfires against the consumers.

Where competition is evident, commercial rivalry will dictate the service and price conditions.  For a government agency to do so distorts this process and engenders additional costs.  It undermines property rights, the key component of the competitive processes.

ADVERTISEMENT

What's in a Name? The Vexed Question of Employment

Backgrounders

SUMMARY

Deregulation of the labour market in Australia has been slow and politically difficult, and the immediate prospects for further reform are not encouraging.

One of the difficulties of reform is that it assumes that the traditional master-servant relationship will continue to be central to the idea of employment.

In this Backgrounder, we show that, even under our relatively restrictive legal regime, there are other, non-traditional forms of working relationships available and in use.  These concepts have the potential in the long run to revolutionise our notion of employment.

Such arrangements, with their emphasis on removal of "control", on freedom of contract and on equality of relationships, should appeal to liberals.

Further, by bringing the internal operations of business closer to market conditions, they should yield better results for productivity and profits than the traditional, non-market, command-and-control notion of employment.

INTRODUCTION

Economists consider that the word "employment" refers to income-producing work by a person.  The ILO definition of those who are employed is "persons who performed some work for pay or profit during a specified brief period, either one week or one day". ⁽¹⁾

This commonly-understood ILO definition is quite different from how the law defines employment.  The law relies on delineating power relationships between people.  In considering employment, the law looks to see if an "employer" has "the right to control" an "employee" in a modified mediaeval master-and-servant style relationship.  According to Revenue Canada, for instance, "An employer-employee relationship exists if you are in a position to control and direct the person or people who perform the services". ⁽²⁾

Legally-defined employment implies the idea that an employee is a physical and psychological appendage of the employer -- unable, unwilling or not allowed to act in an independent manner.

This master-servant "control" legality underpins the regulatory industrial relations system of Australia and other English-based, legal employment regimes.  It dominates management and worker behaviour in the workplace, and is a serious constraint on the wealth of individuals, firms and nations.

THE MODERN STATE OF EMPLOYMENT LAW

Citizens regularly enter and exit employment relationships without the status of that relationship ever being explained to them.  Most of the time, indeed, neither the employer nor the employee knows or understands the legal status.  They usually think they are engaging in a simple work-for-pay relationship.  The work-for-pay relationship, however, is not necessarily considered by the law to be an "employment" relationship.

When a problem in a work relationship results in court action, the courts establish that legal employment exists before they consider the specifics of a case.  They do this by applying common-law "employment" tests.

In the first instance, the courts investigate if the user of labour has the "right to control" the worker.  They will look at the work relationship for indicators of control.  Among the questions they can ask are:

• What is the intention of the two parties?
• Do they wish to be in an employment, "control" relationship?
• Is there an expectation that the worker will attend each day?
• To what degree does the employer dictate what the worker does?
• Can the worker reject work?
• When are holidays taken and are they required to be taken?
• What do written documents say?
• What type of tax is being paid?
• Who is paying superannuation, workers' compensation and other statutory obligations?
• Are there allowances for holiday pay, sick pay, termination pay and other allowances?
• Is the worker compelled to work overtime?
• Who provides work clothing and tools for work?
• Is there stability and continuity in the work?
• Is the work on an hourly rate or job rate?
• Who pays expenses and who retains profit?

This list is not complete, however, and many of these questions may not even be investigated. ⁽³⁾

In investigating the legal relationship, the courts are looking to define whether one of two types of labour contracts exists:  either a "contract of service" or a "contract for service".  A "contract of service" is taken to denote employment.  A "contract for service" does not involve employment.

If the "control test" is not conclusive, which may frequently be the case, the courts may resort to what they call the "integration test".  This seeks to test if the worker is "part and parcel" of the business organisation, and also involves study of each and every specific situation.  The list of questions to be applied can be as extensive as that applied to the "control" test.

