Productive Reform in a Federal System

Address to the Productivity Commission Roundtable on Federal Reform
at Old Parliament House, Canberra on 28 October, 2005

The past two days have provided an excellent opportunity to consider the strengths of Australia's federal system, and how that system can continue to provide a framework for further economic and public policy reform.  In this context my remarks will come under three headings:

• the nature of federalism;
• the nature of the issues confronting Australia;  and
• the impact of globalisation and its relationship to federalism.

THE NATURE OF FEDERALISM

A comment that has been made about the discussion on school funding in Australia could also be applied to the topic of our current considerations -- debate on federal-state relations is like a Russian novel "... long, tedious, and everybody dies at the end".

The statement was made earlier at this roundtable that anyone involved in public policy in Australia will undoubtedly need to consider the issue of federalism.  Nothing could be more true.  That is a little like saying that anyone wishing to play cricket will sooner or later come up against the need to have a bat and a ball.

The point about federalism in Australia is that it is believed in theory but ignored in practice.  The arguments for federalism are well-known and I do not propose to list them.  However, sometimes familiarity with the propositions can breed contempt.  We cannot consider federalism in the abstract -- in 2005 we need to ask the question, what do we want federalism to do?

This question must be considered within a broader framework of what should be our policy objectives:  "equity", "economic development", "sustainability"?  All these objectives are laudable but they are in conflict and they involve making policy choices.  Politicians and the public do not usually like to admit that there must be tradeoffs.  Australia could have an even lower unemployment rate than it has now if we were willing to reduce real wages, but to many the equity consequences of this would be an unacceptable trade-off.

FEDERALISM AND EQUALITY

For much of the last century policy pressures actually mitigated against federalism.  Certainly the States had more financial and policy autonomy than they do now, but overwhelmingly the desire was to equalise economic and material conditions across the nation.  "Equality" was relatively easily measured, and we had a tendency not to be much interested in the cost.

There is still the legacy of such attitudes in the debate about telecommunications for example.  Those who live in remote areas expect the same level of telephone service as those living in inner-city Sydney.  Usually policy-makers have acceded to such demands.  The transfer of wealth to non-urban areas from urban areas, and to small States from large States has long been, broadly, accepted.  Ideas of "federalism" have not had much to do with this process.  To a large extent the national government has operated as the mechanism for initiating the transfer of wealth.

Occasionally national governments have acted in the name of "national interests" as, for example, when it promoted population and land settlement policies for defence purposes, but often they have operated on the assumption that circumstances across the country should be "equal".  The notion of federalism, as a system in which levels of government operated in different spheres of policy, was compromised in this country from the very start.

Instead of calls for "equality" we have now in the twenty-first century demands for "efficiency" and "national markets".  Critics of a federal system cite the need for "efficiency" and "national markets" as one of the reasons why the overlap and duplication of state jurisdictions should be abolished, and why regulation should be centralised.  While it is true that further economic reform does require some degree of administrative clarity, such administrative clarity only needs to exist in the markets for products that are traded on a global basis.

Reform to the regulation of such products is only one-half of the reform challenge confronting Australia.  There is a significant reform challenge in many areas of government activity for which no market exists, such as in areas of social policy, and in such realms it is not necessary or desirable to streamline every aspect of regulation, if such a process results in a reduction of diversity in the way services are offered to the community.

In the debate about efficiency of regulation the states are automatically taken to be the "bad guys", holding out against reform in the name of petty-minded parochialism, while the national government are the "good guys" fearlessly pursuing reform against the entrenched self-interest of rent-seekers.  Such a picture probably has more to do with the superior media management techniques of Australian Government press secretaries than with reality.

Federal Governments are no less effective at pandering to self-interest than are State Governments.  Recent decisions on the regulation of pharmacies, the electronic media, and international air transport are examples of this.  And this is not to mention the matter of tariff protection.  The policies of protection pursued by Federal Governments (of both political persuasions) have had a far more deleterious effect on the economic welfare of the nation than any economic policy ever pursued by a State Government.

There is one respect in which Federal Governments are better placed than State Governments to pursue reform.  The political pressure points of Federal Governments are different from those at the State level, and reform which impacts on, for example, public sector employment can be more easily pursued by a government in Canberra, than by one in a State capital.  There is a sense in which the political (and geographical) isolation of Federal Governments is an advantage.

FEDERALISM AND SIMPLICITY

The desire to "reform" and make regulation "simple" is perfectly understandable.  And sometimes the solution to a problem is simple -- but often it is not.  The claim that providing the Australian Government with regulatory powers over areas which were previously the province of the States is sometimes made.

However, as has been discussed at this roundtable, the track record of the Australian Government in relation to "simplicity" is mixed -- income tax, industrial relations, the regulation of financial services and superannuation are all the responsibility of the Australian Government, and the laws governing these areas are not particularly simple.

WASTEFUL COMPETITION

In the course of the roundtable a number of remarks have been uttered about federalism resulting in "wasteful competition".

My view is that competition is seldom "wasteful" -- and anyway we have to define what we mean by "wasteful".  Certainly in one sense it is "wasteful" that we have more than one television channel -- but the existence of "waste" must be matched against the benefits of choice and diversity.

Competition, by its very nature, involves "waste".  As an argument against federalism, "waste" is not strong.  It may be wasteful for each State and Territory to have its own school curriculum, and indeed this is one of the arguments for a "national curriculum".  Few proponents of a national curriculum, however, pause to consider the practical consequences.

The example of "wasteful" competition provided to the roundtable was that of State Governments offering subsidies and inducements for industries to locate in their State.  Whether this is "wasteful" is extremely debatable.  Given that States have so little capacity and so few means to compete against each other for inward investment it is perfectly understandable that State Governments will resort to using one of the few mechanisms they have left to them to attract business.  Subsidies might be legitimately criticised as a means of economic policy, but this has nothing to do with federalism.

THE NATURE OF THE ISSUES CONFRONTING AUSTRALIA

In the 1980s the economic policy challenges had answers that were more clearly defined than are the challenges we currently face.  The term used during this roundtable to describe today's challenges was "vexed".  The issues of the interface between economic and social policy are not obvious.  As Andrew Podger identified in his paper, there is an intimate relationship between education, health, and welfare issues, and they cross traditional portfolio boundaries.  It is unlikely that there will be one single "answer" to the problems of the future.

Discussions of social policy will inevitably involve all three levels of government -- a "one size fits all" model across the country to, for example, improve indigenous employment outcomes will be inappropriate.  State and Local Governments will have varying areas and levels of expertise, and only a federal system can provide solutions that take advantage of these differences.

THE IMPACT OF GLOBALISATION

The impact of globalisation on the Australian economy and on national politics is yet to be fully appreciated.  However, one consequence that is already apparent is the different rates of economic development of our States and regions.  Western Australia, for example, with its energy and mineral resources and its exposure to Asia is a State whose economy is rapidly "internationalising".

On the other hand, the economy of South Australia is not.  In Queensland, when one talks of China the word "opportunity" comes to mind, while in Victoria because of its manufacturing industries, China is more often associated with the threat of job losses.

All of this demonstrates the need for the application of different sorts of policies according to individual circumstances.  The capacity of States and regions to respond to fiscal challenges is obviously hampered by the existence of a single national currency.  The point has often been made that if during the 1980s Victoria had had its own freely floating currency the worst depths of the recession in that State might have been avoided.

This is not to argue for such a policy, but simply to recognise the costs and benefits of single national systems.  If Australia is to take advantage of the opportunities that globalisation provides all levels of government must be able to respond with policies that take account of the differences between States and regions -- and only a federal system allows this to occur.

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Planning red tape the real culprit

A Malaysian-led consortium's proposal to rezone a new area for housing at Rockbank, near Caroline Springs, west of Melbourne, would bring hundreds of millions of dollars in profits.  But these profits are not the reward of genuine wealth creation but a result of the Government's regulatory gouging of the home buyer.

Spring Street has created a shortage of new housing land, and massive profits are to be earned by anyone who breaches the regulatory walls.  These profits are at the expense of the new home buyer, for whom the regulations that cause the shortage mean excessive prices.

High house prices are the inevitable outcome of government restrictions on building land availability.  Melbourne's planning system aims to prevent the urban blight of new homes on the city's periphery and at the same time create the cafe latte society of dense inner suburbs.  This is idyllic living for the planners and of the baby-boomer generation, but it means creating a shortage of development land.  As with all shortages, the outcome is higher prices for development land and higher prices for the houses built on the land.

The losers are the young who cannot afford to mount the first step of the home ownership ladder.  A $300,000 home is simply unaffordable on the $30-$40,000 incomes earned by most people in the first home market.

High new home prices are not because of building costs -- building the house itself has remained affordable.  The culprit is the land component.  For a typical new home this is $112,000 compared with $15,000 30 years ago.

