Executive Summary

Preface

Project Victoria originated from a concern amongst the business organisations in Victoria to solve the major economic and budgetary issues facing Victoria without increasing the burden of taxation.  Following the 1990 State Budget and subsequent discussions the business organisations commissioned the author to produce an Interim Report setting out an Agenda for Change in Victoria, and directed to reviewing the role of government in the State.

This Report, while preliminary, nevertheless embodies a considerable amount of work by the author on expenditure, taxation and debt issues in Victoria, and on the role of government and state enterprise, and the scope for privatisation, corporatisation and franchising in Victoria.

The business organisations forming and sponsoring Project Victoria are;  Australian Chamber of Manufactures, Building Owners and Managers Association, Business Council of Australia, Bus Proprietors Association, Confectionery Manufacturers of Australia, Insurance Council of Australia, Real Estate Institute of Victoria, Retail Traders Association of Victoria, State Chamber of Commerce and Industry (Vic), Victorian Automobile Chamber of Commerce, Victorian Brick Manufacturers' Association, Victorian Employers Federation, and the Victorian Farmers' Federation.

The above business organisations, while commissioning the study, and while strongly supporting the thrust of the Preliminary Report, do not necessarily accept all the detailed recommendations, which remain the responsibility of the author.

Richard J. Wood
April 1991

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Executive Summary

Victoria is at the cross-roads, and the amber lights are flashing.  Will we try to struggle painfully out of the present recession by using the same philosophies of government which have brought us to the present pass?  Or will we have the courage to change that framework so as markedly to reduce the involvement of government and give the private sector an enhanced role?  That way we would be well placed to overcome present problems and to reap the many natural advantages of what continues to be a wealthy State.

The reforms proposed by Project Victoria, in this Preliminary Report, amount to a major restructuring of the expenditure programs of the Government of Victoria, as well as a broad-based strategy for increasing productivity and living standards, by privatising, corporatising and contracting out many current services of government.  If implemented on a national scale, the strategy would, for example, be compatible with significantly lowering all income tax rates and could dramatically improve the nature of work and saving incentives in Australia.

While Project Victoria stands back from these broader tax issues in this Preliminary Report, we note that a broader strategy could also extend to tax reform, including the rationalisation of existing State taxes and charges, which are discussed in Chapter 5.

CHAPTER 1
Victoria in Perspective

If we are to change course it is necessary to understand why Victoria has in many ways "led" Australian into a recession.  Failures in Federal economic policies, notably high interest rates, were due to an unwillingness to tackle inflation until the current account and debt problems had become acute.  These policy failures created a difficult climate for all State economies.  Furthermore, the Accord appeared to preclude -- almost as a quid pro quo -- urgent micro reforms of the kind addressed in this Report and which Victoria seems to need more than most States.  As an example, privatisation strategies were rejected by some of the key parties to the "Accord", no doubt largely because private owners would be less tolerant of overmanning.

But the reason the business environment deteriorated even more rapidly in Victoria seems in large part because the pump-priming and interventionist policies of the Victorian Government created a perception that government would virtually underwrite economic performance in this State.  These false expectations may have led some businessmen and others to greater over-borrowing and over-spending than elsewhere.  Once the "guarantor" -- the purveyor of "Victoria -- the Next Step" -- was shown to be fallible, once many "winners" were found to be "losers", confidence collapsed.  Victorians had too many eggs in the government basket.

Nor was Victoria's economic performance in the 1980's as good as the Government has suggested.  Also, the public sector has performed badly, with inefficiencies and over-staffing in major services, poor financial results for trading enterprises and sharply reduced public sector capital expenditure.  Servicing costs on public debt are at record high levels.

Without major changes, the outlook is not encouraging.  But the "good news" is that adversity instils a resolve for change.  The community may accept, even demand, a coherent and strategic change of the Project Victoria variety, once the choices are fully understood.  Paradoxically, the wealthiest State in the once "Lucky Country" may now be more able to implement real change, because there is no alternative if we are to trade our way out of the current mess.

CHAPTER 2
Sorting out the Roles of Government and the Private Sector

The experience of recent years -- both in Victoria and elsewhere -- together with re-evaluations of past theoretical justifications of government intervention, indicate that government failure is more, not less, of a problem than market failure.  And whereas failed private enterprises fade away, courtesy of bankruptcy and changing consumer preferences for example, government business failures, funded by unwitting or powerless taxpayers, may sustain their inefficiencies and privileges for as long as the political process permits.  There is an inbuilt tendency for politicians to over-supply government services as a means of currying favour with the electorate, particularly to sectional or vocal pressure groups that do not necessarily perceive the broader community interest.  Also, the intrinsic difficulty in rewarding public servants according to performance creates problems in the operation of public enterprises.

