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Overview of CPDS Comments and Suggestions
The Productivity Commission's (PC's) draft discussion paper on National Competition Policy (NCP) reforms is a reasonable proposal within the bounds of its assumptions. It certainly is important to tidy up the loose ends of NCP and also to find better ways to reconcile market mechanisms with government involvement in areas such as health care and natural resource management.
However there are other more important issues that need attention to continue the process of plugging the gaps in Australia's market liberalization reforms which NCP started. This is because the basic philosophy of market liberalization reforms has been unbalanced, ie emphasis has been given to competition but not to the capabilities require to compete, and to quantitative gains (eg in efficiency) rather than to qualitative factors such as the effectiveness of economic systems as a whole, social equity and the competency of governments.
There are four key issues that should now be the centre a national reform agenda, namely:
The basis for these suggestions is that:
In June 2005 a continuation of the national competition policy reform agenda was reportedly endorsed by the Council of Australian Governments (CoAG) . This decision did not appear to be an adequate response to Australia strategic challenges.
This document presents comments and suggestions in relation to the Productivity Commission's (PC's) draft discussion paper on National Competition Policy (NCP) reforms which is outlined below.
The PC had been asked by the Commonwealth Treasurer to report on NCP reforms because of a decision by the Council of Australian Governments (CoAG) to undertake such a review by 2005. Furthermore the Prime Minister has reportedly indicated to the states that the PC's proposals are expected, when completed, to provide a framework for a future program of microeconomic reform .
In brief the thrust of the PC's discussion paper is that:
A Good Structure Built on Weak Foundations
Within the bounds of its assumptions, the PC's discussion paper is a broad ranging stocktake of issues related to Australia's economic reform which reaches sensible conclusions. It is an undoubted fact that:
However, while much has been achieved through market liberalization (including NCP), much has been lost unnecessarily.
The original purpose of NCP was to 'plug the gaps' in the market liberalization reforms which Australia had adopted in the 1980s (eg reduced barriers to trade, financial deregulation). Unfortunately there are huge gaps which currently need to be plugged which are even more important than those suggested in the PC's draft discussion paper.
For example NCP has emphasized the development of productivity by changes to government operations. Though the latter are the easiest part of the economy for the political system to influence, they are also the ones where it is hardest to get productivity gains and where the side effects of seeking to do so are likely to be most severe. It has not been sensible to do this without doing everything possible to increase productivity in the mainstream market economy where the potential for such gains is greatest.
The Inadequacy of Market Liberalization
The basic philosophy of market liberalization reform (including NCP) is flawed because introducing competition does not in itself ensure that the capabilities to successfully compete will exist or be created. This limitation is discussed in Defects in Economic Tactics, Strategy and Outcomes which particularly highlights:
The importance of systemic factors can be illustrated by the reported conclusion by a federal task force to examine infrastructure bottlenecks affecting exports, that it is more important to promote 'vertical' collaboration between export ports, road / rail linkages and port users than to regulate such ports to promote 'horizontal' competition.
A similar point can be made in relation to innovation. The PC's discussion paper correctly notes that competition provides the incentive for firms to innovate. But unfortunately competition is not sufficient to ensure their ability to do so, as success requires support from an effective innovation system (including, for example, financial institutions with appropriate skills, and a pool of persons with experience in business development). In practice, despite massive competitive incentives for business to innovate, Australia innovation ranking has been in decline (eg see Hart M., 'Our R&D left in the lurch', Courier Mail, 6/12/03).
The effect of market liberalization (including NCP) is thus to stimulate enterprises and individuals to seek to maximize their productivity as best they can within what may be an unsatisfactory environment - the overall effect of which must be:
There is also considerable doubt about what has actually been achieved by market liberalization (see Debating the Impact of Economic Liberalization in Australia). The latter document:
It is also necessary to recognize that (as has in part been the foundation of a long boom in the US also) Australia's long period of growth has also been associated with:
There has been disagreement amongst analysts about the fact that the Reserve Bank of Australia has seen the need to raise official interest rates at a time when growth is seen to be slowing [1, 2, 3, 4]. However the RBA has also expressed concern that demand [which has been driven by the growth of credit and asset values more than by income] has grown rapidly, and that the supply capability of the economy can not match this. In relation to this it is noted that:
There have been a huge range of suggestions about public policy changes (not all of which are consistent) that might remove constraints on Australia's economy (see Australia's Reform Consensus).
