Productivity Commission Carl Toohey Productivity Commission Australia Presentation at the Central Institute For Economic Management Workshop on capacity.

Productivity Commission

Carl Toohey


Australia

Presentation at the Central Institute For Economic Management Workshop on capacity building to improve appraisal of public investment projects in Vietnam

An APEC-funded project

Nha Trang, Vietnam, 30 September –2 October 2013

Importance of Efficient Public Investment and Public Investment Management:

Experience of Australia

Productivity Commission 2

Outline of today’s presentation

• About the Productivity Commission• Short history of economic reform in Australia and its benefits• Framework used by the Commission to help improve decision

making that can be applied to public infrastructure issues• 2 examples of recent Commission work on infrastructure

issues in Australia− Urban water

− Electricity transmission and distribution


Importance of this topic

• Focus is on getting the policy and decision-making processes right to improve public investment across and within sectors of the economy

− This is particularly important where there are multiple infrastructure priorities, and limited funds available to governments

• A key message is that public investment should be productive and economically efficient so as to maximise net benefits (benefits less costs) to the community as a whole


1. About the Productivity Commission

• The Productivity Commission is the Government’s principal review and advisory body on microeconomic policy reform and regulation

• Our role is to promote better informed policy decisions through independent, published analysis and advice

• The Commission has a long history of providing advice and reviewing key infrastructure sectors in Australia

− Water, Electricity, Telecommunications, Gas, Airports, Rail, Ports

− Performance monitoring of government trading enterprises (1991-2008)


Three key operating principles enshrined in the Productivity Commission legislation

• Independent analysis and advice− Statutory agency with Commissioners

− ‘Arm’s length’ from government

• Processes and reporting are open and public− Hold public hearings and roundtable discussions− Receive submissions, which are published on the internet− Analysis and advice is exposed to public scrutiny

− Publish draft and final reports, including modeling

• Community-wide perspective− Examine impacts of policy on the welfare of the whole community,

rather than just particular industries or groups


One geography, two sovereign levels of government

WesternAustralia

NorthernTerritory

Queensland

SouthAustralia

New SouthWales

Victoria

Tasmania

AustralianCapitalTerritory

National reform requires

cooperation across jurisdictions


Website

Our publications can be accessed at

www.pc.gov.au


2. Economic reform in Australia (since the 1980s)

• Since the 1980s, there has been sustained and comprehensive economic reform in Australia. This includes:

− Monetary policy, fiscal and exchange rate policy, capital markets

− Trade and foreign investment liberalisation

− Taxation, Labor markets and industrial relations

− Utility reform (electricity, gas, water, rail, road, ports, telecoms)

− Competition policy (including reform of Government Trading Enterprises, and third party access to essential facilities)

• New National Reform Agenda

− Human capital (education, health, ageing)


Benefits of reform

• Reforms improved productivity by encouraging

− A better allocation of resources

− Improved economic efficiency of utilities sectors

− Opening up of economy to overseas trade and investment (trade intensity of Australian economy increased)

− Enhanced domestic competition

• As a result of reform the Australian economy became more flexible, resilient and adaptable to external shocks.

• However, the reform task in Australia remains ongoing and many challenges remain, including on infrastructure issues


Benefits of Reform: Labour Productivity andMultifactor Productivity (Labour + Capital)

40.0

50.0

60.0

70.0

80.0

90.0

100.0

110.0

Ind

ex (

2008-0

9 =

100)

Multifactor Productivity

Labour Productivity


Benefits of reform: GDP per capita

Australia’s international ranking in terms of GDP per capita


3. Achieving good public investment outcomes

Good public investment outcomes

1. Use principles of good public policy in allocation scarce public capital

3. Undertake rigorous, evidence-basedanalysis

2. Use open and transparent processes to determine priorities

4. Employ strategies to facilitate reform


Principles of good public policy


Identify objectives for public investment

• Identify the objectives• Focus on economic efficiency

− Delivery of utility and infrastructure in an economically efficient manner to maximise net benefits to the community

• Avoid non-economic objectives− Using investment to achieve non-economic objectives (such as income

redistribution, creating jobs) comes at a cost− Services likely to cost more for users, or the investment may be under-

utilised because of insufficient demand− Acts as a drag on the productivity of the economy by diverting scarce

resources from potentially more productive activities− Consider the use of other tools


Identify the problem

• Identify the infrastructure bottlenecks or deficiencies

• Establish why public investment is required

− Governments should not address problems until a case for action has been clearly established

− Not all infrastructure issues are best dealt with through government investment, source of the problem may lay elsewhere

− Government policies, such as pricing or other regulation, may be acting as impediments to efficient and least cost infrastructure provision