In taking all or some of these indicators into account, court rulings are not consistent or predictable.  The courts may look at some or all of the tests, interpret them in different ways in different circumstances and allocate different weightings of importance to different indicators in different circumstances.  The differences between judges, their case knowledge of this particular area of the law, the jurisdiction in which they operate, the evidence brought before them and the specific nature of each case before them all combine to make for an inconsistency of result.

In a most recent high-profile Australian case, the Crisis Couriers (Vabu) Case, ⁽⁴⁾ a single judge ruled that due to the nature of the control operating between the workers and the company, employment existed.  On appeal to the Full Bench, the employment declaration was overturned on the reasoning that the remuneration system indicated that the workers were independent contractors and not employees.

If an employment relationship is found to exist -- that is, that the employer has "the right to control" the employee -- the regulations imposed on the work environment through industrial relations legislation apply.  If no employment exists, then industrial relations legislation, courts and systems, do not have jurisdiction.

It is significant to note that the recent industrial relations reform debates in Australasia have never extended to questioning the appropriateness of maintaining the master-servant "control" situation.  Both the New Zealand Employment Contracts Act and the Australian Workplace Relations Act seek to regulate the "right-to-control" employment relationship.  The "reform" procedures have been limited to resetting the regulations and the legal balance between the employer master and the employee servant.

EMPLOYMENT LAW AND GOVERNMENT AUTHORITIES

Many government bodies legally depend for their authority and revenue-collecting powers on the finding of legal employment.  If there is no legally-defined employment, the government body cannot collect its impost or administer its responsibilities.  Of concern to government bodies is the leakage of both revenue and authority occurring because of the rapid change in workforce engagement arrangements happening in developed economies.  The changes amount to large-scale desertion from legal employment relationships and replacement with contractor or independent contractor systems.

The changes in work engagement are affecting the authorities responsible for collecting payroll tax, workers' compensation, PAYE tax and superannuation, to name the main Australian areas.  The situation is similar in North America and Great Britain.

In the United States, the federal tax base is under stress because of workforce engagement changes.  One US commentator states that "... the IRS decided several years ago that too many businesses are using the independent contractor designation as a tax dodge", and that "according to IRS estimates (1990), $1.56 billion in revenue is lost to the federal government each year because of such abuse". ⁽⁵⁾

In Australia, the trend away from legal employment arrangements concerns the Australian Taxation Office.  In early 1996, the then Federal Treasurer, Ralph Willis, said that the trend "threatened the integrity of the personal tax system". ⁽⁶⁾

Payroll tax and workers' compensation authorities in Australia find themselves fighting to protect their universal coverage capacities:  the Queensland payroll tax authority was recently forced to amend its Act to close a "contractor" loophole, ⁽⁷⁾ after a technical "contractor system" had been created by some individuals which avoided the provisions of the Act.

Payroll tax and workers' compensation bodies, Australia-wide, are currently involved in negotiations aimed at finding resolution on the issue of worker coverage.  High on the agenda is the issue of employment versus contracting and the desired and appropriate scope of their jurisdiction and authority.

Because of the employment definition problems and the changing nature of workforce engagement, government bodies go to great lengths to ensure that some form of legal "employment" can be found to exist.  Having often lost in the courts on common law "control" assessments of employment -- as occurred with the Australian Taxation Office in the Crisis Couriers case -- government authorities resort to writing legislation which redefines employment for the purposes of their particular revenue-collecting powers.  They call this "deeming".

"Deeming" literally means that if legislators wants to call a duck a chicken for the purposes of their legislation, they can do so regardless of the reality that a duck is still a duck.  If the courts determine that there is no "right of control" and so "employment" does not exist, the government body will argue that regardless of the courts' common-law "control" finding, then "employment" will exist "for the purposes of their legislation", enabling the government body to collect the revenue or exercise its authority. ⁽⁸⁾

COMMERCIAL CONFUSION AND RISK

We have, as a consequence, employment defined for common-law purposes which can be inconsistent with and different from definitions for payroll tax purposes, which can be different from workers' compensation definitions, which can be different for income tax revenue collecting purposes -- and so on.