This Project Victoria perspective provides:

• a basis for re-drawing the boundaries between public and private sectors and for introducing competition in the supply of services wherever possible;
• new techniques, such as franchising, contracting out, corporatisation and privatisation, while still leaving government an important vehicle for meeting social objectives;  and
• insights into the fact that earmarked government assistance for needy or disadvantaged groups will enable them to choose where money is spent, rather than be placed at the mercy of State departments and authorities which are constrained to meet what are fundamentally political objectives.

Improvements in technology also allow greater "unbundling" of government services into separate activities.  There is a sound rationale for vastly reducing the role of government in running businesses and in the direct provision of some other services.

CHAPTER 3
Budget Sector Spending

The performance of the State Government in providing traditional services through the Budget shows considerable evidence of government failure and "capture" by sectional interests.  Current government spending in three main areas (education, health and public transport) is significantly higher than the average of other States, and there is evidence that this is mainly due to over-staffing.

In the view of Project Victoria a careful reduction in spending of over $1 billion would be unlikely to reduce the quality of services, which could in any event be improved by qualitative policy changes, notably in education.  There may also be scope for "unbundling" some sections of these services to give an increased role to the private sector and to introduce a more competitive environment through, for example:-

• the provision of education vouchers available for use at schools of parents' choice;
• the contracting out to private hospitals of services for private patients of public hospitals;
• greater use of private transport services in regard to metropolitan and country passenger travel, and freight.

CHAPTER 4
The State Enterprise Sector

Competition is the key to ensuring that the services needed by people and business in Victoria are provided effectively and at least cost.  The most appropriate way of opening up State businesses may vary from case to case.  Where there are already a number of private competitors governments should simply vacate the field.  Where public enterprises are producing "in-house" goods and services for internal use, contracting out would increase competition.

Natural monopoly generally only applies to a part of a public enterprise's operations (for example, to electricity transmission but not generation) and competition is not necessarily precluded by it.  Competition may therefore result from an unbundling of separable activities and the imposition of common carrier requirements on the remaining natural monopoly component.

The introduction of private sector incentives is maximised where ownership of assets is transferred to private hands.  The profit motive, and the disciplines associated with the markets for shares, capital and managers, provide strong incentives to eliminate waste and inefficiency.  But, privatisation is only a means to an end -- the delivery of what users want, and at preferred quality and prices.

Where markets are not naturally contestable, the benefits from privatisation may be conditional upon the prior existence of an appropriate regulatory framework to prevent monopoly abuses.  The greatest need for this exists where existing government enterprises have a natural monopoly -- for example, tram lines, superior port docking facilities, electricity, water and pipeline grids.  But even natural monopoly elements can be subjected to competition, for example, by franchising out the operation of public infrastructure for specified periods (as with railway lines, or water and waste water services in thousands of municipalities in France).

For each public enterprise the Government should immediately form a Privatisation Committee, serviced by a specialist unit in the Government to make sure that the efficiency and other gains from privatisation would be obtained, and with external commercial expertise being used in the flotation process.  The experience of New Zealand and the UK can be drawn upon to avoid potential pitfalls.

The process of converting natural monopolies to private monopolies subject to regulatory constraint is more complicated.  The threat of regulation, or of other pro-competitive techniques, can be used to avoid the pitfalls of heavy handed regulation characteristic of the US, and more recently, the UK, utility industries.  In each case there will be a need for careful attention to the processes whereby the community interests are protected while the potential for efficiency gains is realised.

The Recommendations of Project Victoria regarding state enterprises, in brief, are as follows:

• Natural monopoly assets of the Victorian Government, such as the SECV power grid, the GFCV gas grid, Met tram lines, VicRail lines and the water and waste water pipelines of the MMBW, all be transferred into distinct state owned corporations (VSOCs) which would operate under normal corporate law, subject to safeguards against abuse of monopoly power.
• The separate and contestable business enterprises of the SECV, Gas & Fuel, MMBW and State financial institutions such as the SIO and WorkCare, and most elements of Victorian port authorities and other contestable State business enterprises, be progressively sold to the private sector;
• Where possible, services provided using natural monopoly assets, such as tram lines, pipe lines and power grids be submitted to competitive franchise tenders, with the franchisor being the relevant VSOC.