The price escalation is purely due to urban planning restraints on land use -- indeed, the dollar value of land prices would be a fifth of their present level if it were not for the planning system ramping up prices.

Urban planners, supported by impressionable urban greens, have produced regulations that prevent outer-urban land developments.

These elite have little conception of how land development restrictions raise prices.  In any case, they share a sharp disdain for the aspirationals and outer suburbanites who suffer the consequences.

The outcome of planning systems on new home prices was demonstrated in recent research on housing, "Bigger Better Faster More", by Policy Exchange in Britain.  This offers firm evidence of the causes of the problem and its effects.  It compares Germany, where there is a pro-housing planning approach, with Britain where, like Australia, there is a restrictive approach to the availability of land for houses.

In Germany, houses are a third bigger than those in Britain and, over the past 30 years, prices in real terms have shown a negligible increase compared with a doubling in Britain.

This is entirely due to the different approaches to allowing land to be made available for home building.  In Germany, landowners have much greater rights to use it for the purposes they favour, including developing it for housing.  In Britain and Australia, land use is dictated by planning agencies such as Victoria's Department of Sustainability and Environment, which severely restricts the areas where housing may be built.

The planning system's regulatory tax on the new home buyer creates a money tree for land that is zoned for urban development.  This, in turn, creates opportunities for graft and corruption.

With the Rockbank proposal, developers and political entrepreneurs such as former Cain-Kirner minister David White, an adviser to the consortium, see opportunities to enrich themselves by getting regulations changed for their own benefit.  White and his associate, the former federal Labor MP Neil O'Keefe, use their knowledge of the labyrinthine ALP decision structures to create a rezoning wealth bonanza.

As O'Keefe's former boss Paul Keating would have said:  "If you pull this off it would be the sweetest victory of them all".

Planning Minister Rob Hulls is reviewing the urban growth boundary, which is the present manifestation of the zoning restraints.

The logical outcome of this would be to phase out the current restraints on land supply and sack the mob at the Department of Sustainability and Environment that has given us the escalating house prices.  While reducing the artificially high housing land prices, this would also remove from the temptation of politicians a hidden honeypot of money that invites wasteful lobbying and political corruption.

But the minister has a vested interest in profiting from the artificial scarcity that the planning laws create.  The bureaucrats can therefore rest easy and the new home owner will just have to wear the continued regulatory extortion.

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Tentacles of central control need snipping

The Australian federal system is at a crossroads.  It needs to be reinvigorated or it will become a costly vestige of a noble but failed experiment.

There is no possibility of the states disappearing altogether.  Australians are far too constitutionally conservative to allow this to happen.

However, the states are on a path to become little more than administrative units of the Commonwealth -- and costly ones at that.

While a federal system remains theoretically the optimal system of government for a large, economically diverse country such as Australia in a rapidly globalising world, it depends on how the system is structured and how well it works.  Federal systems can and do fail.  While this point has not been reached in Australia, it is fast approaching.

The signs of a failing federal system abound.  States are receiving near record revenue growth generated by the potent combination of a booming economy, the GST and high state taxes.

But despite this overflowing wealth, the states have shown an intense unwillingness to reduce taxes.

Instead, the states are spending money on virtually everything.  State spending over the past two years has been growing at 8.6 per cent a year.  Public servant salaries have been growing at between 5-7 per cent a year and in Queensland the salary bill has been growing in excess of 10 per cent a year.

As a consequence, innovation and value for money have ground to a virtual halt in the states.

Sure, good economic times have lured the states into complacency.  However, the centralisation of taxing and spending has greatly stifled the incentives for states to act responsibly with taxpayers' funds.

The states now collect less than half their spending needs.  This imbalance gives states strong incentives to spend rather than innovate.

The GST has generated huge increases in funding to the states.  However, it has further undermined their responsibility for effective and efficient spending.  The GST is a commonwealth tax, not a state tax, and its proceeds are distributed to the state on a welfare criterion, rather than based on where the tax is collected, or who paid the tax, or efficiency of spending or innovation.

The state's responsibility for spending has been further diminished by the growth of tied grants.  These grants now account for more than half the total commonwealth payment to the states.  They come with a plethora of restrictions which not only blur the lines of responsibility but generate wasteful levels of overlap and duplications.  They also give significant policy power to teams of unaccountable bureaucrats.

It is wrong to assume that the erosion of fiscal independence of states has been totally foisted on them by the Commonwealth.  While the states have at times resisted the process, they have often quietly accepted or even actively promoted it.

But it is also wrong to see all the efforts of co-operation among government as wrong.

Over the past 100 years some powers have naturally and appropriately migrated to the Commonwealth.

It is time to reconsider the allocation of government functions.  Specifically, it is time to move to a unified national health market driven by individual needs and with a diversity of competitive providers and where the role of the states is greatly diminished.

It is also to time to simplify the arrangements for schools by shifting the responsibilities for funding and oversight of government and non-government schools to the states -- subject to them meeting and reporting on a few valid national standards -- and continue to make payment to non-government schools.

The National Competition Policy process must also be renewed and expanded.  The NCP has enhanced the status of the states by buttressing them against the slide into central control.  Its core principals are simply the underpinnings of good government.

It is particularly suitable for those areas where the roles of state and federal governments are inextricably intertwined and where there is a agreed reform agenda -- such as vocational education, aged care and management of native vegetation and salinity.

In the end, however, any redesign of state-commonwealth relations must provide the states with greater responsibility to raise their own revenue and to spend it.

This means that the states must regain access to a share of income taxing powers;  that fewer funds are distributed through the Grants Commission's process and special purpose grants are both reduced in number and made more outcome focused and transparent.

This will require leadership and institutional support, but it will be worth the effort.

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The Net is anarchy: keep it that way

The internet, long seen as a neutral realm free of government interference, is now hot political property.  Not surprisingly, therefore, both the European Union and the United Nations are now trying to grab control of the internet.  This has major consequences for business and for individuals.

Since 1998, a non-profit organisation named ICANN (Internet Corporation for Assigned Names and Numbers) has been responsible for managing and coordinating the internet's domain names.  ICANN ensures that what is typed in the address bar matches the site trying to be accessed.  Such an organisation is necessary to ensure the stability and growth of the internet.

At the moment, the internet is an ungoverned, unregulated, anarchic medium -- merely a mutual agreement between computer users all around the world to connect to each other in a certain way.  Given this blank slate, business and innovation has thrived online.  Business to business commerce has exploded over the past few years.  In Australia, 31 per cent of businesses reported placing orders over the internet in 2004.  This will grow as business uptake of broadband intensifies.

Until now, ICANN's role has been merely to facilitate and smooth this explosion of internet activity.

The European Union, as well as a motley collection of less-than-democratic nations such as Iran, Cuba and China, are forcefully trying to replace ICANN with an as-yet-unspecified UN department.  Such a proposal will be under consideration at the United Nations Working Group on Internet Governance meeting next month in Tunis.

Arguing that the internet is a global resource, the European Union insists that the private sector must share its responsibility of overseeing it with the UN.

By ceding this power over to governments, every aspect of the anarchic freedom that the internet represents is under threat.  The UN wants to use the internet's structure to pursue specific goals -- to close the "digital divide" and to "harness the potential of information" for the world's impoverished.

But the inequalities the UN claims it wants to overcome stem not from the internet itself, but from government policy.  Syria has even advocated taxing domain names to subsidise an international universal service right.

No matter how hard the new UN body will try to reverse the "digital divide" by reallocating domain names and shifting the location of servers, the only way that internet uptake can be increased internationally is through action within the countries themselves.

That is, the same way any technological advance has filtered down to the poorer countries.  By building stable institutions, maximising economic freedom, and ensuring prosperity, which creates consumer demand.  No amount of political action by the UN can replace this process.

The defining characteristic of the internet is not intelligence or its capacity to fulfil specific aims, but its simplicity.  It is a "dumb" medium, which is only structurally suited to transmitting data from one computer to another.  It can't conduct public policy.

Businesses and individuals have come to rely on the internet to carry out their personal and commercial interactions.  UN control threatens this.

What this new bureaucracy would clearly be able to do is restrict and censor websites and addresses, as well as place heavy regulatory burdens on their authentication, maintenance and pricing structure.  This is a prospect no doubt relished by European social democrats who would like to extend their national content and industry policies across national borders.

Consider the countries most actively pushing for the UN takeover.  Leading the charge is Iran, with Saudi Arabia, China, Cuba and Venezuela hot on its heels.  None of these nations is known for their promotion of political, economic or social freedoms.  Iran bans more than 10,000 websites on charges of immorality, and jails journalists and bloggers who disagree with the ruling elite.  The "Great Firewall of China" has a similar effect.

Should the internet be under the control of a network of regulators hammering out compromises about what is and isn't proper online activity?  Member states in the UN run the gamut from the totalitarian to the democratic.  Any attempt to assert control will result in an approach contrary to the liberal democratic ideals that dominate online activity.