The result is commercial confusion.  Businesses do not know where they stand.

Solicitors, accountants and business bodies, in advising their commercial clients on the application or existence of a legal employment relationship, can never be totally sure of the accuracy of their advice or whether their advice will be confirmed by the courts.  Such legal insecurity compounds the problems which businesses have in attempting to achieve best practice in their operations.

EMPLOYMENT LAW, THE FIRM AND MANAGEMENT

Employment law universally and intimately affects the operations of firms.  The behaviour and performance of workers, managers and firms are influenced by the legal relationships operating within firms;  and the management theories underpinning firms' operations are a product of the details of the internal legal relationships, as are the operational structures chosen by firms.

At the core of the practices, structures and theories is the issue of control.  Traditional pyramid-style organisations, which have so dominated post-industrial-revolution, democratic, capitalist economies, have at their centre classic command-and-control structures, dependent upon the "right-to-control" master-and-servant relationship.  Firms are collectives run by a master.

This was most clearly described by the Nobel Prize-winning economist R.H. Coase, in his seminal 1937 work, The Nature of the Firm.

Coase proposed that a firm's existence and success are dependent upon the ability of an entrepreneur to control the workers inside a firm.  Coase explained why firms exist.  He said that

... the operation of a market costs something, and ... by forming an organisation and allowing some authority (an entrepreneur) to direct resources, certain marketing costs (transactions costs) are saved. ⁽⁹⁾

and further,

We can best approach the question of what constitutes a firm in practice ... by considering the legal relationship normally called that of master and servant or employer and employee. ... The master must have the right to control the servant's work.  We can thus see that it is the fact of direction which is the essence of the legal concept of employer and employee just as it was in the economic concept [of the firm] which was developed above. ⁽¹⁰⁾

Coase reasoned that the "control" inherent in the legal employment relationship is prime to the authority of the entrepreneur and to the existence of the firm.  Given this thinking, if we remove the master-servant employment relationship, then the conceptual understanding of what a firm is and how it operates would presumably collapse.

Whether implicitly or explicitly understood, the link between master-servant control and the existence and operations of firms has underpinned management theory, thinking and practice in post-industrial-revolution economies.  It is, however, under direct challenge in developed societies, where firms are having to find better ways of performing in increasingly competitive and unprotected global economic environments.

In many respects, it is beginning to appear that legal "control" employment has been capable of taking economic development to a certain point, but that beyond that point, the master-servant relationship inhibits further development.

NON-EMPLOYMENT AND THE WAY FIRMS ARE CHANGING

The move away from traditional workforce engagement is readily observed in Western societies, and is perhaps one of the most significant social trends of the end of the twentieth century.

In North America some analysts are predicting that "... by the year 2000, 50 per cent of all Americans will be contract workers". ⁽¹¹⁾  One firm in the US reconsidered who were its key "employees", and concluded that only the Chief Executive Officer should be classified thus.  Its 500-strong workforce are engaged through personnel agencies.  The largest organisation in the United States is the personnel agency Manpower, with 560,000 people in the field.  (This compares with General Motors with 365,000 and IBM with 330,000.) ⁽¹²⁾

In Australia, statistics from the National Institute of Labour Studies indicate a sharp upward trend in the penetration of non-employment arrangements in the workforce.  In 1989, 3.3 per cent of the non-farm workforce were listed as self-employed contractors.  This had risen to 7.5 per cent by 1994, representing 553,900 people working outside legally-defined employment relationships. ⁽¹³⁾

The trend away from traditional workforce engagement to non-employment arrangements is characterised by

• the removal of belief in job permanency and security;
• a sharper focus on performance on a daily basis;
• a shift to remuneration on a results or performance-expectations basis and away from time-based remuneration;  and
• a reassessment of the significance of loyalty between the firm and the worker.

