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Government and State Enterprise in Victoria

Dr Michael G Porter

Introduction---the Project Victoria Approach

Project Victoria originated from a concern amongst the business organisations in Victoria with some of the major economic and budgetary issues facing Victoria. The playing field in Victoria has, over the last decade, been tilted against business. Business has to deal with excessive charges and unit costs which are required to fund a bloated and poorly managed government sector. So it is not so much a matter of levelling the playing field within the business sector, as it is one of removing the governmental 'ball and chain' and the labour market practices that stop business and the work force from prospering.

The reforms already proposed by Project Victoria and those in the pipeline from the principal Consultants, Tasman Institute and the Institute of Public Affairs, amount to a major restructuring, privatising and thinning of the expenditure programs of the Government of Victoria, with a view to delivering higher quality of service at lower cost. They constitute a broad-based strategy for increasing productivity and living standards, by privatising, corporatising and contracting out many current services of government.

Michael Deeley has argued that 60% of ICIs costs are beyond corporate control. Well, what we are tackling in Project Victoria is a large chunk of that 60%. What is more, we are proposing to remove government from provision of many of its current services, allowing new and existing firms, large and small, to get a piece of the action. The same labour reforms which are capable of making business internationally competitive in Victoria can also cut, by perhaps 25%, the costs of the services from what are currently our state enterprises.

The reforms in no way suggest that government should be less concerned with the disadvantaged or needy--- but they do suggest that targeting benefits on those in need, often with delivery via the private sector, is the preferred way to go. What is more, if we are not wasting literally billions of dollars on 'feather bedding' and other forms of state enterprise, we will have far more resources to assist any who fall by the wayside.

But Project Victoria is not about welfare reform. It is about how to get business and Victoria thriving again, because without business prosperity, talk of social justice is largely hot air. The conclusive evidence of waste and inefficiency, and feather bedding in the state sector makes it clear that we could have increased income and discretionary expenditures of around $2 billion per annum but for waste, Victorian style.

If implemented on a national scale, the strategy would, for example, be compatible with significantly lowering all income tax rates and could dramatically improve the nature of work and saving incentives in Australia. The National Priorities Project1 proposed reforms of this kind, more modest in terms of privatisation, but more profound in terms of health and hospitals, and these reforms were sufficient to allow income tax rates to drop to a ceiling of 30%. I think those numbers should put the Project Victoria reforms in perspective.

Without major changes, the outlook for Victoria is not encouraging. But the 'good news' is that adversity instils a resolve for change. The countries that have done well in recent decades have been those facing real threats, such as South Korea, Hong Kong, Singapore and, of course, Japan and West Germany in the aftermath of World War II. Perhaps the crisis we find ourselves in in Victoria will also deliver a sense of purpose in this State.

In my view. the community may accept, even demand, a coherent and strategic change of the Project Victoria variety, once the choices are fully understood. Paradoxically, the wealthiest State in the once 'Lucky Country' may now be more able to implement real change, because there is no alternative if we are to trade our way out of the current mess.


Sorting out the Roles of Government and the Private Sector

The experience of recent years---both in Victoria and elsewhere---together with re-evaluations of past theoretical justifications of government intervention, indicate that government failure is more, not less, of a problem than market failure. And whereas failed private enterprises fade away, courtesy of bankruptcy and changing consumer preferences for example, government business failures, funded by unwitting or powerless taxpayers, may sustain their inefficiencies and privileges for as long as the political process permits.

There is an in-built tendency for politicians to over-supply government services as a means of currying favour with the electorate, particularly to sectional or vocal pressure groups that do not necessarily perceive the broader community interest. Also, the intrinsic difficulty in rewarding public servants according to performance creates problems in the operation of public enterprises.

This Project Victoria perspective provides:

  • a basis for re-drawing the boundaries between public and private sectors and for introducing competition in the supply of services wherever possible;
  • new techniques (to much of government), such as franchising, contracting out, corporatisation and privatisation, while still leaving government an important vehicle for meeting social objectives; and
  • insights into the fact that earmarked government assistance for needy or disadvantaged groups will enable them to choose where money is spent, rather than be placed at the mercy of State departments and authorities which are constrained to meet what are fundamentally political objectives.

Improvements in technology also allow greater 'unbundling' of government services into separate activities. There is a sound rationale for vastly reducing the role of government in running businesses and in the direct provision of some other services.