The internet needs the technicians of ICANN, not the policy committees of the UN.

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A market soaked in controversy

Water restrictions in towns and cities around Australia make striking headlines.  The latest proposal of Victoria's Bracks government is to spend $1 billion swapping Melbourne's waste water with fresh water used by industry in the east of the state.

This exploits the urban legend of natural shortages in drinking water, but only 15 per cent of Australian water is for domestic or industrial use.  Even though Australian rainfall is irregular, there is plenty of scope to satisfy this demand.

Irrigation water is another matter.  Having water at the right time and place means enhanced agricultural productivity.  Hence, demand has grown for irrigation water and its associated water storage and diversion schemes.

By 2001, irrigated agriculture was using 16.6 gigalitres of water per annum and generating a gross value of $9.61 billion.

Yet over the past decade, the pace of this growth has been overshadowed by an increase in competing environmental claims.  Together the two factors have created a scarcity of water.

But scarcity is nothing special in our society.  The trading in markets of rights to all sorts of scarce resources is fundamental to social co-ordination.

However, a good deal of debate remains over the suitability of the market mechanism when applied to the allocation of scarce water resources between competing uses.  This is despite the extent of the different values of water both over time and space.  Such large differences imply that strong gains are available to society from trading water in markets.

To be truly effective, water trading requires private ownership and a regulatory relaxation over water resources.  Yet government is seeking to maintain control, allowing it to hold on to the ability to achieve their individual goals through making allocations to vested interest groups.

Water is in many circumstances a fugitive resource -- it moves through the environment in ways that can be difficult to trace.  In addition, some of the uses of water produce a public good -- namely those associated with environmental protection -- which by definition are non-excludable and therefore impossible, or at least extremely costly, to defend against use by those who do not pay.

In spite of these difficulties, there are powerful arguments in favour of using markets.  Without them, the incentive structures facing politicians and their advisers create transaction costs of a different sort.  Without a market in water in which alternative allocations are priced, there is little possibility of politicians and their advisers achieving efficient allocation for society.

In the absence of a water market, regulatory decisions have no measure to determine their true costs and hence a particularly fertile field emerges for bureaucratic empire-building with all the dead-weight costs that entails.

Even if politicians and their advisers could be relied upon to make decisions on water that are not dominated by personal motivation but are in the best interests of the wider community, it remains doubtful that they could allocate water efficiently.

This is because of the high -- often impossibly high -- costs faced by the state in collecting and processing in a timely fashion the sort of information required to ensure the most efficient uses of water at any particular time.

Among the pieces of information regulators would need to assemble to do the job routinely managed by markets is knowledge of the value of different extractive uses of water available from the production of irrigated crops and non-extractive environmental values such as the values arising from the protection of riverine ecosystems.

There are obvious complexities involved in estimating the latter, non-marketed values but even the task of estimating extractive values in real time is by no means straightforward given government difficulty in finding out the real values that private producers place on their use.

The current evolutionary trend in Australia is towards the use of markets.  Numerous reforms are under way or proposed in that direction.  However, "restraints to trade" in water rights remain, particularly between urban and rural uses and between extractive and environmental uses.

The process by which water is assigned for environmental flows remains arbitrary.

The Victorian government's latest water-swap proposals demonstrate that governments have an irrational aversion to building new dams and remain reluctant to subject investments in water infrastructure to a full cost-benefit scrutiny.

Removing uncertainties over property rights and the scope for regulatory intrusion is essential to enable greater environmental and economic wealth to be generated from our water resources.

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Culture of conservatives' fear

If the debate over the Howard Government's work regulation changes were conducted on purely economic grounds, the Government would probably win the day.  Every indicator is that lighter regulation will assist to further reduce unemployment.  This fact alone should give moral force to the Government's proposals.

But instead of being focused on economics, the debate is heavily skewed to cultural issues.  On culture the Government is struggling.  Why is this so?  Contrary to much popular myth, the Howard Government is not traditionally conservative.  Its changes to work regulation prove that within Australian culture the Government is quite radical.

Since the 1950s Australian conservatism has shifted heavily.  Now the conservative institutions are largely controlled by the ageing children of the post-war baby boom.  What principally defines this conservatism is a longing for the centralised power of the state to protect us from everything and anything.  At the core of this conservatism sits the Australian Industrial Relations Commission.

In reducing the power of the commission to control working lives, the Government is assaulting Australian conservatism.  And the diverse line-up of bedfellows aghast at the assault demonstrates just how comparatively radical for Australia the Government's proposals are.

The Government faces a phalanx of vocal opposition from churches, unions, environmental groups, welfare bodies, opposing political parties and significant elements within its state and federal parties.  Behind the scenes several business associations oppose the changes, as do many business leaders.

The cultural issues are clear and simple.  Allegedly the centralised industrial relations system has preserved the Australian way of family life.  By doubling award pay rates on Sundays, the Christian Sabbath has been protected.  Enforcing time and a half on Saturdays has induced fathers to attend Saturday morning footy matches with their sons.  Locking in high pay rates for shiftwork has kept parents at home with their children in the evenings.  Even the shearing award safeguards dietary standards by prescribing that meat and vegetables must be served.

These are just some examples of how the industrial system has protected our culture, so the reasoning goes.  But more than anything, the system is driven by a key conservative belief that business can't be trusted to treat ordinary Australians fairly.  The AIRC is central to the conservative idea of how to protect Australians from unfair bosses.  Many in the business community and particularly some business associations agree.

The consequence has been that over generations Australia has institutionalised an industrial, business, political and cultural settlement.  The settlement holds that a diverse range of business and community leaders can arrange business affairs and through the AIRC achieve social fairness.  The pay-off for some businesses is that the system secures favoured business deals for inside players and protection for those players from potential competitors.

The proposed significant downgrading of the AIRC and awards by the Government appears to tear this understanding apart.  Most important, it threatens the inside position of the institutions and individuals who have heavy influence over the settlement process.  This is radical for Australia and explains why the Government faces well-organised opposition.

But the bigger issue is not whether the proposals unsettle this establishment conservatism.  The more interesting question is whether the Government's timing and the substance of the changes resonate with the new middle ground that has emerged in Australia.  No one disputes that Australian families and life are radically different from those of the '50s.  Gays proudly proclaim their lifestyle as one model of family life.  Single parents are families, no different from mums and dads with kids.  Work patterns vary extensively from the 9am to 5pm standard.  Many people want to work on weekends and take their recreation and family time midweek.  Diversity has become everything.

And unions, churches and the AIRC supporters are not blind.  The changed family and cultural environment is as much a part of their lives as it is of everyone else.  They know system change is inevitable.  There is one big difference, however.

Supporters of the present system want to be the controllers of change through the AIRC and work agreements.  They believe emphatically that individuals do not have the capacity, intellect, knowledge and power to control work change.  Their message is:  Be fearful of individual capacity.

In this respect the Howard Government's proposals are truly radical because the stark alternative offered is a belief that individuals do and can have the capacity to control their work futures.

This individualism assaults the Australian conservative settlement.  We have a cultural battle, between a belief in the self and a cultural fear of the self.

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Time to dump anti-dumping regime

The Commonwealth has recently established a red tape task force to eliminate many of the costly burdens that government regulation brings.

There are legions of candidates for the task force to review.

One of these is Australia's anti-dumping regime.  Anti-dumping actions can be brought about when an overseas supplier provides goods to Australia at lower prices than in its home market.

Such "dumping" is only possible where the supplier's home market is protected by tariffs or other barriers.

In the absence of protection, the supplier's cheap exports will be re-imported.  In fact, in today's internet age, they would probably never leave the home country.

This would undermine the firm's domestic prices and profits, depriving it of a launching pad to export at below-cost prices.

Once dumping is proven, the imported goods attract extra customs duties.  For an anti-dumping action to be taken, there has to be proof that the exports are in fact hurting a domestic firm.  It doesn't make sense to cut off imports simply because they are cheap.

Anti dumping actions cannot be brought willy-nilly.  Many firms will eagerly seek government support when their customers are voting against them in the marketplace.

Hence, there has to be disciplines to prevent a local supplier crying foul every time it loses a contract to a cheaper import.  Without such disciplines we would see severe impediments to trade.  These would raise local prices by reducing the availability of low-priced imported goods and components.

Anti-dumping proposals need to progress through a bureaucratic mill that involves painstaking checks of prices as well as evidence that the imports are actually causing damage to the profits of the local firm.

But this also provides opportunities to have cases reviewed on technical grounds.  In this way a local supplier can raise a competitor's costs of doing business.

The availability of an anti-dumping challenge to imports can play havoc with a business's internet based global sourcing strategy.  Even the threat of action can introduce a risk both to the buyer and the seller.

