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Technical Papers of market power (if combined with appropriate governance arrangements)8. The Productivity Commission’s recommendations were based on its views that pricing outcomes in the water sector to date suggest that water businesses have not exerted market power, and that the costs of price monitoring will be significantly less than price determination. Following an investigation into a long-term regulatory framework for the South-East Queensland water sector, the QCA has taken up the Productivity Commission view and recommended a price monitoring regulatory framework that monitors retailers’ performance against various price and service quality benchmarks and indicators. Price monitoring would normally not in itself provide substantial incentives for efficiency; rather, price-monitoring approaches can be adopted where competitive forces are perceived to provide adequate incentives for businesses to strive for efficiency. The QCA’s approach, and the Productivity Commission’s recommendations, appear to be based on the view that incentives for efficient behaviour can be achieved entirely via appropriate governance arrangements (it has not been suggested that the water sector is competitive or that there is sufficient countervailing buyer power to keep pricing in check under a price monitoring regime). However, it is clear that the governance of public utilities in Australia has not delivered on this requirement to date. Despite a relatively tight regulatory framework, it is widely recognised that the NSW electricity distribution sector has been characterised by significant over-spending and inefficiency, particularly in relation to labour costs entrenched in EBAs well above prevailing industry rates. The CEO of Networks NSW recently commented on inefficient practices across the sector:
Regardless of the approach to setting prices, in the absence of clear and effective pressure from the shareholder for businesses to strive to meet and outperform the efficiency targets embodied in pricing decisions (and pass on those benefits in terms of dividends to the shareholder or reduced prices to consumers), stringent targets will simply result in worsening financial outcomes, lower dividends and, in the long-run, higher prices for customers.
RE-INVIGORATING THE NATIONAL REFORM AGENDA It is encouraging to see governments and regulators pro-actively tackling a variety of reform issues in their respective jurisdictions. However, the disparate nature of current approaches and reforms creates a risk that the hardwon reforms of the last decade might be over-turned with a regression from independent price setting to models that enshrine government influence on pricing decisions. We note that AWA, the Harper Review, the National Water Commission and others have called for consideration of a national approach to water regulation. For example, the Harper Review’s draft report concluded that: “A more national approach to water reform may re-establish its momentum. An intergovernmental agreement founded on the assumption that a national framework is both achievable and desirable may clear some roadblocks. A consistent national framework may also assist in driving competition into the retailing of water and in creating more effective price signals11.” At the inaugural AWA National Water Policy Summit the AWA also called for a nationally consistent approach to regulation and measures to reduce political interference in the decisions and roles of state regulators and water
utilities12. We agree that re-committing to a national reform agenda consistent with national competition reform principles is a critical step in: • Re-instating momentum for reforms where they have stalled or been slow; • Curtailing the temptation for governments to intervene in price setting and cost recovery for political reasons. Further, it is important that the regulatory framework is seen as part of a holistic approach to driving performance in the sector that includes the role of the shareholder – regulation alone cannot deliver efficiency improvements if supporting governance arrangements are not in place. The regulatory model assumes that boards and management will press for efficient cost reductions against regulatory benchmarks, but this is not a fait accompli, particularly when businesses are government-owned and, therefore, subject to a range of competing objectives. Boards and management are ultimately responsible to their shareholders, and as such, while the water sector remains mainly in public hands, governments have a key role to play in driving industry efficiency. In addition to clear and stable regulatory frameworks, we consider that this is best achieved via an overarching ‘profit maximisation’ objective to instil private sector disciplines in government-owned businesses – while profit maximisation is often associated with negative outcomes for consumers (i.e. price gouging), we believe that it is fundamental to achieving efficient cost reductions and productivity, and does not necessarily imply price increases.
THE AUTHOR Michael Black (email: mblack@deloitte.com.au) is a Director with Deloitte Access Economics, where he has contributed to the design and implementation of regulatory frameworks in the water, ports and energy sectors in Australia, Papua New Guinea and Malaysia. Prior to joining Deloitte in 2008, Michael worked in the water division of the Essential Services Commission (Victoria).
Productivity Commission (2011): Australia’s Urban Water Sector, Report No. 55, Final Inquiry Report. Graham, V (2014): “Selling Off Electricity Networks Will Give NSW Cheaper Power Bills”, The Australian, 20 August. 10 Independent Review (2014): Economic Regulation, Governance and Efficiency in the Victorian Water Sector – Preliminary Advice from the Independent Reviewer, May. 11 Commonwealth of Australia (2014): Competition Policy Review – Draft Report, September. 12 AWA Media Release (2014): Water Industry Picks Up What Government Lets Go, October. 8 9
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Public ownership, politically powerful unions and amenable management have all combined to deliver union agreements that drive higher labour costs … entrenching unproductive and uncompetitive work practices9.
Similarly, in the Victorian water sector, the Independent Review found that the shareholder’s lack of emphasis on performance of the government-owned corporations has resulted in inefficiencies in the sector10.