The COAG Reform Council wanted some lateral thinking done about cities – so who you gonna call?

Being Dr Lateral can be a bit tedious from time to time. You know, spending all that time outside the square. What’s wrong with being inside squares anyway? But like those birds inside appliances in the Flintstones used to say “ehhh . . . .it’s a living”.

The session was on “supporting the private sector in the delivery of strategic vision for Australian Cities”. Now I’m all in favour of the private sector – I really am. And indeed the private sector makes the dominant contribution to our cities funding and building houses and cars and physically building the roads and bridges and wharfs and so on. But it also seems to me that the topic smacks of the main problem with infrastructure in the last couple of decades. It was as if good policy maximised the contribution of the private sector – at the expense of other sectors, when each sector can be of greatest use to the other if each are playing to their strengths.

In the process of thinking about it I came up with an exaggerated, but I think enlightening analogy:

By analogy we might almost as reasonably have focused our energies in monetary policy reform on maximising the contribution that private monetary systems – like gift cards, frequent flyer points and barter systems – might make to Australia’s monetary system rather than take the path we did take to further develop our public monetary institutions and to insulate them from short-term political manipulation.

In any event, given the title of the workshop, I wondered if the organisers really wanted the contribution that I had to make, but they said they did so away I went. Those readers who’ve looked at various pronouncements of mine on public goods, will recognise a theme. I’ve come to think that the way in which we talk of ‘market failure’ is wrong.  It’s wrong because ‘market failure’ suggests a somewhat mechanical procedure by which one presumes that things should be provided by the market until and unless one determines that there is market failure in which case you then consider government involvement, subject of course to the consideration that governments can fail as can private markets.

Though my own way of speaking about these issues doesn’t necessarily introduce anything analytically new, the problem with this way of putting it, apart from the presumptions involved (goods and services are presumed to be privately provided unless there’s a good reason to the contrary) is that it is very mechanical.  I think it provides a more thoughtful and less Procrustean backdrop to thinking about the respective role of the market and collective institutions to say that everywhere and always, markets, if they are efficient and productive, are rich ecologies between the providers of private (competitive) and public (collective) goods and services and that different markets embody quite different configurations of this mutual interdependency.

And that’s how I wrote the paper on infrastructure in cities.

I argued that one of the more unfortunate things about reform is that the model for reform has been tariff reform – yet tariffs are about private goods – and they’re produced in one of the simplest markets around. That inevitably dumbs down our understanding of what good reform should be, and of course makes us prey to those who, as Adam Smith warned, wish to pervert the course of clear thinking to their own ends. What a pity, I argued, that the defenders of reform had not been more vigorous in denouncing the debauch of good policy that PPPs have been in Australia.

I wasn’t too sure how it would go down. However I got a lot of positive feedback personally and the organisers passed on other positive feedback.

And the seminar was held at Suncorp Stadium. I kind of like those functions, where you can walk around the stadium and down onto the ground over lunch.  A bit of variation. Nothing like lush green grass surrounded by tens of thousands of empty seats sitting there in silence for your contemplation and perambulation.

Anyway, the paper is over the fold.

1.      Reform and the ecology of private and public goods

Loaves of bread and pairs of shoes are quintessential private goods. They can be both produced and consumed by many parties each competing with one another. This means that the optimal social outcome emerges from private decision making in a market. By contrast other valuable aspects of our lives – such as clean air or a public park – are not private affairs. Their existence for one is existence for others. Given their collective consequences, it is appropriate that their provision results from public, collective decisions.

It is unfortunate that the template for micro-economic reform was tariff reform because the relationship between public and private goods in the market for simple goods is the simplest and easiest. Though the goods market requires certain public or collective goods to function efficiently – most particularly the currency used for trading and the legal infrastructure to enforce contracts – beyond this vigorous competition generates highly efficient markets.

Yet almost all other markets involve a different ecology of public and private goods, and so function best according to a different configuration of public and collective decision making. As reform broadened to encompass utilities, competition policy and monetary policy and subsequently health and education, it has become clear that reform was not so much about shrinking the role of the public sector, though that might be one aspect of reform in appropriate circumstances, so much as reshaping the ecology of private and public goods in specific markets or parts of our economy and society.