Identify the options for improving provision

• Identify the options− Define a broad set of policy and investment options− Assess whether they actually address the infrastructure problem− Using appropriate frameworks, assess the benefits and costs

(including administration and compliance costs) and the risks

• Select the best options− Consider options as part of an integrated infrastructure portfolio− Prioritize those options that generate the greatest net benefits− Implement options to maximize net benefit to the community, subject

to the budget or capital constraint

• Monitor and review the performance of the investment


Open and transparent processes


Open and transparent processes

• Making public investment choices under a capital constraint is difficult, gaining public support can be useful

• Open and transparent processes (and community consultation) can be important for establishing support for the program

− Stakeholders may provide varied perspectives on infrastructure issues, and suggest varied solutions

− Feedback on recommendations may prevent implementation issues

• Productivity Commission processes and reporting arrangements are open and public

− Analysis and advice is exposed to public scrutiny


Terms of Reference

Issues Paper

Initial consultations (informal)

Public submissions

Initial public hearings

July 2010

September 2010

Roundtables

October 2010

Nov - Dec 2010

Draft reportpublic hearings

Draft report released13 April 2011

Draft report submissions

31 August 2011

Final report delivered to government

May - June 2011

May - July 2011

Example of a Productivity Commission public inquiry process


Championing the benefits of the program

• Governments have an important role to play in providing leadership for determining efficient and effective provision of infrastructure

• Institutions like the Central Institute For Economic Management can play an important role in supporting the leadership of governments

• It is critical to educate and inform the public about the need for (and benefits and costs of) the public investment program and who pays for provision, so that they better understand what is at stake and why it is in the national interest


Rigorous, evidence-based analysis


Adopt an ‘economy-wide’ approach

• Adopt an ‘economy-wide’ focus and framework when assessing potential policy measures and public investment options

− Consider outcomes/impacts on all sectors, groups and individuals

− Particularly important when a group that stands to benefit (or lose) significantly is well defined, well organised, and vocal


Use of evidence-based analysis

• Undertake rigorous, evidence-based (quantitative and qualitative) analysis of the efficiency, equity and risk impacts across the economy

− Draw on lessons and experience from other regions or sectors

• Make use of appropriate economic concepts, tools and frameworks

− Modelling has an important role to play− Economy-wide models can be particularly useful for evaluating large

and complex packages of public investment in infrastructure− Use of rigorously applied cost-benefit analysis to help identify and

prioritise public investment priorities


Strategies to facilitate reform


Identify and deal with barriers to efficient investment programs directly

• Anticipate and manage barriers to implementing efficient investment programs

− The costs of change are often concentrated on particular groups, whereas the benefits are more diffuse

− The potential winners from change tend to be (rationally) poorly informed relative to the losers

− The costs of change tend to be front-loaded, whereas the benefits arise over long time periods

• (In Australia’s case), multiple jurisdictions and levels of government can increase the difficulty of achieving a nationally consistent approaches


Develop appropriate assistance measures to deal with affordability or income redistribution concerns

• Universal assistance measures are available across the community (via the tax and transfer systems) subject to eligibility criteria

• Such measures are the preferred mechanism for addressing affordability concerns from change

− Individuals in similar circumstances are treated similarly− Assistance is targeted at need, whatever the cause− Addresses the net effects, after all changes are taken into account− Supports individuals and families rather than a particular industry

• However, targeted transitional assistance might be efficient in some circumstances


4. Key insights from recent work by the Commission

• Recent work undertaken by the Commission will hopefully provide some useful insights into the types of issues and challenges being considered in Australia

• The two examples I would like to briefly talk about today are in the water and electricity sectors

• This is not intended to be a comprehensive summary of these reports, rather to outline some of the key insights of relevance to the framework


Australia’s Urban Water Sector

www.pc.gov.au/projects/inquiry/urban-water/report

The purpose of presenting this case study is to illustrate the

application of the framework for a sector in Australia


What we were asked to do (Terms of Reference)

• Examine the case for microeconomic reform in Australia’s urban water sector

• Identify opportunities for improving resource allocation and efficiency

• Provide options to achieve these efficiency gains (with cost benefit analysis to be applied)

• Propose a work program including

− Priority areas

− Plans for implementation


The context for reform

• Reform has occurred over the past 25 years• The sector has been under stress in recent times− Unexpected severe prolonged low rainfall/inflows, followed by recent

floods in some areas (eastern Australia)− Demand growth, Ageing infrastructure


Key problems identified

• The existence of multiple and conflicting objectives

• Costly water restrictions and consumption targets

− Lost value of consumption greater than $1 billion per year

• Costly conservation measures

− Rainwater tanks, low flow shower heads, water recycling

− Cost of water saved through installation of rainwater tanks is about ten times the price of water

