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Privatising infrastructure investment

August 16th, 2003

In an article on privatisation in the Fin a couple of weeks ago, I observed that

it was hoped that private ownership would impose capital market discipline on investment decisions … The public sector has been far from perfect in the planning and implementation of infrastructure investment decisions. But public sector failings pale into insignificance compared with the disastrous bubble and bust when investment decisions in the Internet and telecommunications sectors were entrusted to the wisdom of private capital markets. The energy sector has been little better. Enron was just one example of investment decisions being driven by market manipulation and rent-seeking.

In the case of monopolies the most important single regulatory decisions relate to prices charged to consumers or for third-party access. With privately owned monopolies, there is an inherent conflict here. If the price is set too high, consumers will suffer. If they are too low, investment will be inadequate. As regulator, the government has a conflict of interes. On the one hand, regulation is supposed to set efficient prices. On the other hand, as representatives of consumers, governments have an incentive to fix prices at inefficiently low levels.

Public ownership Îinternalises the externalityâ and balances the incentives facing governments. If prices are set below the socially efficient level, the benefit to consumers is offset by a loss in revenue. The converse is true if prices are set too high.

I’m just wishing I had run this last Thursday, just before the big US blackout, which appears to be due primarily to inadequate/poorly co-ordinated investment in transmission.

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  1. August 16th, 2003 at 14:53 | #1

    It’s also a proximate cause/ultimate cause thing. I looked into the area in an article at http://users.netlink.com.au/~peterl/publicns.html#NWKART3, and I don’t think its lessons have faded over the years. Mainly because our built in problems remain, still drawing us in (I actually used an illustrative example before the next instance of it hit!).

    I don’t think we can blame externalities too much, or suggest more state involvement as a cure. In my view state intervention has a natural tendency to aggravate externalities because of the disconnect between public revenue and spending, “unhypothecated”. But wasn’t there a Swedish economist who already pointed out that in an ideal world we would match the two sets of decision up in the democratic process? Someone might be able to remind me of the details.

  2. Mark Upcher
    August 16th, 2003 at 21:22 | #2

    Your argument against private ownership of monopolies states that the conflict of interest is between setting prices to improve consumer welfare and high prices to ensure an adequate level of investment takes place. Isn’t this just a case of a regulator having to balance the two objectives?

    You then say that for a public monopoly the low prices are offset by a loss of revenue, thereby “internalising the externaility”. But isn’t there a different – and potentially more serious – conflict of interest in this case between the need for a public company to use its profits to fund investment and the desire for the government to access these profits to pay dividends to bolster its budget? This can lead to under-investment in infrastructure. In my experience, the Commonwealth Department of Finance never argued for consumer interests or need for infrastructure investment ahead of a healthy dividend.

    And I am not sure that anyone has yet pinpointed exactly why the blackout occurred, despite your characterisation of the reason as being “inadequate/poorly co-ordinated investment in transmission”. The NYT article seems much more equivocal.

  3. Jim
    August 16th, 2003 at 22:44 | #3

    John,
    You’re way ahead of me as usual.
    I haven’t heard or read anything yet which even suggests a probable cause at this stage.

  4. John
    August 17th, 2003 at 06:07 | #4

    From the opening para of the link I quoted “For years, the nation’s electrical engineers and planners have warned that the North American system of transmitting electricity was becoming the orphan of the digital era, approaching a serious failure if not significantly upgraded.”

    The article has at least half a dozen quotes that say the same thing in different forms. Today’s NYT editorial is marginally more equivocal but says much the same thing “There are plenty of theories about factors that may have contributed to the fiasco. One is that there are simply too few transmission lines to pick up the slack if some lines close down in an emergency. Although a lot of new power plants have been built in recent years, there has been no comparable increase in transmission capacity. The system is also antiquated, relying mostly on 1950′s-era technology. Finally, the grid is so complex ÷ with hundreds of companies operating power plants or transmission lines around the country ÷ that it is extremely difficult to coordinate actions quickly.”

  5. Observa
    August 17th, 2003 at 08:16 | #5

    One of the major problems for generators and suppliers of electricity(private or public) was brought home to me on radio the other week listening to Prof Dick Blandy(Flinders Uni Economics and he sits on a local electricity consumers advisory panel for SA-can’t recall the title)

    As I recall he was discussing the introduction and use of special ‘intelligent’ meters, which were apparently being rolled out in Italy in response to their supply problems. Now these meters would cost about $600 each and the commentator was asking why should Aust consumers be asked to invest in this technology. Dick replied this was because approx 25% of our generating capacity(and logically transmission capacity) was only used for 5% of the time, during peak demand(summer air-conditioning in SA)He pointed out that this was an expense currently borne by consumers, which could be ameliorated by these new smart meters. For example he said it would be possible for consumers to enter into a contract(at a lower price) with their supplier, to install such a meter which could switch off their air-conditioner say 1hr in 3 on a planned rotational basis. This type of control would obviate the need for much of our expensive peak load capacity,with marginal inconvenience to the consumer.