Alongside simple deregulatory reform in the area of tariffs or shopping hours, most other areas of reform involved the expansion and refashioning of public involvement. Competition policy, labour market reform, the introduction of economic instruments to manage environmental policy all came with an avalanche of new regulation that became the platform on which private competition was promoted – either more or less successfully in different cases.

2.      The ecology of public and private goods in a city

The ecology of private and public goods is particularly rich in a city with the two frequently inextricably entwined. Planning decisions necessarily involve many people, not just across space, but also across time. And public services – such as utilities, transport, health, policing, suburban services like libraries and waste management – are interwoven through geographic space that is otherwise available for private competition. Indeed these public services and public goods are the arteries of the city’s life. If they are not healthy, the health and prosperity of the city and its suppliers of private goods will also suffer.

Each of these services will require both private and public involvement (collective decision making and collective funding) in myriad ways.

3.      Reform and the ‘do-it-yourself’ economics of everyman

Economic reform is typically antagonistic to what David Henderson (1986) has called the ‘do-it-yourself’ economics of everyman. Before tariff reform could be dismantled it was necessary to convince enough people of influence that in the long run tariffs destroyed at least as many jobs as they created. And given the tenacity of the various fallacies of ‘do-it-yourself’ economics in the mind of the populace, long-term education and leadership was essential.

In 1968, Max Corden accepted the impossibility of tariff reform in Australia “for there is no significant opposition to protection as such”. Within five years, an audacious 25 per cent tariff cut had taken place. Industry assistance was under threat everywhere. After a decade of delay following the setback of two recessions, strong bureaucratic and political leadership from the mid-’80s on saw it become bipartisan holy writ – despite the continuing political difficulties it entailed.

Alan Kholer (2011) recently captured this strange dynamic with reference to contemporary events:

Sometimes politicians act ahead of the curve . . . but most of the time the momentum for reform becomes unstoppable and the politicians simply run out of excuses to avoid it. . . . That’s what happened with emissions trading. ¹our years after a bureaucratic task force first recommended emissions trading, and 11 years afterKyoto, it gets up during a flimsy hung parliament. . . . ²he force of momentum from the bureaucratic, business, economic and scientific classes had become a steam-roller.

Alas this process by which informed elites come to make an unpopular but correct public policy somehow impossible for their political leaders to avoid has not emerged in some areas even where the intellectual issues are relatively straightforward. This has typically occurred where political and commercial self-interest coalesce around less healthy conceptions of economic reform, particularly the idea that it is the simple expansion of private competitive supply and the intensification of private incentives to invest with a commensurate retreat of government.

This has been true in the United States, for instance, in the areas of finance and health reform. Globally intellectual property has been strengthened (for instance with the extension of patent and copyright terms) with scant economic justification. In Australia it has been clearly evident in the policy effort put into encouraging private infrastructure funding.

4.      Infrastructure and reform – the case of public private partnerships (PPPs)

Infrastructure is both planning and capital intensive – and governments have the authority to plan (though of course they should consult widely) and, providing they remain fiscally prudent, they face much lower costs of funding. Accordingly a world in which each sector plays to its strengths is a world in which governments more vigorously help plan and fund infrastructure with the private sector designing, delivering and maintaining it.

Of course where private investment can make a cost-effective contribution to city infrastructure it should always be welcomed. In this sense the basic methodology developed for managing PPPs – the use of a public sector comparator – is the right policy in principle. However this approach was established with the specific intention that it facilitate PPPs. In that context officials saw to it that – the finer points of economic theory notwithstanding – the public sector comparator imputes to government the same high costs as private financiers.3

By analogy we might almost as reasonably have focused our energies in monetary policy reform on maximising the contribution that private monetary systems – like gift cards, frequent flyer points and barter systems – might make to Australia’s monetary system rather than take the path we did take to further develop our public monetary institutions and to insulate them from short-term political manipulation.

5.      Clarifying and strengthening the role of government

Right now infrastructure spending is constrained by well-intentioned but ultimately arbitrary ceilings on public debt levels and by the higher cost of funding from the private sector. Given the private sector’s preponderance in designing and building infrastructure, strengthening the public sector to enable it to fund more infrastructure would benefit both sectors alike. This requires the kind of institution building with which we are familiar in other areas of economic policy like competition and monetary policy reform. In each case, a healthier private sector is the result of clarifying and so strengthening government’s role.