The State Enterprise Sector

Competition is the key to ensuring that the services needed by people and business in Victoria are provided effectively and at least cost. The most appropriate way of opening up State businesses may vary from case to case.

Where there are already a number of private competitors governments should simply vacate the field. Where public enterprises are producing 'in-house' goods and services for internal use, contracting out would increase competition.

Natural monopoly generally only applies to a part of a public enterprise's operations (for example, to electricity transmission but not generation, to rail and tram lines, but not transport services) and competition is not necessarily precluded by natural monopolies of networks. Competition may therefore result from an unbundling of separable activities and the imposition of common carrier requirements on the remaining natural monopoly component---the pipes, rails or wires.

The introduction of private sector incentives is maximised where ownership of assets is transferred to private hands. The profit motive, and the disciplines associated with the markets for shares, capital and managers, provide strong incentives to eliminate waste and inefficiency. But, privatisation is only a means to an end---the delivery of what users want, and at preferred quality and prices.

Where markets are not naturally contestable, the benefits from privatisation may be conditional upon the prior existence of an appropriate regulatory framework to prevent monopoly abuses. The greatest need for this exists where existing government enterprises have a natural monopoly---for example, tram lines, superior port docking facilities, electricity, water and pipeline grids. But even natural monopoly elements can be subjected to competition, for example, by franchising out the operation of public infrastructure for specified periods (as with railway lines, or water and waste water services in thousands of municipalities in France).

Each public enterprise of the Government should be referred to the State Enterprise Reform Corporation (SERC)---to make sure that the efficiency and other gains from privatisation would be obtained, and with external commercial expertise being used in the restructuring process.

The process of converting natural monopolies to private monopolies subject to regulatory constraint is more complicated. The threat of regulation, or of other pro-competitive techniques, can be used to avoid the pitfalls of heavy handed regulation characteristic of the US, and more recently, the UK, utility industries. In each case there will be a need for careful attention to the processes whereby the community interests are protected, while the potential for efficiency gains is realised.

The Recommendations of Project Victoria regarding state enterprises, in brief, are as follows:

  • Natural monopoly assets of the Victorian Government, such as the SECV power grid, the GFCV gas grid, Met tram lines, VicRail lines and the water and waste water pipelines of Melbourne Water, all be transferred into distinct state owned corporations which would operate under normal corporate law, subject to safeguards against abuse of monopoly power;
  • The separate and contestable business enterprises of the SECV, Gas & Fuel, Melbourne Water and State financial institutions such as the SIO and WorkCare, and most elements of Victorian port authorities and other contestable business enterprises, be progressively sold to the private sector;
  • Where possible, services provided using natural monopoly assets, such as tram lines, pipe lines and power grids be submitted to competitive franchise tenders, with the franchisor being the relevant VSOC.


Specific Action Plans

The following section specifies action plans for electricity, gas and fuel, water supply and ports.


Electricity

The recent improvements flowing from the adoption of a more commercial approach by the SECV should be consolidated and extended by immediately proceeding down the path to full corporatisation of the power grid and to privatisation of generation stations and distribution. Corporatisation/privatisation would involve a further restructuring of electricity tariffs towards a 'user pays' system (for example, time-of-day pricing), a greater focus on commercial performance and a reduction in political interference.

Generation is by far the biggest sector in terms of costs. Private generators operate in many countries (for example Germany, Japan, and Sweden). In the UK, generating capacity has been divided between three entities. Indeed, around half of the world's generating capacity is now provided privately. New private power stations are under consideration in NSW, South Australia, and Western Australia.

The SECV has stated its desire to sell Loy Yang B, despite the ad hoc nature of the proposal and the absence of any clear philosophy from the government regarding industry structure. Alcoa has a private electricity generation plant at Anglesea to service its aluminium smelting operations---a plant reputed, despite the coal quality, to be highly cost-effective.

The Victorian Government has billions of dollars tied up in electricity generation. In the absence of any convincing rationale for public ownership, serious questions must be raised about whether ownership of power stations represents a valid government priority over investments in say, schools, hospitals, or police stations.


Transmission

Interstate connection across an enlarged and independent grid also offers great scope for trading power and reducing costs through better utilisation of capacity. The high voltage transmission grid, which can trade power between Victoria, NSW, and South Australia, and potentially Tasmania and Queensland, is seen as a natural monopoly, in that costs should be less with a single service.