In an address to the US Senate Budget Committee earlier this year, the head of the US Federal Reserve, Dr Alan Greenspan, mused on the reasons as to why the tightening in the US labour market was not resulting in wage-induced inflationary pressures.  He saw this as an important departure from past patterns, one which held prospects for sustained, low-inflationary growth.  "As I see it, heightened job insecurity explains a significant part of the restraint on compensation and the consequent muted price inflation". ⁽¹⁴⁾

In legal employment, the trade-off for "control" has been permanency, security, employer responsibilities and bonding through loyalty.

The question deserving of consideration is, does a shift away from the traditional master-servant relationship, and the death of security, hold promise for future economic growth and prosperity?

Certainly, legal employment has always operated as a key mechanism for the suppression of market forces (labour) within the firm, a factor which was thought to be central to the containment of transaction costs within firms.  Legal employment has operated to isolate the operation of the market to transactions between firms and to prevent the market operating inside the firm.  Legal employment has operated as a protective umbrella similar to tariffs, the beneficiaries largely being management.

This is highlighted in a new publication from the London-based Institute of Economic Affairs, titled Markets in the Firm. ⁽¹⁵⁾  This study provides an excellent explanation of the international trend away from command-and-control employment regimes, and describes the management dynamics operating in firms which have welcomed marketplace principles to their internal operations.

As legal employment breaks down, the market enters the internal workings of the firm.  This trend unsettles entrepreneurs used to thinking in terms of traditional arrangements, who simply fear an escalation in labour costs.  But if the parallel to tariffs and the comments of Dr Greenspan are valid, perhaps the result of the diminution of legal employment will be to force up the productive behaviours of the elements within the firm, including that of the entrepreneurs or managers.

NON-EMPLOYMENT MODELS

The types of arrangements being used to break away from employment are varied.  They may often be legally suspect, subject to testing and, when tested in the courts, will be declared to be master-servant "control" employment.  Some systems are legally secure, representing developments on the path to non-employment.

INSECURE NON-EMPLOYMENT

The legally-suspect non-employment arrangements involve engagement between firms and individuals, or individuals and individuals.  Even though they are legally insecure, they survive because the statutory authorities, unions or opposition firms do not have the resources or motivation to find, investigate and move against all the firms and all the systems.  Possession usually takes place of the law when both the worker and the labour-user find commercial common ground.

The less suspect systems are those where work is arranged between structured companies.

The existence of the companies usually denotes a commercial contract for services.  But when one of the companies is, in reality, a single person, the engagement risks being declared legal employment.

The common feature of legally-insecure arrangements is that the participants take the indicators of employment (discussed earlier) and attempt to structure matters so that the indicators cannot be said to apply to their arrangements.

This approach involves high-level commercial risk if the system developed has not been through prior judicial testing.  Getting the system right is such a delicate task that some observers claim it cannot be achieved with certainty.

According to one US commentator, "... there is no action which I can recommend which will establish an independent contractor relationship, and according to one (extreme) Los Angeles attorney, there is no such thing as an independent contractor". ⁽¹⁶⁾

LEGALLY-SECURE FRANCHISING

Franchising has been one of the great growth industries since its invention by the founder of the McDonald's chain in the early 1950s.  Franchising enables a large organisation to exist, with tight control mechanisms which are not dependent on the master-servant relationship.

In a franchise, the head franchiser controls the operation through commercial contracts with the smaller franchisees who are independent businesses.  The franchisees enter the commercial relationship on an offer-and-acceptance-of-contract basis.  None of the legal elements of master-servant control exist between the franchisee and franchiser.

Legal employment, however, will normally continue to exist between the individual workers and each franchisee.

LEGALLY-SECURE "CONTRACTING-OUT"

Contracting-out is used extensively in the building, construction and mining industries in Australia and more recently is being adopted by government sectors.  For example, it is common for companies who own a mine not to conduct the excavation of the mine.  A contracted company will do the mining.  In public hospitals, it is increasingly normal for private, independent businesses to manage wards, operating theatres and other key facilities within the hospital.

