Importance of Efficient Public Investment
and Public Investment Management:
Experience of Australia
Carl Toohey
Productivity Commission
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
Productivity Commission
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
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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
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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)
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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
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One geography, two sovereign levels of government
Northern
Territory
Western
Australia
National reform
requires
cooperation across
jurisdictions
Queensland
South
Australia
New South
Wales
Victoria
Australian
Capital
Territory
Tasmania
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Website
Our publications can be accessed at
www.pc.gov.au
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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)
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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
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Benefits of Reform: Labour Productivity and
Multifactor Productivity (Labour + Capital)
110.0
Index (2008-09 = 100)
100.0
Multifactor Productivity
90.0
80.0
70.0
60.0
Labour Productivity
50.0
40.0
7 4 -7 7 -8 0 -8 3 -8 6 -8 9 -9 2 -9 5 -9 8 -0 1 -0 4 -0 7 -1 0
73 9 76 9 79 9 82 9 85 9 88 9 91 9 94 9 97 0 00 0 03 0 06 0 09
9
1
1
1
1
1
1
1
1
1
2
2
2
2
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Benefits of reform: GDP per capita
Australia’s international ranking in terms of GDP per capita
1
Australia ranked
4th in 1950
2
Australia ranked
3rd in 2010
3
4
5
6
7
8
9
10
11
12
13
Australia ranked
14th in 1983
14
15
16
1950
1955
1960
1965
1970
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1975
1980
1985
1990
1995
2000
2005
2010
11
3. Achieving good public investment outcomes
1. Use principles of good public policy in
allocation scarce public capital
2. Use open and transparent processes
to determine priorities
3. Undertake rigorous, evidence-based
analysis
Good public
investment
outcomes
4. Employ strategies to facilitate reform
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Principles of good public policy
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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 underutilised 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
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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
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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
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Open and transparent processes
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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
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Example of a Productivity Commission public
inquiry process
July 2010
Terms of Reference
Initial consultations
(informal)
September 2010
Issues Paper
Roundtables
October 2010
Nov - Dec 2010
Draft report released
13 April 2011
Draft report
submissions
May - July 2011
Draft report
public hearings
May - June 2011
Final report delivered
to government
31 August 2011
Public submissions
Initial public hearings
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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
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Rigorous, evidence-based analysis
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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
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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
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Strategies to facilitate reform
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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
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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
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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
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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
Productivity Commission
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
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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
Storage levels of Melbourne's reservoirs
100
Flow (GL/Year)
90
80
70
60
50
40
30
20
10
0
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
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Key problems identified
• The existence of multiple and conflicting objectives
• Costly water restrictions and consumption targets
− Lost value of consumption greater than $1 billion per year
• Costly conservation measures
− Rainwater tanks, low flow shower heads, water recycling
− Cost of water saved through installation of rainwater tanks is about
ten times the price of water
• Too great a focus on addressing affordability by distorting
prices
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Key problems (continued)
• Deficient operational and investment practices for some
regional utilities
• Constraints on efficient water resource allocation and supply
augmentation decisions
− ‘Policy bans’: Rural-urban trade, Recycled drinking water, Aquifers
− Limited application of ‘real options’ approach to planning and
investment
• Too much focus on investment in new desalination plants
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Investment in desalination plants
Initial
capacity
Maximum
expandable
capacity
Initial (and
expandable)
capacity as a
percentage of
annual
consumption in
2009-10
Investment
cost
GL/year
GL/year
%
A$m
90
180
18 (36)
1 890
2010
150
200
43 (57)
3 500
2012
49
25
1 200
2009
100
80
1 830
2012
45
18
387
2006
Perth (Binninyup)
100
40
1 400
2012
Total
534
35 (45)
10 207
Units
Sydney (Kurnell)
Melbourne (Wonthaggi)
South-east Queensland (Tugun)
Adelaide (Port Stanvac)
Perth (Kwinana)
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Year
on
line
33
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)
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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
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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
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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
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What we were asked to do (Terms of Reference)
• 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
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Transportation of electricity
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The need for reform
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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
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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
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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
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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
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Conclude
• Thank you for your attention
• Questions
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