Address to APEC Infrastructure Symposium
13 December 2000
Standing here in front of so many distinguished people from many countries on the day the new leader of the world is decided is humbling. So much so that when I thought of ways of dignifying this lunch with some deep aphorism, I reached for a quote from George W Bush. One that fits the future that this conference is looking towards was made two years ago when the president said,
"I believe we are on an inevitable trend towards more freedom and democracy -- but that could change". The trend is, after all, evitable.
There are a great many issues regarding infrastructure that are being aired today and tomorrow. By its nature, infrastructure is the building block on which prosperous modern societies rest. I want to address two prime matters in that provision.
The first of these is whether provision should be by the public sector or by private enterprise, and I know there is far from a clear dichotomy between the two.
Secondly, I want to talk about governance of the "essential facilities" or natural monopolies that infrastructure very often means.
PRIVATISATION
Australian competition reform commenced under a Commonwealth Labor Government. Although it may have been senescent in its ability to handle the budget that government proved remarkably inventive in obliterating the sanctuaries from competition that had shielded government monopolies. For ideological reasons the Labor Party prefers to pretend that ownership is not important, that properly focussed government owned firms can perform just as well as private firms.
In fact, the theory and outcome proves just the opposite.
Private firms operate more effectively because they need to do so. Their management is under constant surveillance either by the stock market and ratings agencies or by an equally focussed parent company.
Public sector firms, by contrast, are often responsible to nobody in particular. Governments of both political persuasions often use them as resting places for political allies. NSW has tried to ensure its corporatised businesses are responsibly managed but even so has installed a variety of ex Labor politicians and even an ex-Communist wannabe federal politician on their boards.
Sometimes such appointees have considerable influence. Thus, the management of the largest NSW electricity distribution business, conscious of a need to keep cost competitive with the nimble privatised Victorian competitors, recommended a strategy that would have halved the workforce. The public sector-oriented board had a better idea -- save money by getting rid of a management that would prune so many union members. On an even grander scale, public corporations acting with undue lack of restraint resulted in the debacles in the early 1990s when State corporatised businesses in Victoria, South Australia and Western Australia racked up such losses that they brought down the Labor Governments.
At other times there is a lack of commercialism on the part of the management. Some see evidence of this in the disastrous contracting that one of the NSW generators engaged in with a Victorian private retailer, losing somewhere between $300 and $500 million. State politicians are also liable to interfere to the detriment of the businesses. For example, one of the NSW generators was seeking to buy its own coal supply but the government vetoed this when it realised that the intention was to make some economies that would involve reducing the labour force.
But profligacy is not necessarily the hallmark of government owned businesses. Indeed, the normal behaviour is excessive caution due to the vast number of restraints the businesses have imposed on them by governments constantly worried about the political fall-out if one of their businesses goes bad. This adds a domain that is not present to anywhere like the same degree with privately owned businesses.
What we have seen with the infrastructure that has been privatised in Australia is a vast carving out of excessive costs and innovations that were not considered possible. In the case of electricity, we have seen generation businesses increase their availability to operate from 70% when they were run as an arm of government to the dizzy heights of 85% as corporatised entities and up to 95% since privatisation. We have seen distribution businesses branch out into telecommunications, activities that would have surely not been allowed of a state controlled enterprise. We have seen with Melbourne's City Link one of the most innovative road projects anywhere in the world.
It has been argued that the private prisons in Victoria have not performed well. This would need to be tested. But it is clear that private prisons in North America have proved so cost effective that few states are building any public ones now.
In short, however infrastructure is defined, the case for it being privately owned is unassailable. Private ownership means:
- reduced susceptibility to political arm twisting inhibiting flexibility and adding costs
- management responsible to the sea of shareholder, predators debt holders and others all seeking to ensure their money is safe and getting the best possible return; important in this respect is the market for corporate control -- a below par firm will see its share price deflated to such a level that it becomes vulnerable to take-over or its parent, fearing for its own on-going existence will divest.
- the possibility of having diversity and limited experimentation; in electricity privatisation, some of the buyers have put, more management effort into retailing, others into lowering costs, others into diversification and others into seeking synergies with similar industries.
