Kerr on infrastructure

In an article in the he Dominion Post on the 8th September Roger Kerr discusses the idea that We Need a Clearer Debate About Infrastructure (pdf).

He opens by making the point that

Much discussion about infrastructure is confused. What is infrastructure and how is it best provided?

Infrastructure is a loose term covering a collection of industries and assets. The government does not have a major role to play in many of them.

This last point is one John Key would do well to note.

Normally we think of things like roads, railways, water, sewerage and stormwater systems, gas, telecommunications, ports and airports as infrastructure industries. Notice two things here, each of these industries has each has different characteristics and most are run as commercial operations in the private sector.

Kerr rightly explains

Thus is it not possible to talk sensibly about any general infrastructure problem in New Zealand. There is very little concern about gas distribution and transmission, for example. The industry is 100 percent commercial and not subject to problematic capacity constraints.

Nor does it make sense to talk about a general infrastructure ‘deficit’. A serious problem in the ports industry, which is largely local government owned, is actually over-investment. It is well known that many port companies are achieving poor rates of return on equity due to parochial decisions to expand capacity beyond levels supported by demand.

A point worth noting is

The only meaningful sense in which we can talk about deficits is if profitable investment opportunities are not being taken up. The high benefit to cost ratios of many roading projects in recent years is a clear indication – assuming the calculations are reliable – that New Zealand has been underinvesting in viable roading projects.

The question therefore would be What are the barriers to efficient investment in infrastructure? The short answer is regulation and ownership. Kerr notes

Electricity is one example. Electricity is overwhelmingly a private sector industry in most OECD countries. Typically mismatches between supply and demand are not an issue.

In New Zealand, electricity is a government-dominated industry and actual or threatened winter shortages have become routine. The problem has been compounded by regulatory interventions by both National and Labour led governments.

Unfortunately government interventions which manage to distort markets discourage private sector investment and typically result in even more government interventions. As Kerr explains

Thus in electricity we have seen the government underwriting Genesis’s E3P project and running Whirinaki as a baseload station for much of this year at prices below the actual cost of its diesel feedstock. The incentives for efficient private sector investment in electricity have been blunted.

Similarly, the government’s forced unbundling and separation of Telecom, the only telco capable of large-scale investment in broadband in New Zealand in the medium term, has damaged investment incentives in that industry. Predictably, we now have both main political parties saying rates of investment in broadband are inadequate and planning to invest taxpayer funds in it.

For more on the unbundling issue see here and here for a good piece by Matt Burgess. Kerr goes on the point out

Arguably this problem is entirely caused by government actions that were not supported by any cost-benefit analysis. At a recent conference, major industry players indicated that government spending on broadband was not needed.

At the most basic level, the important policy issues are how are infrastructure industries to be owned and regulated and whether investments in them are in fact profitable. Kerr notes

Under private ownership (in competitive and well-regulated markets) we can be confident that investments in infrastructure industries will be expected to meet their cost of capital since investors will demand normal returns, adjusted for risk. While some investments will not work out, investors will not continue to throw good money after bad.

In contrast, with government ownership political imperatives dominate over time and returns on capital and hence economic growth will be sacrificed. Government ownership of rail is expected to result in losses, which will reduce GDP. Distortions will be created with sea, air and land transport. Political imperatives also impede industry rationalisation, as is obvious in the port industry.

The state of regulation is no better. It is clear that regulation of electricity and telecommunications is dysfunctional. Kerr explains that

... the operation of the Commerce Act and Electricity Act (which governs the Electricity Commission) is discouraging investment and dynamic efficiency.

He ends his article with a piece of good policy advice,

If National forms a government after this year’s election, a priority should be to review this raft of problems. Putting infrastructure industries like water and roading into government-owned commercial structures (while not excluding private sector involvement), removing heavy-handed regulations and disincentives to invest (including barriers to overseas investment), making the case for shifting central and local government-owned businesses into the private sector, and exploring public-private partnerships should be the first order of business.