Infrastructure: the new hot topic

Infrastructure is fashionable again. For the past six months or so, media and political attention has focused on the state of Australia’s infrastructure. An often neglected aspect of economic debate is back at centre stage.

Over the past year or two there have been numerous problems around Australia. The inevitable interest these problems have generated has been heightened by recent concerns about the capacity of Australia’s transport infrastructure to handle our commodity exports.

It is important to examine the issue in some detail. Is there an infrastructure crisis? Have state or federal governments neglected our infrastructure in times of prosperity? Do we need major reforms in the way we invest in and manage our nation’s infrastructure?

Infrastructure is often divided into economic infrastructure, such as transport, energy, communications and water infrastructure, and social infrastructure, such as schools and hospitals. The current debate focuses primarily on economic infrastructure, and whether Australia has neglected necessary investment in recent years.

There is no shortage of anecdotal evidence suggesting that Australia’s infrastructure is crumbling, but the overall picture is more complex and harder to interpret. Reports by Engineers Australia on Australia’s infrastructure (2001) and New South Wales infrastructure (2003) present a mixed picture.

These reports draw attention to particular problems, such as inadequate road and rail infrastructure, but also indicate that in some areas, such as New South Wales electricity generation and distribution, existing infrastructure is adequate. Nevertheless, in its report to the Property Council of Australia on urban infrastructure, the Allen Consulting Group concluded “there is increasing evidence of an emerging infrastructure deficit in Australia”.

The common thread running through recent studies is although Australia does not have a generic infrastructure crisis, we are quickly approaching the point where if appropriate decisions are not taken, such a crisis will become unavoidable. There are numerous signs of economic infrastructure reaching capacity or approaching the end of its useful life. Even where existing infrastructure is working well, the need for upgrading arises periodically.

Planning and funding infrastructure is a difficult task, because it relies on forecasting future use, and often involves very large financial commitments. Various state governments have established infrastructure councils and published strategic infrastructure plans in recent years. The federal government’s Auslink strategy is a long overdue attempt to build an integrated approach to investment in land transport in Australia.

The debate on infrastructure investment often revolves around comparisons of total spending over a number of years. As infrastructure investment, as a proportion of Gross Domestic Product (GDP), has declined over a long period, such figures are often cited as evidence of inadequate infrastructure spending. The OECD noted recently that total government spending on infrastructure fell from 2.6 per cent of GDP for the 1991-97 period to 2.2 per cent in 1997-03. Government capital formation as a percentage of GDP has fallen from 7.5 per cent to 3.9 per cent between 1984 and 2002.

Such figures need to be treated with some caution. Privatisation and Public-Private Partnerships (PPPs) have moved a significant amount of previously public investment in infrastructure into the private sector. The changing structure of the Australian economy, and in particular the increasing dominance of services, has reduced the level of reliance on infrastructure.

There is also evidence to suggest that greater efficiency in infrastructure construction and operation has contributed to the proportionate reduction in infrastructure investment.

Recent Australian Bureau of Statistics data also casts doubt on the claims of infrastructure neglect by state governments. Figures for gross fixed capital formation, as a percentage of Gross State Product since the early 1990s show New South Wales, Queensland and Western Australia fairly steady over the period, Victoria and South Australia slightly higher after a slump in the mid-90s, and Tasmania slightly higher after a slump around the turn of the century. It is difficult to discern unequivocal evidence of neglect by governments, state or federal.

Similarly, ABS data on government engineering construction activity shows only modest signs of reductions in infrastructure investment.

Funding for infrastructure investment and operation comes from a variety of sources, including taxation, government debt, user charges, producer levies, and special purpose vehicles like PPPs. Across all forms of economic infrastructure, and all sources of investment capital, it is difficult to obtain an accurate picture of investment trends. It is particularly hard to quantify the level of need for future infrastructure investment, as cost estimates will inevitably be rubbery.

The overall picture, then, for economic infrastructure in Australia is a mixed one. There clearly are major problems, but these are not necessarily generic, and vary from sector to sector. It is by no means clear that any particular government or governments should be blamed for neglecting our economic infrastructure, but all governments need to face up to the major task which now confronts them. We need to identify the obstacles to increased infrastructure investment, and deal with them.