We need to develop institutions to provide regular, public, independent, expert advice to governments on the appropriate stance of fiscal policy (the size of the budget deficit or surplus), the level of debt and the management of public balance sheets including the credit ratings to which they should aspire. The Auditor General could grow to fit the role as central banks grew to take on the independence they had thrust upon them.

This would better enable governments to borrow to fund infrastructure that generated benefits than exceeded debt servicing and project risk costs. And, like a company, the government’s targeted credit rating would be tailored to its objectives, rather than fiscal populism and political sloganeering.

There should also be similar public and independent advice on the wisdom of individual infrastructure projects to ensure that taxpayers’ money was used on the projects that offered the best returns as determined by independent cost-benefit analysis, rather than vote buying.

6.      Intangible infrastructure: a new kind of public, private partnership

As we are becoming increasingly aware, the modern economy is increasingly dependent upon intangible capital – the capabilities and routines embodied in existing technologies and the knowhow embodied in people.Australia’s world-leading introduction of income contingent loans (HECS) and the establishment of the Child Support Agency (CSA) transformed the nation’s income tax system by making it available for social tasks other than pure revenue raising. Thus ‘multi-tasking’ the tax system created new public private partnerships in funding tertiary education and in more efficiently administering and enforcing maintenance payments from Australia’s non-custodial parents.

City intangible infrastructure might be capable of similar adaptation and multi-tasking. Could family homes be upgraded – for instance to improve their environmental performance – using financial instruments built around the rates system in the way that HECS and the CSA are built around the federal income tax system?

7.      Taxing rents and congestion: new front for reform

Tax reform is also crucial to optimising our investment in infrastructure and its use. It has been a commonplace since Henry George that ‘betterment taxes’ are efficient. They also provide both a fair and efficient means for capturing for the state some of the value generated by infrastructure investment.

Congestion taxation is a classic ‘green’ or Pigouvian tax – one of the rare ways of improving community welfare while raising public revenue. As O’Flaherty observes (2005, p. 61), congestion taxes are “like making a large amount of money drop from the sky”. Given this it is remarkable that it has played so small a role in the reform era during which time tax reform has been the predominant focus of micro-economic policy no less than three times – in the early Hawke, Howard and Rudd/Gillard Governments.

Congestion taxation is a critical ingredient of efficient infrastructure more broadly. This is not just because it provides a means of optimising the use of existing infrastructure and so minimising unnecessary new investment, but also because it can prevent new infrastructure from perversely generating sufficient new demand to undermine its intended purpose of relieving congestion costs.

In his book City Economics, Brendan O’Flaherty observes that (2005, p. 67):

the reasons we are giving for tolls are almost totally different from the reasons generally given for tolls in the first place. . . . The idea that tolls should be used to pay off a road’s construction costs leads to the worst possible allocation of resources: high tolls at first that discourage trips that should be made, and no . . . tolls later that encourage waiting that should not be done. It’s like taking a vile-tasting medicine when you’re young and healthy, and stopping it when you get sick and it could help you.

To return to our original theme, tackling the ‘do-it-yourself’ economics of everyman was a long-term cultural struggle for reformers from the time of Rattigan’s Tariff Board in the late 1960s. The reformers triumphed, and we are all the beneficiaries of their victory. By contrast, while we have been distracted with the campaign for PPPs, remarkably little effort has been expended, even by the guardians of economic reform, on the corresponding struggle in the area of infrastructure economics.

But it’s never too late to start.

7.      References

Corden, W. M., 1968. Australian Economic Policy Discussion: A Survey,MelbourneUniversity Press,Melbourne.

Henderson, D., 1986. Innocence and Design: the Influence of Economic Ideas on Policy, Basil Blackwell,Oxford.

Kohler, A. “Carbon tax for the price of a broken promise”, The Drum, July 12, 2011 15:38:20 http://www.abc.net.au/news/2011-07-11/carbon-tax-for-the-price-of-a-broken-promise/2789602 (http://bit.ly/pZK1oV)

O’Flaherty, B., 2005. City economics,Cambridge, Mass: Harvard University Press.

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