However, irrespective of what is done in relation to public policy (which is only a comparatively minor part a firm's business environment), it is more important to find methods for economic development which are better able to stimulate a supportive total-environment for individuals and enterprises in the face of intense competition than traditional practices have done. The types of issues involved (and alternative options) are suggested in:
It is of serious concern that states (who traditionally take responsibility for economic development) have no financial incentives to be successful because of the protection which their revenues receive under the Commonwealth Grants Commission's 'horizontal equalization' principles. This point is explored in Review of Grants Commission Arrangements which highlights the concerns which other states have about the (roughly) $2bn pa subsidy which their taxpayers provide to Queensland probably largely because unsophisticated economic strategies have created a low-productivity economy and thus a weak tax base. Australia's experience since the 1980s demonstrates that change and better performance can become an imperative by removing protection.
It also needs to be recognized that there are reasons (related to a deflationary demand deficit which is implicit in the export-driven / high-savings strategies that are adopted by producer-focused economies such as China) to suspect that current patterns of global growth can not be maintained (see Structural Incompatibility puts Global Growth at Risk).
Not all have prospered in the more competitive environment which market liberalization policies have created.
Relative poverty has become a significant and self-perpetuating problem facing many individuals and families due to the limited availability of quality jobs as well as personal disadvantages (see Minimizing Poverty). This phenomenon, which threatens to perpetuate through the generations and create an underclass, seems to have been a consequence of the reduced protection of those suffering disadvantage which was needed for a more dynamic economy. The welfare costs of compensating those who have not prospered have become increasingly significant.
Inequality has been exacerbated by the shift from the hierarchical management models of the 'industrial' economy to the network management style of a 'post-industrial' economy - a trend which has reduced the role of middle management and contributed to a significant decline in the numbers of middle income earners - who traditionally have had an important role in ensuring social / political stability and in promoting social mobility. It can be noted that the wages' share of national income has declined and the profits' share has increased .
Furthermore more flexible industrial relations systems have emerged (including enterprise rather than industry-wide bargaining and the growth of employment based on individual contracts) because productivity depends increasingly on firm's ability to respond to fast changing market and technological trends. This trend appears to have reduced the bargaining power of employees relative to employers, and thus to be a factor in increasing social inequality.
There seems to be a need for systematic efforts to identify a variety of practical business models which would:
Neglected Side Effects
One side effect of the assumption that liberal market reform would be a sufficient basis for creating strong economic capabilities was the adoption of what was seen as a complementary 'new public management' approach to government. This has involved the assumption that governments' primary contributions should be: low taxes; and efficient infrastructure. It has come to incorporate NCP principles.
Unfortunately 'new public management' has downgraded, and led to an erosion of, governments' primary function (ie 'governing'). The latter can simplistically be thought of as creating a framework for community social and economic activities by: creating a system of law and order; providing leadership; setting standards; addressing social and environmental goals; and representing and acting in the public interest.
The PC's discussion paper has correctly highlighted the fact that in dealing with human services there are many social objectives which cannot be dealt with by competition, and pointed out that these issues require attention so that a policy solution can be tailor made to suit each function.
Similar constraints apply in relation to government - ie its core 'governing' function primarily depends on qualitative factors (eg accumulated knowledge, wisdom) rather than on operational efficiency.
However, in contrast with discussion paper's current suggestion for human services, there was no serious effort in 'reforming' governments to cope with what was seen as the new economic environment to consider how those qualitative factors might be reconciled with the search for quantitative improvement that competition introduces. 'Reform' was mandated without taking account of the knowledge of those with long experience of government, and administrations were politicized to ensure that 'reform' could not be 'resisted'. The result has been a serious decline in the effectiveness of governance in Australia (see The Decay of Australian Public Administration).