    Given the general disquiet about possible power black-outs next summer I thought it was a good use of technology, as well as Economics Professors.

  6. Uncle Milton
    August 17th, 2003 at 17:30 | #6

    If the US had a publicly owned electricity system, the probably wouldn’t have underinvested, as they maybe have. They would have overinvested, as has occurred here with publicly owned electricity networks, because the politics of blackouts are too much to bear for politicians.

    So instead of having a blackout when lightning struck a transmission line, they would have had triple redundancies built in, so there would be no blackout, but there would be huge overinvestmnent for the 99% of the time when the extra capacity isn’t needed.

    It’s not obvious which is worse – having excess capacity for 99% of the time, or not having the capacity to deal with an extremely unlikely but very costly act of God, such as happened last week.

  7. August 17th, 2003 at 19:36 | #7

    In light of John’s opening coments, it’s interesting to note the rhetoric reversal that’s occurring in the Australian PPP-style privatisation debate. As John notes, and Uncle Milton also reminds us, the original case for privatisation of infrastructure was very much built on the inefficient ‘gold plating’ that went on under public ownership, with the NSW electricity industry constantly cited as the classic case. Now, with widespread concern about underinvestment in infrastructure afoot, the most frequent rhetoric issuing from the local privatisation lobby is that (1) the governments are too slow to approve the deals and (2) the chief benefit in privatisaing is that the infrastructure will be delivered much more quickly, i.e, if you want gold plating, get these governments out of the way so that we can get stuck into it more often more quickly. Beats me how they lie straight in bed.

  8. Uncle Milton
    August 17th, 2003 at 20:48 | #8

    Well, Chris, I think in fairness the argument from the privatisation lobby is not for gold plating, but to allow sufficient investment to meet demand, especially since, as Observa notes, summer peak demand is growing so fast, as more and more people get air conditioners.

    And to make matters more complicated, there’s the environmental angle.

    More coal-fired power stations? No good for greenhouse.

    What about nuclear? (No greenhouse problems there.) Yeah, right.

    So what do you do?

  9. cs
    August 18th, 2003 at 14:30 | #9

    Uncle, I’m referring to a cross argument from the private lobbies. True it’s not about ‘gold plating’, but arguably it never was. The energy question is one thing, the broader rhetoric another. Take, for example, the material put out by AusCID (press releases here). I just randomly flicked up the one from Nov 2001, where the rhetoric is about avoiding all the delay in infrastructure investment through privatisation. Why it seems only yesterday that similar interests were arguing that there wasn’t enough delay because of government decision making (which was leading to overinvestment).

  10. Clem Snide
    August 18th, 2003 at 23:15 | #10

    What do you do, Uncle Milton asks? It’s obvious. You retreat to a small-scale collectivist agrarian economy based on organic farming and handicrafts, increase regulation of industry (except for complementary medicine), ban chemicals and fossil fuels, hike taxes, ban forced redundancies, provide more free university places for womens studies, peace studies, environmental studies, masturbation studies etc., and dramatically increase arts grants and the public sector in order to provide employment for same. All decisions would be made by committee. It’s obvious, really. I’m surprised you even need to ask. People would be so happy they wouldn’t need electricity, except to electrify the fence that stops everyone from leaving.

  11. John
    August 19th, 2003 at 07:08 | #11

    Clem, I assume you view the return to decentralised private ownership as a step towards your agrarian paradise.

  12. Brian Bahnisch
    August 19th, 2003 at 19:20 | #12

    There are two articles on this topic I found particularly interesting. The first is by Greg Palast ‘Power Outage Traced to Dim Bulb in the White House’ originally published in The Observer (Friday, August 15). Palast goes into some detail about the astonishing corruption that has brought them to where they are.

    The second is by Harvey Wasserman ‘The Latest Bogus Fossil-Nuke Blackout: This Grid Should not Exist’. He is concerned about corruption also but is suggesting that the problem could be ameliorated by a greener approach, better building designs and on site generation through photovoltaic cells etc.

    Both articles are available at a site called “Dissident Voice” (www.dissidentvoice.org) August 16-17, 2003.

    btw I believe the latest is that its proximal cause was a tree in Ohio, hence maintenance (or maybe a terrorist up a tree?) Surely a number of smaller networks would reduce risk in these fraught days!

  13. Clem Snide
    August 20th, 2003 at 21:40 | #13

    John:

    Not really. I was gently parodying the propensity of socialists to seize on every failure and deficiency as proof of the need for more eco-socialism. I am old enough to remember the blackouts/brownouts we used to have under the ETU’s work bans.

    On one of the professional mailing lists I subscribe to, they point out that the problems in the US were in the transmission networks interconnecting the utilities. These are overloaded and undermaintained. By contrast the generation capacity which is overloading the transmission (where ownership/responsibility is less distributed) is healthy. This is another case of the tragedy of the commons. Much-needed upgrades to the transmission system have also been stifled by environmental concerns and NIMBYism.

    But never mind all that. Socialism is the answer.

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