And, Australia is among the world's most aggressive users of anti-dumping actions.

Recent applications have covered fertilisers and explosives from Russia, mushrooms from China, glass from Indonesia and PVC from just about everywhere.

It is unlikely that these cases involve classic dumping activity.  They entail the exporter selling at a price that meets the competition.  This is just the sort of action we see in petrol stations' price duels or on a slow day at Melbourne Market's vegetable stalls.

It is also the sort of actions that Australia's agricultural exporters constantly engage in.

Our exporters seek to get the best price for their produce across dozens of markets, recognising that the ebb and flow of global competition will move prices up and down.

Successful economies like Japan, Taiwan and Israel take hardly any anti-dumping actions.

In the interests of a more competitive Australia, we should at the very least sharply curtail such actions.

Indeed, to obtain dividends from freer trade, the red tape task force should recommend abolishing Australia's anti-dumping regime.

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The Death of Federalism?

Hal Clough Lecture 2005,
Perth, 25 October 2005

The Australian federal system is at a crossroads.

It needs to be reinvigorated or it will become a costly vestige of a noble but failed experiment.

There is no possibility of the states disappearing altogether.  Australians are far too constitutionally conservative to allow this to happen.  The states are however on a path to become little more than administrative units of the Commonwealth -- and costly ones at that.

While theoretically a federal system remains the optimal system of government for a large, economically diverse country in a rapidly globalising world, it depends on how the system is structured and how well it works.  Federal systems can and do fail.  They can increase the size of government rather than limit it.  They can enhance the power of vested interests over the general interest.

Federalism is inherently messy.  By design it disperses power vertically and horizontally across jurisdictions, resulting in a multiplicity of programmes, policies, taxes, regulations, bureaucracies, legislatures and lobbyists.  In the absence of countervailing benefits, federalism will result in excessive government.

This point has not been reached in Australia, but it is fast approaching.  The task of renewing the federal compact will be difficult, as it will go against the flow of over a century of steady centralisation.  But it is worth the effort.

The task is to rediscover the virtues of federalism and then to start rebuilding the institutions which support it.

THE BENEFITS OF FEDERALISM

TAMING THE LEVIATHAN ⁽¹⁾

Good government is an enormously valuable asset -- not only in terms of assisting economic growth but in protecting human rights.  On the other hand, bad government has the capacity to hold people in abject misery and be captured by those who control its levers.

As James Buchanan said, "Government is indeed Leviathan, a giant that can help us or crush us". ⁽²⁾

In 1995 I stated, "The critical and never ending task with which society has to struggle, therefore is to create devices that constrain the politicians and the bureaucrats so that they act in the interest of the citizen [which is] the real principle of governance". ⁽³⁾

Over the centuries, societies have built many mechanisms to control the Leviathan.  The most successful has been the Western liberal democratic tradition of government.  The elements of this tradition are well known:  representative democracy, sovereignty resting with the people, the rule of law, equality before the law, the right to own and trade property, and the recognition of -- and the respect for -- basic rights and freedoms.

The American Revolution added one more layer to that tradition -- what we in Australia understand as "checks and balances".  To foster these, American founders enumerated and divided power between different levels of government.  The aim was to disperse power so as to limit its accumulations and abuse.  Dispersed power is limited power.

Federalism offers the possibility of refuge from exploitation.  This is a valid concern in modern Australia.  One need only cast their memory back fifteen years to Joan Kirner's Victoria when her big government policies were undermining the Victorian economy and allowing political activists to gain undue control over the instruments of state.

Our federal system came to their rescue.  Other states, particularly Queensland, pursued markedly different policies, and provided a refuge for many hundreds of thousand Victorians.

Or think back closer to home in Western Australia just four years ago, when the Gallop Government effectively removed the basic right of people and businesses to freely enter into individual labour contracts.

The individual contracts were, after decades of prohibition, introduced by the Court Government in the mid 1990s.  They were widely adopted, particularly in the State's mining sector, and contributed greatly to industrial harmony and improved competitiveness.  Their removal in 2001 could not have come at a worse time.  Individual contracts were a crucial plank in the mining sector's restructuring and expansion aimed at reaping the benefits of rising China.

The federal system came to the rescue.  The Howard Government's 1996 industrial relations laws also allowed individual contracts, and most of the mining sector was able -- albeit at substantial cost -- to shift over to the Commonwealth system.  This enabled the sector to retain its competitive arrangements, make necessary investments and to tap into Chinese markets.  The lifeline provided by the Commonwealth's legislation has had profound and positive benefits for Western Australians.

States are not always the white knights of federalism.  They can be as abusive to their own citizens as can the Commonwealth.  Moreover, the benefits of federalism arise from the contestability amongst government vertically as well as horizontally.

The most important benefit of federalism in Australia is its ability to inject competition into the processes of government.  It gives people choice as to how they will be governed.

Seen in this light, federalism is a kind of competition policy for government.

By its very nature, government displays all the characteristics of monopoly, with the added twists that it is sanctioned and enforced by law.  But once mobility and choice of jurisdiction is introduced, the potential for competition follows.

Given that the big picture reforms of the future lie in injecting competition into the government services of health, education, welfare and environmental protection, federalism has the potential to play a key role.

Examples of the benefits of constructive federal competition abound.

Sir Joh Bjelke-Petersen in Queensland pursued a markedly different set of economic policies to the other states.  He ran the State's finances as he ran his farm.  He hired a good, conservative accountant as Treasurer, who balanced the books, built-up cash balances in case of drought, kept taxes low, ensured that government businesses were efficient and self sufficient and set aside funds for future liabilities such as public service superannuation.  But Sir Joh was not too keen on fiscal transparency.  Indeed, he went to great length to hide the surpluses.

Derided as simple and undemocratic -- which, in part, they were -- most of Sir Joh's policies contributed to the sweeping improvements in state finances over the last fifteen years.  Sir Joh's fiscal approach -- with exception of his poor standards of transparency -- has become the norm at least until recently.

Sir Joh did not achieve this feat of conversion through the power of his intellect or eloquence of oration.  Rather he did it through the force of competition transmitted through the federal system.

The other states watched as people, businesses and jobs migrated north to Queensland in response to the sunshine state's more attractive economic environment and quality of life.  Other states also finally caught on to the inherent failure of Keynesian policies at a state level.

Clearly not too many people are going to pull-up stakes and move to Queensland to avoid land tax or other state policies.  But some will -- and it is movement of people at the margin that counts.  Moreover, while people may be reluctant to move, businesses activity and capital are much more mobile.  And this is where the real competitive pressures come.

It isn't necessarily movement of economic activity per se that drives competition, but rather the threat of it. ⁽⁴⁾  The threat comes from evidence and knowledge that there are significant differences between states and that the home state is unwilling or unable to match the performance of others -- a key motivating force of competitive federalism.

Federalism offers other powerful benefits.

It has the potential if properly structured to limit free-riders.  One of the key distortions of government is it tends to offer the lure of a free lunch.  It provides valuable services paid-for by others.  This induces a positive response and excessive demand for these goods.  It also gives rise to people depending on others rather than themselves for funding of services.  Since most spillover benefits of government actions are limited geographically, splitting a nation into sub-national jurisdictions makes it easier to align the payment for and benefit from government services.

Federalism also supports the application of the related principle of subsidiarity.  The subsidiarity principle is that decision making power should be exercised at the lowest collective unit that produces efficient results.  The argument is that the smaller the collective unit the better or more democratic the decision.  That is, the closer the decision point is to those who are effected by it, the better.  Indeed this was an underlying principle of the Australia's Founder in allocating responsibilities between the state and Commonwealth.

Federal systems are particularly suitable in the modern, rapidly globalising, world.

It is true that the globalisation of markets, communities and ideas are pulling the loci of some decisions and law-making away from local to the national and international sphere.  These include laws governing trade, accounting and operating standards for business, some environmental issues such as global warming and even policing in the age of international terrorism.

But at the same time, "place" matters more in a globalising world.  As the geographic reach of markets expands from local to global, regional economies tend to specialise and differentiate themselves more and more.  As their links with global and national markets increase, they become more different from one another.

Industries cluster in regions most suitable for their productions, which results in even further specialisations.

Accordingly there needs to be often subtle, but significant, differences in policy across regions.

Take Western Australia and New South Wales.  Sydney is steadily becoming the business services and financial center of the Australia-Pacific region.  Western Australia has in recent decades become a regional centre for the various industries focused on finding, developing and exporting minerals on a huge scale and as a home base for the many skilled professionals working in the region in these activities.

As such the economies of Sydney and Perth have diverged.  While their development paths are logical and successful, they require a different mix of policies.  Their differences foster divergent values.  For example in Sydney the provisioning of extensive national parks, as well as the imposition of environmental restrictions on mining and agricultural development help attract and retain the wealthy financial services workforce.  Sydney can also afford to heavily tax housing and promote concentrated high-rise urban living, as the location with which it competes are the high priced financial clusters of Hong Kong, Singapore, London and San Francisco.