The fact that the market is not readily contestable does not in itself justify monopoly provision. For example, ownership options considered by the Industry Commission include a corporatised public enterprise, a club of generators, a club of distributors, and independent private ownership. Experience in the US, the UK and elsewhere suggests that it can be efficient to place the grid in private ownership, subject to a regulatory constraint---the controversial issue is the form of regulation which delivers the best mix of efficiency gains and constraint on monopoly power.

It is particularly important to open generation up to full competition, and this means we need to ensure that the independent owner of the transmission network does not discriminate against generating and distributing companies by denying them access to the (pool) network or by permitting access only on unfavourable terms.

Project Victoria suggests that there should be an unbundling of power generation from the transmission system, and that the owner of the network should be required to act as a common carrier (that is, be required at law to transmit electricity on behalf of any party on a non-discriminatory fee for service basis, rather than purchasing and re-selling the electricity itself).

There are also advantages in having geographically distinct re-sellers of power, with separate 'wires' and energy charges, so that consumers can, in principle, experience meaningful choice.


Distribution

At present, about 30% of distribution of electricity in Melbourne is undertaken by eleven Municipal Electricity Undertakings (MEUs). Distribution in the rest of the State is performed by various SECV District Business Centres (DBC).

Again, restructuring these entities on a more commercial footing via corporatisation and subsequent privatisation is likely to bring significant improvements in their performance. However, further pressure on the performance of distributors (and others in the industry) requires the on-going stimulus of competition. While some elements of localised natural monopoly may apply to electricity distribution, there is still potential for competition through 'wheeling' across zones, which will be facilitated by separate and transparent wheeling charges. The SECV has stated that it 'has an open mind to examining the possible benefits of conducting a trial of a privately franchised MEU or DBC'.

Project Victoria suggests that exclusive franchises currently in force should be made competitive, and distribution should be unbundled from generation and transmission. Moreover, distributors should also be made to act as common carriers, thus facilitating competition in all sectors of the industry as outlined above.


Gas

The GFCV has a virtual monopoly over both the transmission and distribution of gas in Victoria. The GFCV has tended to be inward-looking (as evidenced, for example, by its reliance on inside appointees and its ambivalent attitude to its performance relative to the SECV or other gas authorities). This suggests the urgent need for greater exposure to the external pressure of competition.

    The integration of distribution with other activities leads to lower costs and increased operating benefits, as demand and transmission capacity can be more effectively matched.[2]

The apparent reluctance of vested interests clearly to demonstrate the benefits of vertical integration is in itself an argument for separation to allow the market to test the issue, or at least an argument for 'ring-fencing' transmission. The overriding concern must be to promote competition so that distributors or end users can negotiate directly with gas suppliers for the competitive provision of gas, thus stimulating efficiency throughout the entire industry.

In the UK, the privatisation of British Gas occurred without simultaneous introduction of effective measures to inject competition into the industry. The upshot was a finding by the Monopolies and Mergers Commission in 1988 that British Gas had practised extensive discrimination in the pricing and supply of gas to contract customers in a manner which deterred new entry into the market.

It is pertinent to note that in NSW, where gas distribution is undertaken by a private firm (AGL), the NSW Government has moved to regulate AGL by a price control formula based on the CPI, rather than the previous complex and expensive system of negotiating gas tariffs by ad hoc boards of inquiry and arbitration. The new legislation will also promote competition through provisions allowing third party access to the distribution network if required.

Project Victoria proposes that gas distribution and transmission should be unbundled, and that operators of pipelines be constrained to act as common carriers. Provided adequate safeguards against the possible abuse of monopoly power were in place, there would be considerable advantages in privatising individual distribution units in geographical areas, and even privatising the transmission pipelines.


Water Supply

A 1990 Industry Commission study of the Australian water industry found that there was great potential for reducing costs in the industry, particularly by appropriately managing assets to ensure that they are not replaced prematurely, and by placing greater emphasis on competitive tendering for asset replacement.3 The IC suggested that contract rather than 'in-house' labour could yield cost savings of around 25%. The Commission observed that authorities which exclusively use contractors for asset replacement (for example ACTEW) reported asset replacement costs substantially less than in other parts of the sector.

Project Victoria contends that Melbourne Water is well placed to take advantage of overseas experience with reform in the water industry. Governments world-wide are increasingly turning away from public ownership and management in search of more efficient arrangements for delivery of water and sewerage services. Private sector provision is prevalent, but to differing degrees, in the United Kingdom, France and the United States.