The most common popular explanation for recent infrastructure problems is the heavy emphasis on reducing government debt in recent years. Indebtedness of federal and state governments is at an extremely low level. By 2002-03, borrowings for the various states had reached very low, even negligible levels. Australian government debt is almost the lowest in the OECD.

However, available evidence does not indicate a pattern of shrinking government borrowing coupled with shrinking investment in infrastructure. Between 1996-97 and 2004-05, net debt of state public non-financial corporations has remained relatively stable, according to parliamentary library analysis of the relevant budget papers.

The primary rationale for government debt as a means of financing infrastructure is intergenerational equity. As future generations enjoy the benefits of infrastructure constructed now, it is appropriate that they contribute to the cost.

Moreover, economic modelling by the Allen Consulting Group indicates that of all the available methods of financing infrastructure, government debt is the most economically beneficial, followed by special purpose vehicles like PPPs. Allen Consulting concludes that “the objective of zero debt does not make economic sense”, and “by restricting infrastructure development in the name of fiscal conservatism, the approach of Australian governments has undermined our future economic potential.

In spite of respected economists making this argument, politicians have studiously avoided advocating government borrowing as an avenue to better infrastructure.

The use of PPPs for infrastructure financing is now well-entrenched in Australia, particularly in New South Wales and Victoria, although it is much more established in some sectors than others. Rating agency Fitch notes that in spite of some failures, this method of financing is “perhaps more advanced and more successful than in any other country”.

A vigorous debate has emerged around the appropriateness of PPPs, which are sometimes portrayed as an expensive mechanism for beautifying government balance sheets. The higher cost of capital involved supposedly reflects the assumption of risk by the private developers, which would previously have been hidden in government finances.

Private investment in infrastructure has long been complicated by the existence of s.51AD and Division 16D of the Income Tax Assessment Act. These provisions prevent private developers from claiming interest deductions on borrowings used to invest in infrastructure where they do not exert sufficient control to be deemed the genuine owners. Originally designed to prevent state governments circumventing Loan Council restrictions, these provisions make private investment in public infrastructure significantly less attractive.

Both Labor and Liberal governments have sought to ameliorate the impact of these provisions, through Infrastructure Bonds and the Infrastructure Borrowing Tax Offset Scheme respectively, by means of a rebate equivalent to interest that would otherwise be deductible. Private investors in infrastructure have campaigned for reform of these tax arrangements for many years.

Regulation is also becoming a major influence in private investment in infrastructure. The Howard Government has made much of the recent congestion at the Dalrymple Bay coal terminal, blaming the Queensland Government for inadequate capacity. In fact, the barrier to further investment lies in a draft decision by the Queensland competition regulator regarding the regulated rate of return applicable to access arrangements for new terminal capacity. The long-term lessees of the terminal contend that the level required is too low to justify investing.

Competition regulatory issues are prominent in many infrastructure debates because of the widespread move away from monopoly public sector provision. Productivity Commission Chairman Gary Banks has described this new regulatory framework as “experimental”, and points out that price increases leading to more investment without excessive returns can be positive. The Productivity Commission has proposed substantial reforms to the national access regime for declared infrastructure, to remove inappropriate disincentives to investment.

The Productivity Commission’s recent review of National Competition Policy focused heavily on infrastructure. It concluded that in spite of improvements arising from competition reforms, “significant impediments to competition and efficiency remain evident in several infrastructure areas”.

Other regulatory issues also affect investment in infrastructure. The absence of a uniform national regulatory regime on issues like safety and communications is often cited as a problem for investment in the rail industry.

Australia has a lengthy history of inappropriate infrastructure investment, driven by short-term political considerations. Although this is perhaps less of a problem than it was in the past, there are still instances of poorly directed investment more designed to build political support than economic development.

The Howard Government’s Auslink strategy has commendable features, such as integrating road and rail investment, but it is carefully designed to enable political considerations to prevail in decision-making. The strategy is built around the concept of a National Network and the notion of long-term transport corridor investment strategies, but it does not commit the federal government to funding any particular part of the network. The federal government has abandoned its obligation to fully fund the National Highway, and all future funding of road and rail will be based on one-off deals with the states.