In contrast, Western Australia's specialisation is rooted in gaining access to new ore bodies and the development of a large resource base.  As a regional home base, the Perth economy is very sensitive to housing prices and needs to place a premium on maintaining the traditional suburban living environment.

Centralised government, with its tendency to promote one-approach fits all policies, will fail to understand, let alone foster, these regional differences.  And being controlled by a largely majoritarian political system, they will always tend to see the world through the prism of the larger centres.

But does the Australian federal system work?

So much for theory, the real question is:  does the Australian Federal system perform to its potential and, if not, why not?

It does not, because it is not allowed to.

The problem started from the beginning, with the Australian Constitution.

While the Australian founders were well acquainted with the workings of the federal systems in the United States, Canada, and Switzerland, they chose a weaker form of federalism.  Although they were aware of the dangers of the Commonwealth Government acquiring excessive taxing powers, they put in place inadequate safeguards against such an eventuality.

They chose a less than complete separation of powers between the executive and legislature.  They specified the powers of the Commonwealth and not those of the States, and shared many powers between the two jurisdictions.  They specified that, in a conflict of laws, the Federal law would prevail.  They allocated considerable taxing power to the Commonwealth.

These decisions provided the capacity and motivation for the Commonwealth to steadily takeover the State powers -- undermining the functioning of the federal system.

The Constitution's greatest weakness is its failure to reconcile the conflicting Washingtonian and Westminster traditions.  The primary concern in the Washingtonian tradition is to limit government by dispersing powers across levels and sections of government and embedding then these in a constitution.  The Westminster tradition is based on the idea of responsible government where the focus is on the need to empower a single national parliament, unencumbered by a written constitution.

The Australia Founders combined the two traditions into what has been labeled the Washminister Model.  Predictably, at least in hindsight, the Australian politicians, Federal and State, have preferred the less restrictive and more positive Westminster perspective

Federalism is not a system of choice for people who believe in the inherent benevolence of government.  Nor is it a system that pleases politicians.  Politicians do not take kindly to competitive pressures over their powers.  Perhaps understandably they try to respond to the every demand of their constituency, even if it concerns issues outside of their constitutional responsibility.

The dominance of the responsible government ideal, in combination with the relatively weak limits placed on the Commonwealth, has allowed the steady accretion of power in Canberra.

This has been assisted by the failure of the institutions established to buttress the federal system -- the Senate, the High Court, and the Interstate Commission.

TAX AND FEDERALISM

The dominant factor behind the failure of federalism has been the steady accumulation of taxing powers by the Commonwealth.

The states' share of total government tax revenue has declined from 75 per cent at the time of federation to less than 20 per cent today.  (Figure 1)

Figure 1: State Own Source Revenues, % Commonwealth and State Revenues

Between 1910 and 1942 the states share declined largely as a result of the expansion of the Commonwealths tax base.  In 1942, the states' share decline sharply as a result of the Commonwealth taking over income taxing powers from the states.  This was initially put forward as a temporary war measure, but remained.

The states were "given" a series of new taxes over the succeeding 50 years;  including payroll, franchise fee, debit tax, and more recently the GST (though neither the Commonwealth or the States claim this tax for themselves).  These new taxes did allow their share of the tax base to increase from its low of 8 per cent in 1952.  Nonetheless, the states' share of tax revenue remains much lower than that envisaged by the Founders and is once again declining.

The so-called vertical fiscal imbalance -- the difference between spending and revenue raising at Commonwealth and State levels -- is large.  It is much larger than in comparable federal nations.  (Figure 2)

Figure 2: Vertical Fiscal Imbalance, Ratios.  Own Source to Own Purpose Outlays

The critical assumption that underlies the benefits of a federal system is that each level of government is responsible for raising its own funds.  In order for competitive federalism to work the states must have the powers to vary their taxing and spending policies to compete for economic activity.  If the Commonwealth raises the bulk of tax revenue in a nationally uniform manner, then the potential for this competition is muted.  If central government collects money from all to provide service to a limit number then free riding is encouraged.

The potential for a federal system to act as protection against the accretion of power is dependent upon revenue raising being shared across the jurisdictions according to their responsibilities.  If the central government retains spending power far in excess of it own spending requirements, as is the case in Australia, its powers are not limited but augmented.

Importantly the GST has significantly increased the dependence of the states upon the Commonwealth.  (Figure 3)

Figure 3: Revenue Sources, All States, 1999-2000 and 2005-06

The Commonwealth has used this control over the taxing power to become involved in spending activities of the states.  The share of Commonwealth Grants with strings attached has grown dramatically.

It has increasingly used its control over the public purse and its constitutional powers -- particularly its external affairs and corporation powers -- to directly takeover state powers.

As a result, the Commonwealth and the states share responsibility for over half of the functions provided by the public sector.  This has not only blurred the lines of responsibility but has resulted in most areas being run by large bureaucracies.  It has also led to wasteful levels of overlap and duplications.

The best, and really the only, detailed research on the extent of overlap and duplication in the public sector was undertaken by us ten years ago. ⁽⁵⁾  It found that in 1995-96 there were 466 separate inter-government sub-committees involved in managing Commonwealth tied grants to the States, each with different and often complex rules.  The study also found that parliaments, particularly state parliaments, played a minor role in authorising administrative arrangements, setting objectives and assessing the performance of the grants.  Instead of being responsible to democratic bodies, programmes were in the main initiated and managed by the bureaucracy.

In a separate study, the National Audit Office concluded that "for many programmes [tied grants] accountability to the Commonwealth is poor". ⁽⁶⁾  State programmes are far worse.  The study also found that few tied grants had clear performance objectives and that their matching requirements bore no relationship to the spillover effects that they were supposedly meant to address.

To add to this is the allocation of general purpose grants administered by the Commonwealth Grants Commission (CGC).  The CGC methodology aims to provide each state and territory the financial capacity to provide a uniform set and level of services irrespective of differences in cost and revenue raising ability.  This set of services is very comprehensive, including debt levels and superannuation liabilities.  The benchmarks used in the assessment are based on current policies and cost structures.  The benchmarks do not consider best practice, efficiency or effectiveness.

The methodology is designed to be policy neutral.  But of course it isn't.  Instead, it provides an incentive for uniformity, it compensates for inefficiency, it dulls the incentive for reform and experimentation, and it facilitates expansion in the size and function of government.

More money is now being poured through the system than is needed.  Even if one accepts the need for equalisation through the CGC, the $37 billion in GST revenue now being allocated is far in excess of what is needed to achieve an equalisation of capacity.  The over-funding further distorts the incentives to State governments.

It is wrong to assume that the erosion of fiscal independence of the states has been totally foisted on the states by the Commonwealth.  While the states have -- at times -- resisted the process, they have more likely to either quietly accept it or actively promote it.

Sir Joh's famous statement "the only good tax, is a Commonwealth tax" was not made as comment on optimal tax policy, but rather his desire for the Commonwealth to "pluck the goose" for him.  This view has been widely held by Premiers through history.

The CGC process is of the states' making.  And as the Howard Government has made clear, it is in the states' collective power to reform it.

It is also wrong to see all the efforts of co-operation amongst government as wrong.  Over the last 100 years some powers have naturally and appropriately migrated to the Commonwealth.

Some degree of co-operation is necessary between government -- for instance agreement as to the rules under which states compete.  A good example of this has been the National Competition Policy process.

Nonetheless, the centralisation of taxing and spending powers and the intermingling of responsibilities have grown far beyond the requires of an effective federal system.

Figure 4: Special Purpose Payments, % Total Payments to the States

SUMMARY

While federalism has the potential to be the optimal system of government for a modern Australia, the current system falls far short of that optimum.

In order for competitive federalism to work, states must be responsible for raising their own revenue and controlling their spending.  Under the Australian system they do not.

The signs of a failing federal system abound.  Innovation in the provision of state services has ground to a halt.  The focus of all states, now that the GST has delivered the growth tax wanted, is on spending.

States are receiving near record revenue growth -- an average of 8.5 per cent per year over the last few years.  This has been generated by a booming economy, the GST, and high rates of state taxes.

Despite their overflowing wealth, the States have shown an intense unwillingness to reduce taxes, even those that are small, destructive relics of the pre-GST era.

Instead, the States are spending money on virtually everything.  State spending over the last two years has been growing at 8.6 per cent per annum.  Public servant salaries have been growing at between 5 and 7 per cent per year and in some states the salaries bill is growing at a rate of in excess of 10 per cent per year.

Innovation in the state sector has ground to a virtual halt.

Most of the reform that is coming through is being forced on the states through the lure of National Competition Policy (NCP) money.

Moreover, there is growing trend amongst state governments to seek national agreements which limit the scope for policy variation.  In short, they are colluding to limit competition.