Like franchising, the contractual relationship is between structured companies with no employment arrangement between them.  An employment relationship continues to exist, however, between the workers and the contracted company.

A key element of contracting-out is that the head company is removed from direct managerial control of workers on site, with the contracted company exercising the management employment control.

"EMPLOYMENT" AGENCIES

This is one of the big growth areas of workforce engagement, which should not be confused with legally-secure non-employment.

"Employment" agencies supply workers to a user business in one of two ways.  In the first, the agency is the legal employer but exercises limited, if any, control of the workplace.  If the agency did exercise management control, it would be engaging in contracting-out.  In the second, the agency supplies the worker and the worker becomes an employee of the user business.

Employment agencies most often supply casual workforces, but an emerging trend is for them to supply all ongoing workers to user businesses.  Legal employment continues to exist but the exercise of control can become "fudged".

If an "employment" agency claims to be supplying "contractors", it is making claims which cannot be substantiated unless tested in the courts.  If tested, the workers will usually be found to be employees of someone.

SECURE "ODCO" ARRANGEMENTS

An Australian High Court development in 1991 -- in the case of Odco Pty Ltd vs BWIU -- saw the creation of perhaps the purest form of legal non-employment arrangements yet witnessed, the "Odco arrangements".  The initial trial judge referred to Odco arrangements as "sui generis", something unique and different to any prior known legal work arrangements. ⁽¹⁷⁾

The Odco High Court judgments declared that an individual person can work for a business through a properly constructed contract administrator and be at law an independent contractor.  Under Odco work arrangements, the master-servant, employer-employee relationship does not exist.  The "right to control" workers is eliminated but the user business can "direct" the work.  Work is organised under the principles of "offer and acceptance of contract" with workers having freedom of choice.

Contracts may not be exploitative.  The work need can be of a continuous nature, which is facilitated by new contracts being offered each day.  Contracts exist between the Odco contractor and the administrator, and the user business and the administrator.  Significantly, no contract exists between the user business and the Odco contractor.

The Odco system does not come under the jurisdiction of either State or Federal legislation pertaining to unions or awards.  Odco arrangements are starkly different from "employment agencies" because with Odco, "employment" does not exist.

The significance of Odco is that it is a secure, non-employment system which is portable across all business and industry sectors where there is a need to break free from the constraints of employment.  Odco is unique to Australia and observations to date have not found any similar legal breakthroughs in North America or Great Britain.

There has been significant and growing application of Odco arrangements in the Australian scene in the last two years.

EMPLOYMENT, UNIONS AND FIRMS:  AN INTERDEPENDENCY

It is perhaps no coincidence that the rapid decline in union membership in recent decades has coincided with a shift away from legal, master-servant employment relationships.  Union membership remains strongest in firms and industries where master-servant legalities and master-servant management mentalities prevail.  The reason for the link is the mutual benefit unions and some firms obtain by maintaining master-servant control relationships.

Unions exist because of the master-servant relationship.  The union role has been to act as a countervailing force against the dominant legal position of the employer as the master.  When the employment "control" relationship is removed, the worker exists in a business relationship with the user of labour, with the achievement of commercial common self-interest driving the relationship.  In this business relationship, the workers' need for collectivist action by unions is diminished -- some may say neutralised.

Legal employment and unions have acted to assist firms to gain and maintain monopoly market positions.  Employment regulation has been important to the suppression of market (labour) forces within and between firms, so assisting the minimisation of competition to existing market-dominant firms from new or growing firms.

When non-employment relationships are utilised, unions' reasons for existence are threatened, as is the market position of established firms.

THE FUTURE IS THE PRESENT

The shift away from the legal "right to control" master-servant employment relationships represents one of the great movements of social history.  Yet, like any evolutionary change, the participants rarely realise the full significance or nature of the change occurring to and around them.

