Executive Development
Programme for Senior
Government Officers
The Economic Basis of
Public Policy
Microeconomic perspective
1
EDPSGO 2005
Dr Roger Lawrey
2
EDPSGO 2005
Part One: An Introduction to Economics
and to the Brunei Economy
Part Two: The Economic Basis of Public
Policy
Part Three: The Economic Rationale for
Privatisation in Brunei
Dr Roger Lawrey
3
What is Economics?
“Political Economy or Economics is a
study of mankind in the ordinary
business of life; it examines that part of
individual and social action which is most
closely connected with the attainment and
with the use of the material requisites of
wellbeing"
Alfred Marshall
Dr Roger Lawrey
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The most fundamental
concept
Because resources (time, money, oil etc)
are limited, using them in one way
precludes using them in any other way.
“Opportunity cost” is the forgone benefit
from not using a resource in its best
alternative use.
Dr Roger Lawrey
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What is economic welfare?
Somewhat philosophical, but generally to
do with the “well-being” achieved from
economic activity.
Economic welfare could include:
Real Gross Domestic Product (GDP),
household production, leisure time, economic
equality (absence of poverty), environmental
quality.
Dr Roger Lawrey
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What is GDP?
The market value of all final goods and
services produced in an economy in one
year.
Real GDP: GDP adjusted for inflation so
that it reflects changes in production, not
just prices
Real GDP per capita: GDP divided by
population.
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Trend real GDP
Over the long-run real GDP increases
because:
Growing population
But this will put downward pressure on per capita
GDP
Growing stock of capital equipment
Growing stock of human capital
Advancing technology
Dr Roger Lawrey
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Brunei per capita GDP at
current prices
1983
1984
1985
1986
1992
1998
2003
-
B$39,629
B$38,167
B$35,544
B$22,805
B$24,570
B$21,111
B$23,615
Problem 1.
Volatility of oil prices
Problem 2.
Calculations
Problem 3.
Over-reliance on oil
and gas
Dr Roger Lawrey
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Brunei Citizen and PR only
2001 Population
Age Group
15-24
25-34
35-44
45-54
55-64
TOTAL
47017
36419
31289
20779
9892
145396
Labour
Participation
force
rate
18662
29097
23917
14170
2667
88513
39.69%
79.90%
76.44%
68.19%
26.96%
Note this is unofficial data. The participation rate is the percentage of the
population that is employed or actively seeking work
Dr Roger Lawrey
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Brunei Citizen and PR only
2011 Population
Age Group
15-24
25-34
35-44
45-54
55-64
TOTAL
60285
47017
36419
31289
20779
195789
Labour
Participation
Force
rate
23928
37564
27838
21337
5602
116270
39.69%
79.90%
76.44%
68.19%
26.96%
Note: these are my calculations, not official. Everyone is 10 years older in
2011 than in 2001. The 15-24 age group shown here was 5-14 at the 2001
census. We will need nearly 28,000 more jobs in 2011 than in 2001.
Dr Roger Lawrey
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The Brunei Public Sector
For year 2003
(Department of Economic
Planning and Development, Prime Minister’s Office
(2003) Brunei Darussalam Statistical Yearbook)
Provisional data.
2003 GDP $8,236.9 million
2002 GDP $7,651.7 million
Government expenditure 2002
$4,736.14 million: 62% of GDP
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The Brunei Public Sector
Public Expenditure 2002 (Four largest
departments)
Education 10.4%
Defence 8.6%
Health 4.4%
Public works 3.1%
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The Brunei Public Sector
Revenue (2002)
$4,267.83 million of which
Duties, taxes and licenses 54.6%
Revenue from government property
38.3%
Commercial activities 6.7%
Other 0.4%
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The Brunei Public Sector
Revenue breakdown
(Department of Economic
Planning and Development, Prime Minister’s Office
(2004) Brunei Economic Bulletin Volume 3, Issue 1)
Data for Q1, 2004
Total revenue $1,398 million
Oil and Gas contribution $1,240.5 million of which:
taxes $758.4 million
royalties $160 million
dividends $322.1 million
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EDPSGO 2005
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What is social welfare?
Social welfare is the concept of the
general level of well-being of an
individual, family or society. It includes
economic welfare, plus health, peace,
justice etc.
If economic welfare increases and there are
no other negative effects, social welfare will
also increase.
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In practical terms
Thinking economically means thinking
about how we can increase economic
welfare
Because resources are, usually, limited,
actions will have both benefits and costs,
even if these are opportunity costs
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In practical terms
Think in terms of maximizing net benefits
Think at the margin.
Incremental benefits and incremental costs
of a change
JPMC
Short-run and long-run decisions
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The case for policy
intervention
National Development Plans
Promoting and controlling development that
is not happening in a free market
Market failure
When markets don’t maximize economic
welfare
Monopoly, other forms of market power,
externalities, public goods.
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The basis for policy
recommendations
If a problem is perceived to exist (markets
have failed, maximum net benefit is not
being achieved) then government should
intervene.
Economics is then concerned with finding
the “best”, most efficient solution.