In the UK, the responsibilities of the ten existing water and sewerage authorities were transferred into private hands in December, 1989, when the authorities were transformed into public limited companies. Privatisation has been coupled with a strict regulatory regime. Regulation of prices and service quality is seen as a necessary constraint on the exploitation of monopoly power by the PLCs, which are the sole providers of combined water and sewerage services in their respective areas of operation.

Private management of water and sewerage facilities has also been occurring in France and the United States. In the US, where the burden of constructing and maintaining facilities falls on local councils, and where augmenting and replacing the present infrastructure is proving a substantial drain on government budgets, local councils are seeking out savings by contracting with private firms to operate sewerage facilities.


Ports

Project Victoria contends that the scope and pace of change which is so urgently needed will only be secured by introducing the disciplines of competition and private ownership to a much greater extent than has so far been the case. We need competitive private docks, capable of contracting directly with labour, shippers, exporters, importers, and other customers.

The strategy of promoting competition does not equate to handing over all port functions to the market. Government has a role to play in making sure the docks are competitive and efficient, and that no private dock or labour group is allowed to exploit monopoly power. Rather, the aim is to obtain that mix of public and private involvement which delivers the services port users require at the lowest possible cost.

Implementing this strategy requires identifying and then addressing any natural or institutional constraints to competition. Among those identified by the Inter-State Commission are:

  • industry-wide employment arrangements in the stevedoring industry;
  • restrictive container depot arrangements;
  • port authority leasing policies;
  • union monopolies over the supply of labor.4

There is a number of steps which the Victorian State Government and the port authorities themselves could take to stimulate competition, in the delivery of port services to users.


Unbundling the Wharves

A useful starting point is to critically examine the full range of functions currently undertaken by the State's port authorities and ask whether many of these could not be more efficiently delivered by the private sector, and concentrating on certain 'core' functions.

The Port of Melbourne Authority currently has some 1250 employees.5 Obvious candidates for unbundling include ship services such as towage, pilotage, and berthing lines; and complementary services such as ship repair, engineering, and electrical services.

There are clearly some 'core' functions which would remain within the purview of public port authorities. These core functions are those concerning the basic rules within the port such as ensuring maritime safety, overseeing contracts for private provision of port services including channels and navigation aids and, perhaps, basic port planning.


Corporatisation of Port Authorities

Corporatisation of the port authorities may allow many of the gains of full privatisation to be achieved, although ultimately privatisation will be required to 'lock-in' the gains. At the very least, it would go a long way towards providing the appropriate incentives for efficient performance. In particular, there is a need to more clearly specify the objectives of port authorities and to create a board which is accountable under the Companies Code.

The benefits of the corporatisation approach are clearly evident from experience in New Zealand and in the UK.


Pricing Policy

An integral part of the corporatisation of port authorities would be adoption of more cost-based pricing policies, not least because of their capacity to achieve economies in capital expenditures. While part of the privatisation strategy will lower costs, as waste is eliminated, the shift to commercial pricing and time of day charges for example, may increase some charges. A major point is that when services are under-priced, an artificial excess demand is generated.

Project Victoria suggests that consideration should be given to privatising Victoria's ports (and individual docks), starting with the first authority willing to cooperate. An expected objection to the sale of port facilities to private operators is that it might afford opportunities for the exploitation of monopoly power. One response to this objection, drawing on experience in the UK and Australia, is that the combination of ports, rail and road transport means that ports such as Melbourne, Geelong and Westernport, not to mention Sydney and Adelaide, are in competition. But, taking a narrower view, in the Port of Melbourne the volume of trade would in any case seem sufficient to ensure competition in the provision of most port services. For example, there are 58 berths for commercial shipping at five docks---Victoria, Appleton, Swanston, Holden, and Webb docks. Swanston Dock has four container terminals with a total of eight berths while Webb Dock has five berths serving coastal and overseas roll-on roll-off vessels. There is also some container handling capacity at Appleton Dock.


Franchising

Making ports 'contestable' by allowing new entrants provides a stimulus to performance by incumbents rather than relying solely on the 'heavy hand' of regulation. One way of doing this would be for port authorities to become franchisors who allocate the right to provide a particular port service for a period of time (for example, 5 to 10 years) to private firms on the basis of competitive bidding, and subject to agreed contractual terms of performance. On expiry of this period, or if the terms of the contract were violated, the contract would again come up for tender.