In introducing NCP little consideration was given to the character of true public goods and services. While not everything that governments have undertaken are true public goods, the latter had become public responsibility because they suffer serious market failures (eg being natural monopolies, having large externalities or social policy implications, or suffering 'free-rider' problems). The same factors which led to market failures usually lead to complexity when attempts are made to introduce competitive arrangements to the delivery of public goods and services. This in turn translates into either significant cost in managing the complexity (which offsets hoped-for increases in production efficiencies), or eventual systemic failure if the complexity is neglected. While there has been a need for mechanisms which allowed innovation, for true public goods and services competitive service delivery is arguably not the best method for achieving that goal.
This phenomenon is well illustrated by the problems which have arisen in infrastructure management - an area for which the PC's discussion paper argues that there is a need for further policy development. In practice the major requirement for improved infrastructure is probably to overcome the administrative mish-mash which has resulted from poorly conceived public administration changes over the past 15 years - including those resulting from NCP. In particular,
The Failure in Queensland's Electricity Distribution Network and SE Queensland's water crisis illustrate the resulting problems.
In addition to dealing with the above unforeseen side-effects of public sector reforms intended to suit a competitive environment, there is an increasingly urgent need for national coordination of a solution to the most chronic defect in Australia's system of government, namely the Federal / State fiscal imbalances which:
The Global Context
The PC's discussion paper implied that NCP was introduced purely as a result of Australia's long-term drift backwards in international economic rankings. However there were factors in the global context which also contributed to the adoption of market liberalization policies - specifically
Policy concepts derived from these trends and ideas were imported into Australia with inadequate consideration of any differences in circumstances. For example:
Moreover de-industrialization in developed economies 'shifted the goal posts' for high productivity economic success towards knowledge-based functions, a factor which was not specifically considered in devising Australia's economic reform agendas.
Likewise there are significant elements of Australia's economic environment now which do not seem to have been realistically evaluated as the foundation for developing a reform agenda. For example:
The external environment seems to be viewed through the lens of domestic political biases, resulting at times in seriously distorted understanding.
Economic reform in Australia (by business, community leaders and governments) needs to be founded on a realistic assessment of the implications of dozens of currently under-evaluated factors, rather than on the basis of a view which is idealized and simplified to suit favoured theories.
An Alternative Agenda
It is concluded that issues that should be of high priority in a national reform agenda include:
In June 2005 a CoAG meeting reportedly endorsed the concept of renewal of the national competition reform agenda involving (a) cutting business regulation / red tape (b) promoting transport, infrastructure and energy efficiency and (c) a national approach to infrastructure .
This seems an inadequate outcome because:
In February 2006 COAG agreed to a future national reform agenda which reportedly involved:
There is undoubtedly value in shifting towards an emphasis on national reform in which competition policy has a less dominant role, and improving the way the federal system deals with health and education. However the proposed National Reform Agenda seems likely to be inadequate because:
Those involved in dealing with the (so called) 'National Reform' agenda seem to be confining their attention to an unrealistically narrow set of alternatives.
One observer suggested that the reform proposals amounted to little but good housekeeping. 
December 2004 (and subsequently amended)
Review of National Competition Policy Reforms, Discussion Draft
Australia. Productivity Commission., October 2004
National competition policy (NCP) has been a landmark reform achievement - though there were costs and implementation difficulties. Most agreed reforms are in place, and there is a need to decide what to do next. Commission as been asked to report on this, to inform CoAG's review of NCP.
Why was NCP introduced?: Australia's current economic strength is a turn-around from long periods of malaise. Performance in 1970s and 1980s was poor by international standards - due to both international factors as well as trade barriers and domestic market regulatory and institutional restrictions. This led to inefficiency and a business culture focused on government preferment rather than gaining a competitive edge.
Recognizing policy-related growth inhibitors, governments in the 1980s embarked on widespread reforms - including capital market liberalization and reducing quotas / tariffs. Increased competition put pressure on rigid labour markets and required institutional / regulatory reforms to delivery of infrastructure. As reforms proceeded it became apparent that wider competition policy regimes were an obstacle. Thus governments committed to NCP in 1993 - on the basis of the Hilmer Review.
What changes were introduced under NCP? NCP was based on recognition that competitive markets will serve interests of consumers / community by providing incentives for cost-consciousness, price competition and innovation. Arrangements that detract from competition should only be retained if they are in the public interest.
