15 minute read
Peter Harris AO | Productivity Commission Chairman
Peter Harris AO
Despite broad consensus across the political divide around the importance of infrastructure investment to productivity growth, Productivity Commission Chairman, Peter Harris AO, asks why it is that Australia continues to under-invest.
First, let me say, it’s great that infrastructure investment has never been as popular as it seemingly is today.
Most of us are commuters, and many of us are also regular airport users, and maybe that makes this renewed interest in infrastructure sound like a more than fair thing.
But there is still a need for some structured thinking to intrude on such a rosy scene.
The idea that there is an infrastructure gap has persisted for some time, and perhaps there is. But even if there is a gap, the lessons we have learned over the past 10 years about how to address infrastructure suggests that it’s best not to simply rush in and fund the next big project that claims to be ready to go.
You don’t fill gaps measured in the hundreds of billions of dollars with an icon project or three, no matter how iconic it is.
The better approach is to undertake a review of all the factors that go together to address the infrastructure conundrum. And that conundrum is: we all favour more investment in this basic underpinning of productivity improvement, but we continually seem to be under-investing – why?
And since, in my assessment, this question needs to be properly reviewed, I am not going to solve it here today.
Peter Harris AO
But I will give you some context and make some comments on things that I think are tremendously important for creating an effective environment for future infrastructure investment.
So first, this bit of context.
The Howard Government in 2005 reviewed export infrastructure, and came to the conclusion that there was a bit of a problem with regulators and regulated pricing, but that there were no actual real impediments to this.
The Rudd Government in 2008 also undertook a serious infrastructure review, and we ended up with Infrastructure Australia and the Building Australia Fund. The funding has now ended, but the structure at least remains.
Both of these processes were quite worthy examinations of the overall question of why we continually seem to be under-investing in infrastructure.
But today, five years on, we still have this focus on the iconic infrastructure project as if it is going to solve the problem. And it isn’t going to be sufficient to solve the problem.
Moreover, while there is a focus on just one icon project, not only will the conundrum remain unanswered – simply because there is no solution to it from a single funding effort by private partnership or public investment – we also risk squeezing out any focus on how to get the best combination of productivity-enhancing investments.
If you look at an aggregation of the projects submitted to Infrastructure Australia by a benefit cost ratio (BCR), it will show you that the very large projects have quite low BCRs, and some of the small projects have very high BCRs.
So the icon project, the very big project, may not necessarily be the best way of solving a productivityrelated issue.
Another factor is that infrastructure funding is up. Analysis by the Australian Bureau of Statistics of public sector investment across the country shows quite a large increase as a percentage of GDP in infrastructure spending in recent times.
But these numbers do not include anything on the NBN, 4G Mobile, or airport projects, and little, if any, contribution from Public Private Partnerships (PPPs), so even these increases are probably an underestimate. We have more going on in infrastructure than we might think.
Nevertheless, the trend increase does not tell you anything about whether or not we are meeting needs.
Infrastructure isn’t something we just want to have; its purpose is to meet consumer and business needs.
Treasury noted a few budgets ago that the average age of our infrastructure is increasing, suggesting a potential build-up in replacement need. And it is true that a significant part of our major urban transport infrastructure is either Depression-era or immediate post-war – that is, 50 years old or more.
Congestion figures are rising. Peak period travel times on arterial roads in urban areas continue to rise. Melbourne and Sydney trains and trams regularly exceed their ‘crush’ crowding levels.
Airports like Perth and Brisbane – not just Sydney – regularly suffer infrastructure-related delays; Melbourne’s airport road access is poor, and Sydney’s is probably not much better.
At the same time, there is also overinvestment occurring.
Peter Harris AO
Productivity Commission figures indicate that one of the more notable causes of the productivity declines of the past decade was over-investment, driven substantially by a lack of pricing signals and poor links to early planning intervention in new assets, in areas like electricity and water.
With demand not meeting expectations, consumers are still required to pay for all of this via regulated pricing.
This exemplifies the important role of pricing, and how poorly-constructed pricing models can get things quite wrong.
A helicopter view of infrastructure pricing systems shows something like this: telecommunications has reasonably good links to future needs, freight rail has some links to future needs, electricity and water have weak links to future needs, and roads have virtually no links to future needs through pricing systems.
And in water, as I found working on water projects in Victoria, it’s too late to change the pricing system and get better planning signals when you’re just about to pump the mud off the bottom of the dam.
In electricity, incentives skewed by regulated pricing often create over-investment in peak period infrastructure. The Productivity Commission put out a report earlier this year, which quite clearly demonstrated just that.
And road pricing has the worst structure of all. It skews expectations from consumers, such that current ‘pricing’ systems tell users that the infrastructure is already paid for by fuel excise; so tolling or congestion charging will be seen as ‘double dipping’, and therefore morally wrong.