To gaze into the crystal ball and declare that "control" employment will be dead in the future, would be simplistic.  The patterns of the future are, however, observable in the present.

The trend away from legally-defined employment is substantial and growing.  Where non-employment is used, the systems which are utilised and the legal security which applies will vary from case to case.  Legal employment will most likely continue to have a solid although diminishing position in economies.

In the immediate future, interest will be on observing how "employment" corporations compete against rising "non-employment" organisations.  Also of interest will be how government bodies, eager to protect both their revenue and regulatory powers, grapple with the growing non-employment trend.

Civilised societies have long recognised that truly creative artistic talent finds its peak when artists are free to explore and develop their creative self.  The same applies to all individuals in a society.  In the work environment, individuals will not release their full potential when they are "controlled".  The error of "wage slavery" is the suppression of individual productive potential.  The promise and hope of legal non-employment systems is the release of creative but latent economic potential, with resulting increases in the wealth of all nations.

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ENDNOTES

1.  Statistics of Labour Force, Employment, Unemployment and Underemployment.  International Labour Organisation, Thirteenth International Conference for Labour Statisticians, Geneva 1982, page 10 6)1) (a).

2.  Employers' Guide to Payroll Deductions 1995-1996.  Revenue Canada Page 1-1.

3.  No one court case provides a definitive picture.  Sources for this list of questions can be found in two ground-breaking Australian judgments:  the Odco judgments of 1991 (which involved six judicial considerations, two being at the High Court);  and the Vabu (Crisis Couriers) Case (involving three judicial considerations, one involving the High Court).

The main Odco judgments are:

the published judgments of the trial judge, Woodward J., in the action Odco vs BWIU & Ors, no. VG 151 of 1988, in the Federal Court of Australia (unreported), 24 August 1989;

the appeal judgment in BWIU & Ors vs Odco Pty Ltd, no. VG 322 of 1989, in the Federal Court of Australia, reported at (1991) 29 FCR 104;

the High Court judgment in Accident Compensation Commission vs Odco Pty Ltd, FC 90/040 of 22 October 1990.

The Vabu case is Vabu Pty Ltd vs Commissioner of Taxation, no. CA 40206/95, 6 September 1996, in the Supreme Court of New South Wales.

4.  Vabu case, op. cit.

5.  Miles Miller, "The IRS finds invisible employees", ACC Communications Inc. USA, October 1991.

6.  "The trend that worries the Tax Office", Australian Financial Review, 8 January 1996.

7.  Office of State Revenue Queensland, "The Pay-Roll Tax Liability of Employment Agents", Circular, December 1996.

8.  For an example of employment "deeming", see Ss. 8 and 9 of the Victorian Accident Compensation Act.

9.  R.H. Coase, The Firm, the Market and the Law, Chicago:  University Press, 1988, page 40.

10.  Ibid., page 53 (parenthesis added).

11.  Fortune, January 1994.

12.  William Bridges, Jobshift:  How to Prosper in a Workplace without Jobs, Sydney, Allen & Unwin, 1995.

13.  M. Wooden and A. VandenHeuvel, "The Use of Contractors in the Australian Workplace;  Evidence from a Survey of Employers", National Institute of Labour Studies, Flinders University, Monograph Series No. 3, 1996;  M. Wooden and A. VandenHeuvel, "Self-employed Contractors in Australia:  What are the facts?", National Institute of Labour Studies, Flinders University, Working Paper Series No. 136, February 1995.

14.  Dr Alan Greenspan, testimony to the US Senate Budget Committee, as reported in the Australian Financial Review, 23 January 1997.

15.  T. Cowen and D. Parker, Markets in the Firm.  A Market-Process Approach to Management, Institute of Economic Affairs, London, July 1997.

16.  Ethan A. Winning, "Pitfalls in Independent Contractor Relationships", from Labour Pains:  Employer and Employee Rights and Obligations, TFM Publications, USA 1995.

17.  Cf. note 3.