NCP involved: extending the Trade Practices Act (TPA) to more businesses; exposing government businesses to competitive pressure; third party access to essential infrastructure; avoiding overcharging in monopoly areas; and reforming legislation that restricts competition. To implement this the Australian Competition and Consumer Commission (ACCC) and National Competition Council (NCC) were created, and states gained financial incentives (competition dividends) for implementing reforms. Specific reform processes were established for electricity, gas, road transport and water.
This package did not deal with: industrial relations issues; competition in delivery of human services which were being introduced at the same time (eg via 'purchaser / provider' models). It did not require asset sales / privatization, compulsory tendering or contracting out of government services, removal of community service obligations (CSOs which were made transparent) or rural service reductions. NCP sees competition as a means to an end and not necessarily always appropriate. Thus social, environmental, equity, regional and adjustment objectives can be explicitly considered in assessing reform options.
While most of this agenda has been implemented, outstanding issues involve: water reforms (eg environmental allocation and water trading); and anti-competitive legislation (including cabotage and anti-dumping arrangements).
What has NCP delivered? NCP has contributed to strong economic performance (13 years of uninterrupted growth; high growth rate of real per capital income in late 1990s; low unemployment rate). In the 5 years to 1998-99 productivity was strongest for 40 years and strong by international standards. It subsequently slowed due to the drought - but has since rebounded. This was achieved despite stagnation in largest trading partner (Japan) and Asian financial crisis.
Many studies show that micro-economic reforms (including NCP) have been significant in productivity growth - while other suggested causes (eg recovery from recession, increased work intensity) has not stood up to analysis. Such gains had previously been predicted and modeled.
Increased national income has also increased tax revenues - and capacity for public spending. NCP has reduced the costs / prices of many goods and services. This has allowed firms to increase productivity and motivated them to pass benefits on to consumers. While the effect of NCP can't be separated from other factors, in some areas targeted by NCP price reductions have been significant. Introducing competition also complemented technological changes which were leading to lower prices. Superficially firms have benefited more than households (eg the latter faced higher real prices in some cases). In some cases this was part of NCP goal (eg to rebalance costs for electricity, and increase cost recovery for water). But even where prices are up, so is productivity. And where some low income households have faced higher costs, compensation measures have offset the impact. NCP has also contributed to improved service quality / reliability - and to an increased range of products / services.
Benefits have not flowed only to consumers, but also to: regional communities (through reduced controls on marketing of grains / lamb); more efficient water use; road safety. Almost all regions have been net beneficiaries - and those under pressure need to recognize that factors other than NCP are involved (declining terms of trade; population drift to larger centres).
NCP has not been an unqualified success. In some areas reform efforts have not been sufficient (eg in creating a national electricity market, water). The legislation review program has encountered problems in some areas. Some who had benefited from competition restrictions have lost out. The adjustment burden has sometimes been difficult (eg dairy deregulation, improved infrastructure efficiency has had adverse regional employment effects, some infrastructure reforms have led to higher charges). The cumulative effect of such changes, together with other pressures, have threatened the viability of some communities. There have also been high procedural costs for NCP implementation - especially for local government and smaller states.
Overall the benefits have outweighed the costs. Moreover the benefits will be ongoing.
What reform lessons emerge? NCP has been an innovative exercise in national economic reform which succeeded because: all governments saw the benefits and agreed about main problems; there was a solid conceptual framework and information base; and effective procedural / institutional mechanisms to implement reform. Flexibility and transparency in implementing reforms have been important. There have also been procedural problems (lack of priorities; public interest tests have not always been applied; some legislation reviews have not been independent; backsliding on reforms; lack of guidance on adjustment assistance and adverse distributional consequences).
Why further reform is essential NCP has taken 2 decades, leading to reform fatigue. There is also a perception that reform task is complete. But to improve living standards it is vital to deal with challenges such as: integration of global economies (which increases opportunities and competitive threats); preferential rather than multilateral trading arrangements; the need for improved environmental outcomes. Economic reform (including competition reform) will be needed to: improve productivity; reduce infrastructure costs; and promote flexibility in responding to customer needs. Reforms to reduce constraints on labour supply can also help overcome effects of population aging. Also competition reforms may improve cost effectiveness in delivery of health and aged care services, and improving environmental outcomes. Population aging will: reduce labour supply growth; constrain growth; increase demands for health / aged care and social security. Future gains could be large (eg achieving same productivity as US could raise incomes 20%)
What criteria for nationally coordinated reform? It is hard to report on areas offering opportunities for competition reform because there are so many opportunities, many are already being addressed, or competition is only part of the issue. Thus criteria were adopted involving: potential for large gains; competition is part of the issue; and a high return is likely from a nationally coordinated approach.