That’s a bad perception to encourage if you want to expand funding beyond the current horizon.
And worse, that thinking is flawed because fuel excise and all primarily road-related charges together fall around 30 per cent short of the amount Australian governments spend on roads annually.
Pricing systems across publicly funded infrastructure, in my view, need review if they are to support the aspiration for private partnership funding.
But the larger reason to review them is not just about private partnership funding; it’s that too often they seem unable to achieve what pricing is meant to achieve, which is a reliable link between what is supplied and what consumers are willing to pay for.
Let’s not forget consumers. They need to be brought squarely into the process in advance of investment commitments. Some of the more spectacular failures in recent infrastructure investment appear to have focused a lot less on consumer willingness to pay, and much more on financing structures.
Mentioning financing structures leads to thinking about superannuation investment – another highprofile issue in the infrastructure discussion. There is substantial interest in this, not only in Australia but also globally.
The Organisation for Economic Co-operation and Development (OECD) has noted that only about one per cent of pension assets are invested in infrastructure globally. Here in Australia, the percentage is higher, and the interest is stronger because of our relatively advanced superannuation system.
The very size of the savings pool, long-term in nature and fixed in inflow, seems to suggest to some that the simple social purpose of funding long-term retirement needs is an insufficient target for super.
I find this unpersuasive. Fixing the retirement planning needs of a nation is one of the most pressing policy purposes of governments globally – it should be a sufficient target in itself.
And imagine the consequences if a mandate – a forced requirement to invest in infrastructure – was imposed. Large flows of money would be chasing a difficult-to-define target – what is infrastructure? – where planning is generally not well-linked to willingness to pay.
Overall, that doesn’t sound too good.
But this is not to say that some of the issues in attracting – rather than mandating – super to infrastructure shouldn’t be solved.
Let’s start with pricing again. Superannuation is about earning returns for members – so to attract it will require a reliable revenue stream.
But opaque charging systems of the kind I referred to earlier – ones prone to ministerial intervention or
where consumer willingness to pay overall is not clear – will not attract support.
And locking charges in via today’s cost recovery models tells you nothing about the project’s economic or social desirability. It’s more like, ‘if you build it, they will pay.’
With greater emphasis currently on benefit cost analysis (BCA), the creation of business cases by strong and well prepared accountancy firms, and particularly with the advent of Infrastructure Australia and gateway assessments in most state government processes now, we are improving planning in those inputs.
But where they are simply bolted onto an otherwise skewed pricing system, the attractiveness of the investment is likely to be affected.
BCAs are curious creatures when they suddenly appear in a world of commercial analytics of private investment.
Externalities and network effects are very significant in infrastructure investment. And if they dominate a BCA, there may be very significant differences between the story as told by a BCA and the story as told by a commercial business case.
And I make this comment quite consciously, because I regularly see a BCA being thrown around, as if it is the pre-emptive and primary tool for a commercial analysis. Most of you will know that’s not the case, but, frankly, it’s not commonly explained publicly in the commentary.
So adding BCAs to a planning process – a desirable thing in itself, a very desirable thing – does not necessarily help the investment process.
Infrastructure Australia has prepared data on the BCAs of projects submitted to them.
If you look at it, you’ll see that the very largest projects have quite low BCRs, and the smallest projects appear to have quite high ones (see graph below).
There are some reasons for those low BCRs: network benefits are sometimes very difficult to fully capture; transformational gains, like investing where you are trying to change a whole suburb or a whole city landscape, are difficult to fully crystallise.
In Sydney, for example, there is clearly a suburban revitalisation that took place as a result of the airport train project. But the train project owners didn’t benefit from that. And the value was almost certainly underestimated in the BCA, simply because it’s hard to calculate that ‘blue sky’ potential when you need to assume that property developers, and, frankly, foreign apartment buyers, are going to be involved in a project over a decade or two.
Perhaps, therefore, we can at least agree that explaining BCRs might be very important to an investment case – much more important than is currently imagined in public commentary. And that’s particularly true where consumers are involved, where some of the larger road projects, for example, end up with apparently very low BCRs.
Peter Harris AO
Source: Productivity Commission
Peter Harris AO
For superannuation, other aspects of infrastructure that might be considered in order to improve its attractiveness include things like: • how to fix demand risk: particularly low early-life take-up, which is exemplified by toll road projects but not limited to them. Most infrastructure, due to its lumpy nature, is at risk of poor early take-up, if it’s priced. If you get it for nothing, it probably doesn’t matter, but if it’s priced it’s at risk of poor early take-up • illiquidity: the second thing in superannuation that strikes me as being quite important. Because with few buyers at any time for very large projects – and, of course, very few buyers if you are subsequently forced to sell – deep pockets are required; it’s a thin market. We need to address these issues.