Auslink renews funding for Roads to Recovery, a program of regional road funding which has funded roads overwhelmingly in Liberal and National electorates. It also dedicates $400 million over four years for strategic regional investments by local councils. The blatant pork-barrelling nature of this program is indicated by the statement that “the Government will give preference to funding applications that are supported by relevant stakeholders”, and the acknowledgment that in some cases benefit-cost ratios will be adjusted “to give greater weight to factors other than economic efficiency”.

The Liberal Opposition’s commitment at the 2005 Western Australian election to build a canal from the Kimberley region to Perth is a reminder of how easily politics can override rationality in infrastructure investment decisions.

Other difficulties for infrastructure investment include planning regulation, mixed public and private ownership across different jurisdictions, the uncertainty surrounding Australia’s approach to climate change, and the need to keep infrastructure operating while it is being upgraded. None of these problems is critical, but they all act to inhibit the process of renewing Australia’s economic infrastructure.

The overall picture, therefore, is by no means clear-cut. The available evidence suggests that claims of chronic neglect of infrastructure by governments are exaggerated. There are, nevertheless, serious problems which need to be dealt with. Moreover, although recent investment levels may have been reasonably adequate, there are clear signs that higher levels of investment will be required in the near future. Aside from simply spending more money, there are four related initiatives which federal and state governments should pursue:

• increased government borrowing to help finance the renewal of Australia’s infrastructure;
• completion of taxation reform to make infrastructure investment more attractive to private investors;
• further reform of the national access regime; and
• a national Infrastructure Commission, independent of governments, to scrutinise and report on infrastructure projects and financing.

Australian infrastructure has always been funded by private investors, predominantly though government borrowing. The emergence of specific-purpose vehicles like PPPs has changed infrastructure investment, but the need for government borrowing is still substantial. The recent cycle of fiscal consolidation has reached a point where refusal to borrow for infrastructure investment is economically counter-productive.

The case for finishing the reform of infrastructure taxation arrangements is very strong. Direct private investment in infrastructure is now a reality, and if we are not to return to the past level of reliance upon government debt, taxation impediments to private investment need to be removed. The process of reforming s.51AD and Division 16D of the Income Tax Assessment Act has been slow and meandering. It should be completed as soon as possible.

The regulation of access to monopoly infrastructure is complex and challenging, and involves different considerations in different sectors. Nevertheless, the reform agenda set out by the Productivity Commission provides an appropriate starting point for action. It suggests that the existing regime contains aspects which unduly deter investment.

The most important initiative which should be undertaken is the creation of a national infrastructure commission. The role of such expert, non-partisan bodies in economic policy is steadily increasing. Although in many cases the ultimate decisions properly remain in the hands of elected governments, such bodies play a vital filtering role. They elevate public debate on economic issues, and provide benchmarks against which the actions and promises of governments can be measured.

At the 2004 Federal election, Labor promised to establish a National Infrastructure Advisory Council to conduct “rigorous analysis on who should build infrastructure, how it should be funded, and who should own it”. This proposal is now being embraced by Howard Government backbenchers.

We should take such proposals one step further, and establish an Infrastructure Commission on the same basis as the ACCC, with joint federal and state government control. This commission would:

• undertake indicative planning and analysis with respect to Australia’s long-term infrastructure needs, such as that conducted by NEMMCO;
• scrutinise the viability and financing arrangements of infrastructure projects;
• establish model regulatory codes for all sectors, to facilitate the emergence of uniform national regulatory approaches; and
• monitor the quality and performance of existing infrastructure, and gather data on infrastructure issues.

Increasing government borrowing without appropriate external scrutiny and restraint would be dangerous, as the Western Australian canal proposal indicates. An independent expert body charged with evaluating infrastructure financing proposals would provide a critical safeguard against the excesses of the past.

An advisory council would tend to reflect sectoral interests, and therefore may not be seen as truly independent. A statutory commission, properly appointed and run, would add rigour and depth to national debate on infrastructure. It would not be able to instruct governments, but it would exercise a powerful discipline over governments. The blame-shifting and finger-pointing between federal and state governments which currently characterises our national infrastructure debate would be much harder to sustain.

Australia is at a turning-point on infrastructure, but not for the reasons currently supposed. Serious challenges are looming. Rather than adjudicating a debate about responsibility for emerging deficiencies, we should be preparing to tackle the challenges of the future. There are weaknesses in our recent performance, but they are not egregious. Without serious reform, however, we may face future problems of a much more serious nature.