Enterprise-Based Employment

The full benefits from competitive franchising of port services (for example stevedoring) are unlikely to be secured unless inflexibilities in the relevant labour markets are also removed. For example, the National Farmers Federation's attempts to establish a stevedoring operation were 'stymied by overly restrictive industrial relations legislation' by virtue of the union monopoly over cargo handling activities.

Put simply, Project Victoria emphasizes that, as a matter of principle, the role of governments is to govern, and not to run or own trading enterprises. There is no evidence that the private sector market will fail to deliver quality products at viable prices. The functions of providing statutory classes or other forms of general insurance should be placed in the hands of competitive private insurers, subject only to appropriate prudential legislation. The former government instrumentalities should be sold, at market prices, and the funds applied either to retirement of existing state debt.


A Timetable for Reform

Project Victoria recommends that the Government of Victoria immediately appoint a Minister for Victorian State Owned Corporations (VSOCs) and a State Enterprise Reform Corporation (SERC).

It is envisaged that the specialist unit, SERC, would have skills in privatisation and corporatisation, and would report to the Minister for State Owned Corporations. All state business enterprises would be charged with preparation of detailed plans for corporatisation and privatisation. SERC would also service individual transition committees appointed to oversee the two year transition to corporatised or privatised companies for each of the respective areas (for example, electricity, gas, water, transport, port and dock authorities).

An initial task of SERC would be to classify all business enterprises of the Victorian Government into those which are natural monopolies and those whose services are either contestable or capable of being made competitive.

Businesses which provide services which are fully contestable would be listed as part of a planned privatisation program. Each business would be given a timetable, and a reporting process.

In the case of natural monopoly assets, such as the SECV power grid, the Bass Strait gas pipeline, the water and waste water pipe networks, rail and tram lines and some port authorities, these business activities would be listed for conversion into VSOCs such as Transpower Victoria---the power grid; GasGrid Victoria---the gas pipeline company; VicLines---the tram lines system; VicRail---the railway line system, WaterCorp Victoria---the company or companies owning the water and waste water pipe transportation systems, and so forth.

The Minister would transfer the ownership of natural monopoly assets of the Victorian Government into distinct corporate entities. Under a State owned Corporations Act, the VSOC Minister would apply private sector standards and normal commercial law to all companies in the VSOC Act Schedule. It is envisaged that the boards of these corporatised enterprises will have an agreed Statement of Corporate Intent (SCI) negotiated with the shareholder Ministers, specifying the objectives of the organisation and making board and management fully accountable under normal corporate law. Boards would be appointed on the basis of commercial expertise.

The only difference between the VSOC and a normal public company would be that the voting shareholders of the VSOC would be the Treasurer and the Minister for VSOCs, whereas the shareholders of public companies are private individuals and corporations.

The above agenda for change would aim to see an ending over the next decade of the Victorian 'corporate state'. The agenda could see selected natural monopoly assets remaining as state owned corporations, or preferably privatised, and subject to some form of regulatory constraint against potential monopoly abuse. Unlike earlier Victorian state enterprises, the Directors of these companies would be fully accountable under corporate law, and members of the Board and management would have the same legal responsibilities as their private sector counterparts.

The privatisation of all those State business activities which are not natural monopolies, and the unbundling or franchising of service functions associated with natural monopolies, should start to generate productivity levels which give the State a competitive edge.

While the prime aim of the reform package is the delivery of services consumers want at least cost, significant Victorian debt retirement will be possible through the privatisation of the power generation stations and other public assets. Project Victoria suggests that any proceeds of privatisation should be used for debt retirement, not for funding government consumption.

It is expected that with corporatisation and privatisation, less workers would be employed but on terms and conditions which would be much more attractive than at present. However, these terms and conditions that would be matters for competitive bargaining between management and the unions would tend to form around the new business enterprises.



References

    1. M G Porter, J W Freebairn and C Walsh, Spending and Taxing: Australian Reform Options, National Priorities Project, Allen & Ujnwin, 1987.

    2. Gas and Fuel Corporation of Victoria 1991, Submission into Industry Commission Inquiry into Energy Generation and Distribution.

    3. Industry Commission 1990, op.cit. p.51.

    4. Ibid p.xvi.

    5. Port of Melbourne Authority 1990, Annual Report 1989/90.



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