- privatisation with overseas ownership, offers the possibility of leveraging off experiences to make innovations without suffering from the hard knocks that often accompanies such activity.
Corporatisation, the preferred approach in Australia for shifting businesses away from government oversight, barely makes a dint in the deficiencies of government ownership. Even though corporatisation means a board of directors operating under company law and making decisions accordingly, it is a bold Board that will take an issue at variance with the government's wishes. Thus, if a shareholder minister writes to the board drawing attention to the government's support of centralised wage bargaining rather than individual contracts, as the government of Queensland -- and probably NSW -- has done, I doubt the Board would give licence to the CEO to move ahead with individual contracts even though they may save 10% plus in labour costs.
Corporatisation can be a useful half-way house to privatisation where a previous state monopoly is being split into several entities which are placed in competition with each other with the objective of injecting some competitive tensions into the market. This is the approach used in those Labor controlled state governments with either an ideological aversion to privatisation or an inability unable to move because of their union support base.
But this still suffers from many of the disadvantages of public ownership. In addition, it places Minister-shareholders in impossible conflicts of interest. Rob Lucas, the South Australian Treasurer, tells of these when he was the shareholding minister of the five entities formed out of the previous electricity business. He relates that briefings at each of the businesses would often outline their capital investment plans to overcome a supply problem. Each business would have similar plans and if all were set in motion their goals would not be reached. But as a shareholder minister he faced a dilemma. On the one hand he was obliged not to divulge confidential information to competitors. And on the other hand he could see the potential for wasteful expenditure by concerns for which he was responsible. And a further more fundamental problem was that he was never quite sure whether the proposals he was hearing were those he had heard before from the business briefing him or whether it was from one that was ostensibly a competitor.
REGULATORY EXCESS
I have expressed concern at the imperialistic behaviour of Australian regulatory bodies. Those bodies, with the ACCC at the pinnacle, include the National Competition Council (NCC), State regulatory bodies like the Victorian ORG and some quasi regulatory bodies like the National Competition Code Administrator, NECA, with which I have an association.
While the two most important bodies, the ACCC and the NCC -- and particularly the latter -- have undertaken very useful work in promoting competition their zeal is undermining some of the very drivers that efficiently bring new infrastructure. Promoting competition can have adverse effects on efficient infrastructure development if the regulatory authorities insist upon conditions of access that the developer finds onerous. It is all very well to argue that extant facilities are best opened to all at prices that simply cover their marginal costs. However such approaches, even in a diluted form, will assure the goodies are not there to be shared in the first place. There is inadequate recognition of this by Australian regulatory bodies. Perhaps this is because they are loath to relinquish regulatory control. Indeed, they have sought to expand such control into new areas.
This is amply illustrated by Duke Energy's Eastern Gas Pipeline, which is now carrying gas between the Bass Strait and Sydney.
Under the national Gas Code, pipelines are generally envisaged to be natural monopolies. Their prices are regulated and they are not allowed to discriminate between potential users.
Two alternative regulatory routes are in place.
The first is through the National Competition Council (NCC). This establishes the need for regulation, then passes the baton to the Australian Competition and Consumer Commission (ACCC) to determine prices.
The alternative is for the ACCC to accept an "undertaking" by the pipeline owner on price and other conditions. At least according to the ACCC, this pre-empts the need for NCC involvement.
A fundamental issue with this important pipeline is why should there be any regulation at all? Its construction means there are two transmission pipelines serving the Sydney region, one from Bass Strait and one from the Central Australian Moomba field. Such rivalry is the very definition of competition, the absence of which provided the initial rationale for regulation.
The NCC however claims that the two pipelines both need to be controlled because they traverse different paths. But it is rarely the case that two competitive products are identical and if we were to use their differences to justify regulation, almost everything would be covered. Two robust competitors, as long as they do not collude, are usually sufficient to bring the required efficiency driving customer focus. With the Eastern Gas Pipeline and Moomba line, we have Coke versus Pepsi, Ansett versus Qantas. In such cases, as few as two rivals prevents price-gouging and promotes cost savings far more effectively than regulation. And it does so without the price distortions and paperburden costs that are inevitable with regulation.