Of course, the good economic times have lured the states into complacency -- the money is easy, so they take it easy.  But there is little doubt that the perverse incentives of our crippled federal system is encouraging them down this route.

WHAT TO DO

Supporters of a functioning federal system must seek to go back to something close to the original constitutional settlement, where the states were responsible for the majority of government powers -- and were required to raise their own funding.

Such a reconstituted settlement would mean:

• states regaining access to a share of income taxing powers
• far fewer funds distributed through the Grants Commission's process
• special purpose grants and inter-government committees reduced in number and made more outcome focused and transparent.

This should be the agenda.  The redesign of the federal system will require a concerted effort as well as leadership and institutional support.  Australians are a pragmatic lot -- change for its own sake is not in the Australian nature.  While many recognise in a general way the failings of the federal system and the need for its reform, they need to be convinced of a workable alternative.

Moreover, given the current tax and spending policies of the states, I doubt that many people would want to hand the states even partial control over income tax.

The initial leadership for reform of the federal system must come from voters and specifically from policy-makers -- the individuals and organisations which develop debate and market ideas.

During the 1980s and early 1990s reform of the federal system was on the agenda.  The rationale and agenda for reform was widely debated and supported, albeit not uniformly.  The result was two major attempts at reform of the federal system -- the Hawke New Federalism Initiative of 1990 and the National Competition Policy initiative of 1995.

During the last ten years, federalism has fallen off the agenda.  But there is now movement again.

We plan to re-enter in the debate with the re-establishment of the States Policy Unit.  The Chamber of Commerce and Industry of Western Australia has also been a long standing participant in the debate on improving the federal system.  It plans to soon release a document on the issue.  Similarly the Productivity Commission has organised a conference on productive reform in the Federal system later this week.

It is also vital that academia be brought back into the debate.  With the demise of the Federalism Centre at the Australian National University, research on federalism at Australian universities has waned.

THERE IS THE NEED FOR GREATER SCRUTINY OF STATE SPENDING AND TAXING POLICIES

As Professor Walsh (former Director of the ANU's Federalism Centre) recently stated,

"... competition must ultimately be explained by citizen-voters using some form of benchmarking of their State government against others, and that this is what effectively make state governments compete with each other". ⁽⁷⁾

The benchmarking work undertaken in the past by us, CCIWA and others played a vital role not only driving competition between states but enhancing state accountability.

The states face a veritable army of social advocacy groups whose survival lies in keeping the government funding taps open.  These groups not only act as lobbyists for more spending but assist the states as they seek more money from the Commonwealth.  At the same time the states -- who employ the majority of the country's public servants -- are under the thumb of public sector unions like never before.

Advocacy groups and public sector unions are very satisfied with the status quo.  Money is more easily extracted from unaccountable governments than those that must directly face their taxpayers.

THE STATES WILL AGAIN BE BENCHMARKED

Eventually states and the Commonwealth Government must jointly take on the mantle of leadership.  To be successful, leadership must come from both levels of government with support of the major parties.

This will not be easy.  The current federal government has many centralist tendencies.  The Labor Party -- which is in government in all States and territories -- has been at best agnostic towards federalism.

While all governments recognise that the system is not working well and is holding back essential reform, few have been willing to wear the political cost that comes with change.

The redesign process must include reform to the CGC process, re-alignment of roles and responsibilities, and strengthened competition policy.

The states need to take the lead on reforming the Grants Commission process.  This will not be easy, as the smaller states and the territories have become highly dependent on interstate subsidies.  But it is clearly necessary, and there are a range of options readily to hand

The process of redesigning the federal system must avoid a narrow "states rights" perspective.  States do not have rights, people have rights.  States have roles and responsibilities, which change over time.  Indeed, they have changed significantly over the last 100 plus years.  Thus the process must include a pragmatic review of the role of the states not only of their relationship with the Commonwealth, but also with regard to their own citizens.

As the CCIWA recently pointed out, "the concept of subsidiarity ... has broader implications and applications than managing the boundaries of government jurisdictions.  It means that government should not interfere in the activities of individuals, families, businesses and civil society except where these are not capable of effective self-management or where their activities might spill over to affect others". ⁽⁸⁾

Governments -- state and federal -- have interfered too much.  It is time to begin peeling back the role of government by placing greater reliance on competitive markets, innovation, and individual responsibility.

This process has begun but needs to be expanded and accelerated.

Any reform of the federal system must facilitate this, while at the same time realigning the role and responsibilities between the levels of government.

Two areas stand out for realignment:  health and schools.

HEALTH

The Australian health system remains mired in bureaucratic control.  It suffers from the undue influence of medical providers, its balkanisation into over 60 different programs, and its funding source -- largely Commonwealth through a mishmash of uncapped budgets and run-away entitlements.

The states' role in health has largely been relegated to owning and managing public hospitals -- which in turn are half funded and indirectly controlled by the Commonwealth.

It is time to move to an unified national health market driven by individual needs and with a diversity of competitive providers.  The role of the states would change radically under such a system.  They will no longer be required to fund it.  They may wish to continue to operate public hospitals but as businesses paid for by user charges.  Some states may wish to convert their hospitals to non-profit organisations or to privatise them.  They will necessarily retain a role in planning and over sight of the heath market, but broadly speaking, their role in health would greatly be reduced.

EDUCATION

Currently, the Commonwealth's role in primary and secondary education is limited to providing quasi-vouchers for non-government schools, providing some funding for government schools, and trying to ensure that national goals are met.

It is time to simplify these arrangements by shifting responsibility for funding and oversight of government and non-government schools to the states -- subject to meeting and reporting on a few valid national standards and to continue to make payment to non- government schools.

These changes -- the shift of health to the Commonwealth and schools to the states -- would greatly reduce overlap and duplication.  It also has the potential to substantially reduce the imbalance in spending and taxing.

In some areas -- where the role of state and federal government are inextricably intertwined and where a reform template is available -- the responsibility for reform should be part of a renewed mandate for the National Competition Policy.

With the funding set to run out soon, the initial NCP agenda is coming to an end.  Governments are currently considering what to do next.  All agree that the process was successful in inducing the states to put into effect market-based reforms more thoroughly and quickly than would other wise be the case.  Federalists might lament the need for a national approach and the need for fiscal inducement, but given the distorted incentives in the federal system it was probably necessary.

The NCP has enhanced the status of the states by buttressing them against the slide into dirigisme.

The NCP's core principals -- transparency, market-based competition and measurement of cost and benefits of regulation -- are simply the underpinnings of good government.  These principals can and should be applied to a wide range of government services.  A nationally coordinated approach is particularly suitable for those areas where the roles of state and federal governments are inextricable intertwined and where there is a agreed reform agenda.

For instance, suitable candidates of an expanded NCP are vocational education and aged care.

Environmental policy is another area where all levels of government interfere with each other, often resulting in illiberal and duplicative policies.  The states are particularly guilty of undermining basic rights, including the protection of private property and due process.  The Commonwealth's approach is a little better, but not much.  However, rather than trying to improve the approach of the States, the Commonwealth invariably seeks to duplicate and/or override the states to impose uniformity

Here expanding the NCP process of subjecting environment regulation to cost -- benefit analysis and requiring market-based approaches may be helpful.

For environment policy however, the real solution lies with constitutional reform at the state level.  While the Australian Constitution places limits on the Commonwealth's ability to take property without compensation, state constitutions do not.  This needs to be addressed.

A debate about state constitutions would also facilitate wider public dialogue on the role of the states -- essential to renewing the federal system

In the end, the key reform will be for the states to be able to level an income tax through the Commonwealth system, as in the United States.  Only when the states are responsible for raising a greater share of their own revenue can a federal system function properly.

There is work to do, and federalists must get to the task.

---

REFERENCES

1.  The next two sections draw heavily from:  Wood, R.J. (1996), Restoring the Balance:  Tax Reform for the Australian Federation.

2.  Buchanan, J (1975), The Limits of Liberty:  Between Anarchy and Leviathon, Chicago:  Chicago University Press.

3.  Wood, R.J. (1995), Competitive Federalism:  Promoting Freedom and Prosperity, Federalism Issues Paper No. 3, January.

4.  Walsh, C. (2005) Competitive Federalism:  Wasteful or Welfare Enhancing?, Productivity Commission Roundtable:  Productivity Reform in a Federal System, October.

5.  Wood. R.J. (1996), Roles and Responsibilities in the Australian Federal System.

6.  ANAO (1995), Specific Purpose Payments to and through the States and Territories' Report No. 21, 1994-95, Australian National Audit Office, AGPS.

7.  Walsh, C. (2005), page 23.

8.  CCIWA (2005) Federalism in Australia:  A Discussion Paper, Chamber of Commerce and Industry of Western Australia, Draft, September 2005.