Key elements of proposed agenda Infrastructure reform must be high priority (because it is a large segment of economy, is capital intensive, and potentially has serious consequences through underinvestment). There is significant further scope for improvement in infrastructure (of which two areas have been studied by COAG - namely energy reform and water).
Other issues requiring attention include: market power effect on National electricity market; greenhouse issues; managing adverse environmental impacts of water use; post-NCP monitoring; freight / passenger transport; communications sector.
Further work is required on legislation review (eg in relation to cabotage and anti-dumping provisions, and various other areas).
Apart from sector specific reforms, there are defects in the way competition has been effected in large parts of the economy. Three aspects are particularly important: targeting legislation review against the most anti-competitive legislation; monitoring new regulation to prevent backsliding; and pricing regimes for infrastructure to ensure investment. A national review of consumer protection policy and administration is also needed.
Key human services (eg health, education and aged care) have been outside NCP - and have important non-economic objectives. Also there is less scope for competition that in infrastructure - though 'managed-market' concepts are relevant. Reform in these areas is important because of: the need for equitable access; very substantial resource commitments involved and large potential savings. Many areas of human service delivery have involved competition - and partial government funding - eg private medical practice, private hospitals, private schools and child care. Recently competition / market mechanisms have been introduced more widely (eg 'yardstick competition; performance based funding). Other arrangements seek to indicate to service providers the value placed on their services (eg by user choice arrangements for VET; requiring users to meet more of the cost). Other market-based mechanisms to improve resource allocation include: levies on waste disposal / pollution; salinity and nutrient trading schemes. Because of the important social objectives involved many different strategies will be needed; competition related reform may only be a small part of what is required; and reform will need to be tailored to the circumstances of each function.
The two highest priority areas are health care and natural resources management.
Health care faces many problems (rising costs, inefficiencies, poor outcomes for some communities, difficulties with access). Overlapping roles of different levels of government cause these problems. The underlying service interface and funding difficulties need to be addressed. Thus health care is prime candidate for CoAG sponsored national reform approach. A circuit breaker could be achieved by independent public inquiry (which could incorporate CoAG review of medical workforce issues).
CoAG could also focus on natural resource management - looking beyond water towards: less costly means of dealing with environmental goals for native vegetation / biodiversity; and coordination of greenhouse policy.
Two other areas of potential large gains from reform are aged care and education. However a review of aged care has recently been undertaken, and while a good education system is important, the need for reform seems less urgent than for health. For example: past university reforms need to be monitored before considering more: many policies to introduce competition to VET are in place; and action on primary and secondary education is better undertaken within individual jurisdictions. Other areas where reform could be beneficial will not be advocated including urban planning and regional development (which are matters for individual jurisdictions); tax policies; and labour market arrangements (which are very important but for which CoAG would not be be best forum).
Robust institutional arrangements are key to delivering on the agenda The agenda outline by Commission is challenging. Success will depend on: defining objectives / principles; facilitate analysis; independent monitoring of progress; and mechanisms to lock in gains
Potential payoffs would be large Australia's infrastructure productivity is still below world's best. Health care is a major cost area, and savings though improvements could be large. Dealing better with natural resource management could also generate large savings.
Draft Proposal for a national reform agenda Nationally coordinated reform is appropriate for: energy; water; freight transport; passenger transport; communications; legislation review; applying TPA to government businesses; consumer protection; assistance related impediments to competition; competitive neutrality regime; legislation review process; gate-keeping arrangements to prevent backsliding; regulated infrastructure providers; health care; natural resource management; general framework of nationally coordinated reform; adjustment support
Other key reform areas Matters which would not appropriately be coordinated by CoAG include: education and training systems; aged care; industrial relations; tax system inefficiencies / incentives; city and regional development; and market failures in technological innovation.