• Too great a focus on addressing affordability by distorting prices


Key problems (continued)

• Deficient operational and investment practices for some regional utilities

• Constraints on efficient water resource allocation and supply augmentation decisions

− ‘Policy bans’: Rural-urban trade, Recycled drinking water, Aquifers

− Limited application of ‘real options’ approach to planning and investment

• Too much focus on investment in new desalination plants


Investment in desalination plants

Initial capacit

y

Maximum expandable capacity

Initial (and expandable)

capacity as a percentage of

annual consumption in

2009-10

Investmentcost

Yearon

line

Units GL/year GL/year % A$m

Sydney (Kurnell) 90 180 18 (36) 1 890 2010

Melbourne (Wonthaggi) 150 200 43 (57) 3 500 2012

South-east Queensland (Tugun) 49 25 1 200 2009

Adelaide (Port Stanvac) 100 80 1 830 2012

Perth (Kwinana) 45 18 387 2006

Perth (Binninyup) 100 40 1 400 2012

Total 534 674 35 (45) 10 207


Costs of misdirected investment

• In Melbourne and Perth, (modelled) $3.2-4.2 billion loss in NPV of community welfare over 20 years

• In Melbourne, (modelled) $229–736 million loss in NPV of community welfare over 20 years from policies to use new desalination plant, not use the new Sugar Loaf pipeline, and proceed with new water recycling projects

• In Adelaide, purchasing Murray River water offered large advantages over desalination (up to $1.6 billion capital saving plus other benefits)


Some of the proposed reforms

• Overarching objective for all utilities of providing water services that maximise net benefits to the community

• Limit use of water restrictions• Improve pricing regime

− Move from regulatory price setting to price monitoring− Encourage more cost-reflective pricing− Use the tax and welfare systems to achieve affordability objectives

• In metropolitan areas, improve allocative and productive efficiency by introducing contestability

• In regional areas, aggregate small utilities to exploit economies of scale


Proposed reforms (continued)

• Improve supply augmentation decisions− Consider the costs and benefits of all supply augmentation options

using a real options approach− Make information on costs, risks and benefits to consumers of all

supply augmentation options publicly available− Remove bans on particular resource allocation and supply

augmentation options

• Make retail-distribution utilities responsible for service delivery, including procurement of supply

− Subject to security-of-supply standards set by government− These utilities might be owned by state or local governments

• Monitor the performance of utilities, and the progress of reform


Australia’s Electricity Transmission and Distribution Network

http://pc.gov.au/projects/inquiry/electricity/report

The purpose of presenting this case study is to illustrate the

application of the framework for a sector in Australia


• Examine existing regulatory arrangements for electricity in the National Electricity Market (NEM)

• Specifically examine:− The use of benchmarking to enhance

efficiency− Whether the current regime is

delivering efficient investment in interconnectors

What we were asked to do (Terms of Reference)


Transportation of electricity


The need for reform


Key problems

• Current regulation and policy approaches create incentives for inefficient investment

− Current ‘incentive based’ regulation encourages network businesses to build too much

− Some current infrastructure inefficiently utilised − Reliability standards are prescriptive

• Some consumers are forced to pay for higher reliability than they value

− Reliability standards do not reflect consumer preferences− Few consumers face time-of-use pricing− A large share of retail electricity bills (25% in NSW) is required to

meet approximately 40 hours of very high demand each year


Key problems (continued)

• State-owned network businesses have conflicting objectives, which reduces their efficiency

• In the presence of congestion, current pricing regulations encourage strategic behaviour

− This can lead to short-term productive inefficiency as high-cost generators are dispatched to meet demand

− The long-term effects are greater, and include inefficient generator location and network investment

• Progress in implementing electricity network reform is slow


Some of the proposed reforms

• Modified reliability requirements to promote economic efficiency

• More efficient planning process for large transmission investments (including a full cost benefit analysis for larger investments and consideration of system-wide impacts and efficiency)

• A suite of reforms to improve demand management, including (over time) the introduction of time-based pricing for critical peak periods


Proposed reforms (continued)

• Clarify the objectives for state-owned network businesses, and remove non-commercial objectives

• Phase in alternative pricing regimes to discourage strategic behaviour by generators in the presence of congestion

• Speed up the reform process by applying tighter implementation timetables

• The potential gains from reform are significant


Conclude

• Thank you for your attention

• Questions

Productivity Commission Carl Toohey Productivity Commission Australia Presentation at the Central Institute For Economic Management Workshop on capacity.

Documents