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
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
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
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
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
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
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.
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
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
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.
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
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.
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
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
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
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.
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
- industry-wide employment arrangements in the stevedoring
- 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.
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.
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.
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
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.
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
3. Industry Commission 1990, op.cit. p.51.
4. Ibid p.xvi.
5. Port of Melbourne Authority 1990, Annual Report