The NCC further argues that even if the lines were parallel regulation would be necessary because each of the lines would have "market power"!
The distressing aspect of all this is the negative value the regulatory authorities add. If each new pipeline needs to pass an exhaustive regulatory review before it can seek customers, there will be far fewer pipelines built. Companies will be unwilling to leave their money hostage to an unnecessary regulatory regime and consumers will lose fuel choice options. Ironically, not only will this mean fewer opportunities for increased income but it will mean fewer competitive pressures.
The regulators' gas decisions are based on a misplaced assumption that pipelines are natural monopolies that can charge any price they choose. For a start, they are subject to competition from electricity and other fuels. Moreover, although the pipes are difficult to duplicate in full, they can be partially by-passed, thereby limiting their owners' pricing latitude. Curiously, the regulators cite possible "uneconomic by-pass" as a major reason to keep the price low. Yet the price cap they imposed does not prevent gas pipeline owners from reducing prices to meet competition. Regulators' suggestions that the avoidance of uneconomic by-pass is a reason for them to impose low prices implies a pompous self-deceit on their part. They are saying that the owners would be too stupid to determine for themselves when to meet a competitive threat with price action.
The ability of rival firms to by-pass existing lines and of rival fuels to win market shares provides strong disciplines on price gouging. It should be left to the competitive process as much as possible to drive down prices. Where a regulator attempts to do so, we run the risk of prices being set too low with inadequate incentive to upgrade and maintain the facilities.
Gas is not the only case where the NCC has sought to impose price reductions on private businesses where capital is sunk. It had previously tried to force Rio to open its railways in WA to a then competitive iron ore producer. In that case a rather strangely based legal decision and the eventual merger of the two firms thwarted it. But is seeking to force the opening of a privately built railway to a rival firm the way to encourage new infrastructure?
The NCC is dwarfed in importance by the ACCC as an Australian regulator. And the ACCC has its own ambitions to exercise control. This is illustrated in the spat it has with Telstra who hired Professor Ordover to examine the extent of the control. This was found to have increased from 38% to 76% of the firms' business.
Even if Professor Fels is correct in his retort that this increase is misleading as it occurred simply because of the commencement of regulatory control where none was needed previously, 76% of the telecommunications business is an awful large slice of a pie that has legions of new competitors entering the market.
Jim Hoggett has argued persuasively for a considerable trimming of the ACCC's regulatory powers in telecommunications. He points out it is an industry with no lack of new entrants and some of these are of a comparable or greater scale and technological sophistication as Telstra
He goes on to say "If there was a need five years ago for the current highly intrusive level of regulation then the operation of the regulation should have led by now to a point where some of it could be dismantled."
Contrary to this, the ACCC calls for further powers. Such calls suggest that the existing structure may be, perversely, generating its own amplification. The ACCC seeks the power to direct persons to do what it thinks would conform to competitive behaviour. An example might be a direction to enhance or replace technology. This is an astonishing expansion of government control and one that would considerably augment the ACCC's powers and bring unfortunate increases in bureaucratic controls.
These access matters, the general Part IIIA controls and the specific Telecom Part XI are presently before the Productivity Commission. In the interest of enterprise rather than the central planners seeking to assume control of infrastructure development and access, it is to be hoped that the outcome is a considerable diminution of the regulators' powers.
On that note let me finish with another quote from our new President. Governor Bush said
"We are ready for any unforeseen event that may or may not occur."
Well, there are so many unforeseen events that have occurred in American politics in recent weeks it is just as well some did not occur.
All I can add is my satisfaction at having a man in the White House who got there notwithstanding some human fallibilities rather than a man whose febrile imagination claimed credit for more inventions and insights since Gallileo and rivals the late President Ceausescu for claimed innovations.
Our regulators are no more infallible and for the most part have no business experience. We must ensure they do not prevent the beneficial operations of robust competition in the name of moulding the outcomes of that competition in their own image.
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