CHAPTER 5
State Revenue

Given present national economic requirements, the Commonwealth Government is most likely to pursue policies designed to intensify the pressure on the States to reduce spending and improve public enterprise efficiency.  It is unlikely therefore to cede a major new State tax power or to give States greater scope for borrowing.  Accordingly, while it would be desirable to reduce the vertical imbalance between the Commonwealth and the States, this goal is unlikely to be achieved in the immediate future.  In these circumstances, the Victorian Government should not put any reliance on a substantive change in Federal-State relations.

Rather, the focus should be on reducing the overall burden of Victorian taxes, which has increased from 4.7% in 1981-82 to nearly 6% in 1990-91, cuts being effected through expenditure reductions and other efficiency measures.  The overall severity of taxes is higher in Victoria than the States' average, although it may be fractionally lower than in NSW.

There is also a need to exert greater discipline on the propensity of State politicians to increase State taxes.  Moves to a Federation Budget (thus including the States more into national economic management) and improvements in State budgetary and other financial information would help.

Constitutional constraints on State tax increases would be highly desirable if States were to be given access to a new broad-based tax.

Unless States are given such access, they are largely "stuck" with the existing State tax "mix".  While there could be benefits from some changes in the structures of State taxation, the practical opportunities are very limited.

CHAPTER 6
Borrowing and the Burden of Debt

The Victorian Government faces a serious debt problem.  The cost of debt servicing, now taking about 22% of public sector revenue, is the highest among the States and is more than double the average for the States.  Estimated interest payments in 1990-91 of $3.4 billion are more than total estimated expenditure on health, social security and welfare combined -- and $800 million more than for the much larger State of NSW.  Further, even though the burden of debt itself has fallen since 1986-87, the interest burden has increased significantly since then.  Moreover, given that capital spending has also been financed by quasi-borrowings, the published figures do not tell the full story.

The ABS official net debt figures show public sector debt at over $27 billion at 30 June 1990 (over $1 billion more than the Victorian Government figures).  However, if unfunded superannuation liabilities are included, along with other quasi-debt, our estimates are closer to $50 billion.  The real figure could be higher.  In addition, contingent liabilities, excluding those in respect of the now sold State Bank, amount to over $23 billion, almost three times higher than three years ago.

The continued high reliance of the Victorian Government on debt finance has been particularly inappropriate in the 1980's, given the shift to high positive real interest rates and the apparent inefficient use of capital, as reflected in public enterprise losses running at around $1 billion p.a. and an increased resort to "social" (i.e. non-revenue earning) capital expenditure.  This has left the "present generation" of Victorians bearing the burden of higher taxes and facing the prospect of lower standards of services.  Far from being "fair" on the present generation, as the Government claimed, this is a cause for resentment that is creating political instability.

Although the Government has now acknowledged the need for a fundamental change in resort to borrowings, the reliance on asset sales for reducing debt fails to go to the heart of the problem and will be difficult to sustain.  The possibility of an extended period of slower growth in Victorian revenues will also make it difficult to maintain lower deficits without other policy changes.  In addition, the current relatively low level of public fixed capital expenditure will not be sustainable.  However pressures to again increase borrowings would conflict with Commonwealth macro-economic policy objectives.

Top priority should now be given to stopping the further growth of public sector debt, by bringing public sector receipts and expenditures into balance, without relying on asset sales, (whose proceeds should be used to retire debt), and without increasing taxes.

The next step would then be to move into surplus.  The aim should be to gradually reduce debt represented by "social" capital expenditure.  However, if it is necessary to borrow temporarily to finance redundancy payments arising from spending cuts, that would be well justified.

There also needs to be a change in the role of public sector borrowings and in the capacity of Victorian and other State Governments to undertake such borrowings.  In particular, more needs to be done to prevent politicians succumbing to the strong temptation to resort to borrowings to finance expenditure that will result in short term electoral support.

The success of the balanced budget requirements in the States of the US, as well as the poor fiscal performance of the Victorian and other Australian State Governments over the last decade and the weakness of other fiscal disciplines, strongly suggest the desirability of an amendment to the Victorian Constitution to require a balanced budget.  The precise form of such an amendment would require detailed examination and community debate.  We propose that the Government issue a Green Paper on the matter in the first instance.