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Some policy instruments
Regulations backed by penalties
Control of prices, volume of production,
imports/exports, rates of return on investment,
entry of firms to an industry, licensing, output of
pollutants
Public enterprises/direct provision
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……. Policy instruments
Criteria for evaluation of policy
instruments (Field 1995)
Efficiency (and cost effectiveness)
Fairness (equity)
Incentives to innovate
Enforceability
Morality
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Three examples
Externalities
Public goods
Natural monopolies
Externalities are effects from economic activity
that are external to all the direct parties of the
activity.
A negative externality imposes an external cost
• Pollution
A positive externality results in an external benefit
• Education
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Externalities
Pollution is a cost of economic activity
borne by those not involved in the activity
The result:
Too much output of the polluting good at too
low a price
The solution?
Regulation, taxes, property rights/permits
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Public goods
Rivalry (exhaustiveness)
Excludability
High
Low
High
Private good
Toll good
Low
Common
Pool good
Public good
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Toll goods
These goods can be provided by the
market because they are excludable. It
may be unfair to provide them out of
general government revenue (everyone’s
tax payments) when only some people
use them. User pays principle.
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Common pool goods
The danger is that, unregulated, these
good will be depleted. There will be over
use.
The solution is to make them private
goods by issuing licenses, quotas etc as a
form of property right. This gives owners
the incentive to conserve.
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Public goods
Pure public goods will not be provided by
the market because they are
non-excludable (provide for one and you
provide for all)
non-exhaustible (one person’s consumption
does not reduce amount available for others)
Examples……….
Community service obligations
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Natural monopolies…….
Defined as having continually declining
costs over the whole range of output
covered by the market demand curve.
Per unit
cost of
production
Quantity
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……. Natural monopoly
Examples of natural monopolies are firms
with large fixed costs such as water,
telephony and electric utilities.
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……. Natural monopoly
What is the rationale for government
ownership or control of natural
monopolies?
To avoid wasteful duplication of facilities
One supplier has lower costs than two or
more suppliers
Because without government involvement the
industry would monopoly price
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……. Natural monopoly
Is this monopoly pricing desirable from
society’s point of view?
No,
supernormal profits may be made
too little output
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……. Natural monopoly
So, with natural monopolies, traditionally
governments have either left them
privately owned but heavily regulated (US,
Canada)
or had them owned and operated by
government - “public ownership” (UK,
Europe, Australia, Brunei)
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EDPSGO 2005
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Negative aspects of
government ownership
Crowds out private sector
Legislated monopoly
State-owned enterprises get preferential
treatment from government
Output subsidized so private firms cannot
compete
Incomplete accounting of costs and revenues
Poor performance (low productivity)
Dr Roger Lawrey
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Privatization
What is the rationale for privatization?
Improve efficiency by exposure to
competition
Improve government fiscal position
Allow use of private sector capital
Less natural monopoly than imagined. For
example, electricity generation
Access to natural monopoly facilities without
duplication.
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Efficiency
Technical efficiency refers to getting the most
output per unit of input. Production efficiency
refers to producing at lowest per unit cost
Does private ownership on its own result in
efficiency?
What about competition?
What impact does greater efficiency have on
costs per unit?
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Government fiscal position
Fiscal considerations may be just shortterm.
Price should reflect future earnings
low earnings = low price
high earnings = high price but future
earnings are forgone
Can private firm transform low earnings into
high earnings?
Dr Roger Lawrey
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Private sector capital
Private firms can tap huge global financial
markets, which may be needed for
investment
Government agencies may be restricted to
applying for government funds
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Natural monopoly or not?
The extent of natural monopoly may have
been exaggerated.
Some aspects of industries may be natural
monopolies and others not, e.g. in
electricity, only the transmission and
distribution networks are now considered
natural monopolies
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Duplication?
An appropriate access regime allows
competitors access to essential facilities
without duplication, e.g. telephone lines.
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Negative aspects of
privatization
Private monopoly may be worse than
government monopoly (regulation)
Country may lose control of the pace
and direction of development
Prices may increase
Jobs may be lost
Maintenance may be insufficient to
meet profit targets (see Energex)
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The Brunei case
Is competition possible?
Is regulation
feasible?
economical?
Is increased efficiency possible with
government ownership?
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Contracting out or internal
organisation?
Costs of internal organization
Offices,
secretaries,
administrators,
human resource managers
pensions
bureaucracy, inefficiency?
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Internal organisation
Benefits:
workers have no direct claim to profit (2
divisions of same firm)
less self-interested behaviour?
Feeling of belonging to organisation may
induce cooperative behaviour
Internal auditing
Management can resolve disputes between
divisions
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Contracting out
Costs
costs of searching for suitable suppliers and
choosing between them
lack of performance due to incomplete
specification of contracts
breaking a contract and subsequent actions
monitoring costs
loss of knowledge by not learning by doing
potential for corruption
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Contracting out
Benefits:
cost of internal organisation saved
promotion of private enterprise
development of other related skills
entrepreneurial, managerial
secondary effects may be greater than those
when a function is done internally
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The value of an enterprise
to society
Society = the enterprise, consumers,
the government
The enterprise variable is net profit
The consumer variables are price and
output (quantity and quality)
The government variables are required
subsidies or net tax revenue
Jobs?
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