Nuclear waste site in outback makes cents

The Northern Territory Chief Minister, Clare Martin, has said she will fight "tooth and nail" the building of even a small nuclear waste facility in the Territory.

Australia produces nuclear waste at Lucus Heights., where the Sydney facility undertakes nuclear-related research including for diagnosing and treating cancer, Alzheimer's and multiple sclerosis.

The preferred site for the Lucas Height waste, which is apparently a Federal Government responsibility, is Woomera, but the South Australian government has said "no".

The Northern Territory looks set to end up with the waste facility because the Commonwealth can force it on a Territory.

This issue alone has both sides of politics in the NT united against the Federal Government.

There will be risks associated with the storage of nuclear waste, but as I see it, the stuff needs to be stored somewhere.

While the state and federal governments argue about what to do with the relatively small amount of waste from Lucas Heights, others worry about waste from the 440 commercial nuclear power reactors currently operating in 31 countries across the globe.

These nuclear reactors include power stations which supply 17 per cent of the world's electricity without producing the greenhouse gases associated with the use of coal and other fossil fuels.

A few weeks ago former Prime Minister, Bob Hawke, suggested Australia should take the whole world's nuclear waste.

He said it would be an act of environmental responsibility and economic sanity.

Countries can apparently earn more from storing waste than selling uranium, and when you think about it, no where is as safe as outback Australia.

We live in a politically stable country and outback facilities could be made very secure from terrorists.

Places like the US, Japan and Pakistan are on fault lines and are thus geologically unstable -- in contrast outback Australia sits on a single tectonic plate.

Also, correctly managed, arid regions can be made safe from bushfires and the corrosive potential of dripping water.

Outback Australia is away from the sea and the risk of tsunamis.

The environmental movement once promoted the slogan "think globally, act locally".

It is perhaps this concept that Bob Hawke had in mind when he made the suggestion that we take the world's nuclear waste.

I wonder whether Clare Martin, would reconsider the proposal if it was about taking waste from, for example, her near neighbor Indonesia, rather than from Sydney?

Indonesia has three nuclear reactors, but so far no nuclear power stations.

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The Energy Efficiency Opportunities Bill 2005

Submission to the Senate Economics Legislation Committee

"Ladies and gentlemen, the Treasurer and I have called this news conference to announce the appointment of a taskforce to identify practical options for alleviating the compliance burden on businesses from Commonwealth Government regulation.  The taskforce will examine and report on areas where regulatory reform can provide significant, immediate gains to productivity and for business.  Regulation is necessary to protect the public interest but it can become too burdensome and there has been a growing chorus of concern expressed by both small and large businesses about the regulatory burden."

The Prime Minister's Press Conference, 12 October 2005

ENERGY REGULATIONS AND RED TAPE

At a time when the Government has just launched its Task Force to reduce the regulation on business, it is simultaneously introducing new measures like the Energy Efficiency Opportunities Bill which will needlessly intensify that regulation.

It is an unfortunate commentary on the efficiency of government that no conflict is apparently recorded in the simultaneous pursuit of goals that on the one hand seek to reduce the impost government has on business efficiency and on the other seek to impose a greater impact.  It is even more regrettable that the increased regulatory activities require firms to take measures in their own interests on matters and in ways in which the government itself has scant information.

DEVELOPMENTS IN ENERGY USE

The events that centred on oil in the 1970s led to the development of a quite massive change in attitudinal approach to energy.  The effects of higher crude oil prices on overall energy prices in Australia were moderated by a switch to coal, the cost of which has risen less than that of crude oil.  Other countries have also seen their aggregate energy prices moderated by coal (and, in many cases, nuclear energy) assuming an increased importance.

The switch in energy use over the long term was founded upon a general view that the OPEC oil cartel, supported by a scarcity of low cost energy, would bring a steady increase in the price of energy.  The attitude change also had concrete effects in bringing a rapid shift of demand into existing and innovatory energy saving methods and of research and development effort into energy efficiency improvements.

The ensuing introduction of energy saving technology and supply side economies appear to have broken the previous relationship between GNP growth and energy growth.  Prior to the early 1970s, the use of energy in developed countries increased more rapidly than real levels of income.  Since then, energy growth has been below the growth in real GDP.

For Australia, between 1973/74 and 1990/91, energy consumption increased by only 51 percent compared with a growth of GDP of 63 percent.  This represents a ratio of energy use to GDP of 0.8:1.  Moreover, the reduction took place in spite of a rapid expansion of energy intensive industries like aluminium that took place as the industry migrated from Japan to lower cost energy locations like Australia.

The trends to lower ratios of GDP to energy are expected to be maintained.  Over the medium term ABARE forecasts an annual growth in energy demand in Australia of under 2 per cent, only two thirds of the average 3 per cent annual GDP growth forecast. ⁽¹⁾

THE EVOLUTION AND MERITS OF GOVERNMENT
ENERGY SAVINGS POLICIES

Prior to the 1970s energy crises, the focus of government policies towards energy was in regard to exploration and, given its inelastic demand, taxation.  This changed markedly from the mid 1970s.

Government policy of promoting energy saving had their genesis in the long discredited Club of Rome notions that the world was about to run out of energy and many other resources.  This gradually infiltrated government thinking and was the basis of many of the energy saving regulatory polices that are in place today.  Among these are the star system for refrigerators, and regulations covering other domestic appliances.

No sooner had the excitable claims about an energy crisis been dampened by reality when the greenhouse scare emerged.  Without skipping a beat the same pressure groups that once urged us to conserve energy to prevent its depletion now told us that government must regulate to prevent carbon dioxide emissions building up.  The policies to prevent energy use were pulled off the shelf and mutated into policies to reduce carbon dioxide emitting energy use.  Government under pressure from the elites in the media (and in some cases persuaded by the arguments) acted to implement a new phase of regulatory measures.

Stemming from these developments there arose a plethora of regulatory measures targeted particularly at energy conservation.  These gave expression to some politicians' views that they are better able to recognise what is good for businesses than firms' managers and directors.  Thus, in his Earth Day address back in 1993, President Clinton offered a view that lower use of energy is beneficial in itself.  He said that energy savings mean there is, "More to invest in new jobs and providing better living standards".  In a statement that he would obviously not wish to be remembered for, he suggested that higher energy efficiency is, "One of the reasons why over the last couple of years, for example, the average German factory worker has come to make over 20 per cent more than his American counterpart".  It is doubtful that Mr Clinton, or those writing his speeches, would now view the reversal of the productivity gap between Germany and the US as evidence of the benefits of increased per capita energy consumption.

In truth, it is very easy to sacrifice overall efficiency on the alter of energy efficiency.  European energy usage is less than that of the US (or Australia) because of energy taxes and the different availabilities of local low cost energy sources.

Obviously, raising the price of energy means less will be used.  But this is no more a contribution to efficiency than are Japanese and European agricultural policies raising domestic beef prices and reducing its consumption.

Although reduced energy use per unit of output, like reduced labour input or reduced raw material input, brings gains to productivity and to real incomes, the means by which the reduction is achieved is critical in determining whether or not it is real.  Government imposed cost increases for one input will lead to substitutions away from it.  But this is very different from saying they will bring net economies.  Gains to income levels are best achieved through the government adopting a neutral stance on their attainment.  Cases where markets, left alone, fail to achieve the best outcomes are much rarer than many choose to think.

President Clinton's remarks refer to a partial concept of efficiency, one that focuses entirely on the use of energy.  Yet, greater energy use may be more efficient than conserving energy if it results in a lower use of other factors of production.  That Clinton's view is widely shared reveals deep popular misunderstandings of the nature of market forces and of demand.  They are posited on the notion that government measures are required to combat adverse decisions taken by individuals in the marketplace.  However, satisfaction of demand brings benefits;  where regulation, forces managerial resources to focus attention on a particular area of business will shift demand and supply and result in output migrating to less productive sectors.

Where any one input into production and its supply is required to receive special attention, other inputs are denied attention by an equivalent amount.  The blend of inputs is shifted away from those with the lowest costs;  and consumers' preferences no longer fully determine final outputs.  These distortions reduce the economy's level of real income.  They bring some consumers to shift their purchases to goods and services that they would not have chosen in the absence of the differential tax rate.  And they rearrange relative costs, causing producers to shift their own purchases to inputs that would give less value if goods were treated similarly.

In some cases, these outcomes are the very ones that governments want to bring about, as they consider themselves better judges of individuals' true interests.  This can be true if there is inadequate information on which individuals can base their decisions or if there are monopolistic situations in the market.

The case for the sorts of taxes that President Clinton's Earth Day remarks may presage rejects this view.  It rests on the government being superior than the market at collecting and sifting the complex amalgam of information on costs, preferences, and changes in demand and supply.  The absence within governments of the strong personal interest that individuals have in obtaining the best value for their money, and their frequent bending to the power of interest groups makes this unlikely.