Fortunately, in this area I think the market is showing signs of solving these problems itself.
As funds obtain scale, similar to the Canadian funds we have seen here as active buyers, they can retain the in-house expertise necessary to overcome these information uncertainties; and explain them better to boards for investment cases.
They can undertake their own demand assessments, rather than relying on others, and the concept of creating portfolios of infrastructure, rather than single infrastructure assets, can address, in part, the liquidity issue.
These, on their own, may not be silver bullets, but they have the dual merits of not being regulated solutions, and also of not shifting risk back to the public sector.
I mention risk at this point because I think it is fundamentally important – particularly in discussion of PPPs.
PPPs are a partnership concept that I have seen through our public transport contracts in Victoria, a number of large water projects in Victoria, and even the NBN–Telstra contracts, which have elements of PPPs at the high level.
PPPs are not really something to target in their own right; there are many circumstances in public infrastructure where they will not be suitable.
But they are at their best where they offer clear net benefits beyond those of traditional public funding. That sounds like a very simple motherhood statement, but, in applying it, the benefits of PPPs tend to apply the most where risk sharing or risk allocation is the principal subject under consideration. The more difficult it is to define the nature of an infrastructure investment and design it effectively, the more likely it is that a PPP will be a helpful device.
Moreover, PPPs apply particularly where those concepts can be well expressed in contract, because if they can’t by definition, you’ll find it very difficult to run a PPP. They must also be well expressed in potential pricing structures.
Looking at risk, PPPs are often good at improving risk management in the design phase. Adding a private partner early creates an incentive for the financier and the builder, if the tender process will allow, to advise on how to ensure that the project is deliverable at the chosen cost and time frame, to find efficiencies and to remove contingencies.
The result of this is quite evident. There are studies, both in Australia and overseas, that support the idea that PPPs experience lower cost overruns and nearer on-time delivery than alternative systems.
PPPs also demand comprehensive whole-of-life costing. Whole-of-life costs need to be crystallised and potentially funded, because if you are an investor, you want to know that the thing is going to be maintained throughout the period in which you are expecting to get your money back.
This whole-of-life costing concept is a very welcome development for those of us who have run infrastructure agencies; we are used to begging for maintenance funds. The idea that you can crystallise and contract them up-front is very attractive.
Peter Harris AO
PPPs require a payment stream, but here the outcome is a lot less clear. PPP payment systems often aren’t anything like the sort of pricing systems that I’ve been talking about today. They are not necessarily directly linked to willingness to pay.
They may even come straight out of state treasuries, or they may come through regulated pricing outcomes. These are not necessarily demonstrating willingness to pay, and therefore they are leaving you exposed to demand risk.
It will be of significant value, therefore, in the future, if increased use of PPPs improves the linkage to consumers and their willingness to pay – and perhaps creates incentives to review this whole area.
History will tell you that the development of such reforms generally requires a comprehensive public policy review.
And if pricing policies are effectively reviewed and reformed, projects – regardless of who finances them – will be demonstrably more sustainable and, as a result, will put less pressure on public sector balance sheets, which is a primary theme for why governments are looking at PPPs.
Also with effective pricing systems, we might see prices emerge that will differentiate between users for different level of use, that will allow people to propose alterations to services, and that will innovate rather than simply have one price for all. These are things that we should all want to see in our future infrastructure.
In conclusion, I posed the infrastructure conundrum as being about why we seem to continually under-invest in infrastructure. And I know I haven’t solved that, but I do think the absence of effective pricing systems is a significant element of under-investment.
Introducing private investment, including super funds, either directly or via participation in PPPs, will be a useful tool, particularly for the sort of concepts I mentioned earlier.
But this alone will not solve the conundrum. A key reason that we under-invest is almost certainly that we limit both planning and investment to what the cost recovery or the general budget system will bear, rather than encouraging it via better pricing models.
We have improved pricing systems before, in interstate freight rail and in airport privatisations, and I think we can do it again.
Peter Harris is Chairman of the Productivity Commission. Peter has previously served as Secretary of the Commonwealth Department of Broadband, Communications and the Digital Economy, and the Victorian Government agencies responsible for Sustainability and the Environmen, Primary Industries, and Public Transport.
Peter has worked for the Ansett-Air New Zealand aviation group and as a consultant on transport policy. He has also worked in Canada on exchange with the Privy Council Office (1993–1994). His career with the government started in 1976 with the Department of Overseas Trade and included periods with the Treasury, Finance, the Prime Minister’s department and Transport, and he worked for two years in the Prime Minister’s Office on secondment from the Prime Minister’s department as a member of then Prime Minister Bob Hawke’s personal staff.
In 2013, Peter was made an Officer of the Order of Australia ‘for distinguished service to public administration through leadership and policy reform roles in the areas of telecommunications, the environment, primary industry and transport’.