Moreover, under close scrutiny the sorts of claims of major savings becoming possible if there were less consumer ignorance have been shown to be groundless.  People's decisions on matters like avoiding up-front expenditures that save future on-going costs are generally in accord with their budget constraints and the risks and opportunities that they face with their outlays.  For example, many people have avoided tying up capital in innovatory new lighting systems, even though it could be demonstrated that future savings offer a high return.  Such actions reflect a need to avoid being locked into one form of capital when the future might bring something even better.  Such measures receive even greater scrutiny in business situations where people are specifically tasked with taking a view on the most productive course of actions.  Moreover, in so being tasked, there are abundant opportunities for those seeing to win business from them to point out the savings available by adopting a different expenditure pattern.

THE ENERGY EFFICIENCIES OPPORTUNITIES BILL

As the paper accompanying the invitation to offer submissions to this Review has noted, the Productivity Commission has expressed grave reservations about the Energy Efficiencies Opportunities Program. ⁽²⁾

According to the Explanatory Memorandum (the Regulation Impact Statement) circulated by the Minister, there are many available free lunches, of which private sector businesses are unaware.  Essentially, according to the framers of the RIS, business firms, not having the same level of skill that the public servants who have drafted the RIS claim for themselves, should be required to undertake measures for their own shareholders' good.  We would not support this conclusion.  On the contrary, we consider it risible to imagine that a government agency without the day to day operational responsibility of managing businesses and without the motivation that comes from private sector pursuit of profits can know better what is in firms' interests than their management.

The RIS, in arguing that there are major savings from the regulatory route proposed draws upon information prepared by Victoria's Environment Protection Authority (EPA).  The EPA is charged with implementing the Protocol for Environmental Management (PEM) as part of its Greenhouse Gas Emissions and Energy Efficiency in Industry Program.  Under the PEM, EPA license holders are required to undertake an energy audit if usage and emissions are above threshold values.  All identified action items that provide financial payback within three years or less must then be incorporated in action plans and undertaken.  Table 1 illustrates the anticipated GHG savings from action plans approved to date.

TABLE 1:  Anticipated Annual GHG Savings -- EPA PEM Program

Action Category	Number of Actions	GHG emission reductions, (kt CO2-e/yr)
Air conditioning / heating / refrigeration / ventilation	120	56.7
Appliances / office equipment	15	0.4
Boilers / steam plant / steam reticulation	188	99.8
Building construction / modification	18	2.7
Compressed air systems	232	40.8
Energy management systems	300	73.7
Hot water systems	34	4.7
Industrial / manufacturing process modifications	517	374.6
Lighting	305	43.1
Plant drives (motors)	278	82.2
Power generation	10	5.59
Other	62	123.6
Non-energy related	45	134.0
TOTAL	2,124	1,041.8

Greenhouse Gas Emissions And Energy Efficiency In Industry -- EPA Victoria's Role In The Victorian Greenhouse Strategy, John A Marsiglio

The report estimated that these measures will achieve financial payback between 1.5 to 2 years on average, with a net financial saving of around $30 million per annum.

It is it is unusual for such savings opportunities to be discovered by government agencies and their existence would mean the Directors of the businesses concerned have been ignoring profitable opportunities to improve the wealth of their shareholders.  There is now a very broad consensus agreeing that private sector provision of business outputs is more efficient than public sector provision.  Accordingly, legislators should examine critically claims that the latter have insights that would allow them better to operate the formers' businesses.

The RIS takes two lines of argument.  The first emphasises the market failure of corporate ignorance.  The second addresses the externality benefits that regulation might bring but the RIS itself does not estimate these or discuss them other than in passing.

In developing its case for regulation, the RIS argues, "While the relatively lower price of energy in Australia may explain some of the difference, Australia has lower rates of energy efficiency improvements than countries with similar energy prices, such as Canada and the USA".  No evidence is provided for such a sweeping statement.  If this is true (and not simply a result of the different aggregation of supply within GDP), the statement would seem to suggest that there are shortcomings in our nation's entrepreneurial culture.  This would, indeed, be a grave issue facing the nation.

More generally, the paper claims that there is an "energy efficiency gap".  The Commonwealth's RIS on this matter, to demonstrate that its authors have read the requisite literature says,

"The existence of an energy efficiency gap may appear counter-intuitive.  Generally, firms would be expected to take up cost-saving energy efficiency opportunities without any need for government intervention.  Firms which use large amounts of energy would have a particular incentive to increase energy efficiency and reduce their input costs."

As is typical of such pieces of work designed to prove the need for regulation, the RIS then says that, "However, empirical evidence has established that an energy efficiency gap exists.  There are a number of possible explanations for the energy efficiency gap.  These include:

• Market failures, including imperfect information, split incentives and externalities;
• Organisational failure and behavioural norms;  and
• Other reasons, including hidden costs". ⁽⁴⁾

The sophistry such statements encapsulate is breathtaking.  The RIS simply entails trotting out the textbook reasons for non-intervention to disarm future detractors by maintaining that it is on the right wavelength before proceeding to undermine the reasons against government intervention with spurious empirical data.

This has been the classic approach used by all pro-regulationists.  Historically, those favouring protection would assure everybody that they were in favour of free trade -- with its demonstrable income enhancing features -- but, for reasons like those sketched out above, would maintain that the particular industry for which they were batting was different.

In support of the regulatory requirements, the RIS refers to a report quoted in the PC Draft Report on Energy Efficiency by Energetics.  This argued that over 90 per cent of firms with annual energy bills exceeding $5 million did not do what Energetics regarded as being adequate energy management diagnostics.  Doubtless encouraging firms to do more such diagnostics would proved beneficial to Energetics and this might have given the authors of the RIS cause for concern about the dispassionate nature of the advice.

The RIS then constructs hypothetical scenarios on the basis of which it estimates major savings to the economy (and to the firms on which its regulations are imposed).  These involve three options ⁽⁵⁾ against which totally fabricated estimates of savings are made.  On the basis of these a net benefit is claimed in Net Present Value terms of between $239 and $497 million for Option 2 and $279 and $557 million for Option 3.  This extrapolation of fanciful assumptions to detailed pseudo-scientific estimates provides no basis for supporting the Bill.  Rather, it underlines the considerable politicisation inherent in government agencies' decisions, a politicisation that is one reason why government businesses are seldom able to compete successfully with those of the private sector.

The PC's Draft Report on Energy Efficiency discusses many reasons why firms and individuals do not wait to assemble all the possible information before making a decision.  The notion of "bounded rationality" helps to explain why perfection is never achieved -- in order to thoroughly examine all options before taking a decision would require spending inordinate amounts of time.  It makes sense that decisions are made on partial information and that the more important a decision is, the greater the amount of time spent acquiring and processing information.  Thus we spend more time assessing our needs and the offerings available in buying a house or a car than in buying a computer.  In the case of very low cost goods we may spend hardly any time -- some may be "impulse" purchases.

The PC (p. 93), drawing on research from ABARE also marshals evidence that half of the recommendations of energy audits are not taken up.  This is thought to be because the implementation costs are not adequately recognised by the audits.  It also suggests that there may be some double counting in the cost saving estimates.

CONCLUDING COMMENTS

It is instructive in this regard to recall the words of Arthur Seldon, the immensely influential recently deceased head of the British IEA, who confronted the frequent cry of "market failure" with the charge of what he called "incorrigible government failure".  The trouble he diagnosed was "that politicians are not generally saints pursuing the long-term public interest, but party politicians responding to demands from organised lobbies". ⁽⁶⁾

The cynical would argue that the proposed provisions were put in place as a sop to those seeking more draconian measures like steeper energy taxes.  They would maintain that the obligations to be put in place are unlikely to entail significant costs since most firms should carry out energy audits in any event.  Requiring actions simply to allay misplaced concerns and to forestall even more onerous regulation impact may be preferable to the sort of policies that those same concerns have fostered in the EU, particularly Germany with its aggressive energy taxes and consequential economic lassitude.

Even so, putting in place a set of second best requirements is hardly a noble and efficient basis for the formulation of government policy.  Passing legislation on the basis of palpably deficient evidence placed before it sets a poor standard for Parliamentary democracy.

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ENDNOTES

1.  Australian energy:  national and state projections to 2029-30, ABARE eReport 05.9

2.  Productivity Commission, Energy Efficiency, Draft Report, April 2005

4.  http://www.comlaw.gov.au/comlaw/legislation/bills1.nsf/0/0285C33447F2CF3BCA25707D00062087/$file/05158em.pdf (p. 9).

5.  Option 1 is the status quo scenario;  Option 2 is the initial proposal for a mandatory scheme, entailing assessments with minimum performance standards;  Option 3 is the revised proposal for a mandatory scheme, without minimum performance standards.

6.  http://www.telegraph.co.uk