Executive Summary

Sustainable Infrastructure: A Policy Framework

[ Last Updated 12 December 2005 ]

Policy Framework
Principles
Choice of Interventions and Tools
Responsibilities for Dealing with Issues

The purpose of this report is to develop a "best practice" infrastructure policy framework that takes account of conditions in New Zealand, particularly sustainable development objectives, against which existing settings can be compared and areas identified where enhancements may be made. The report outlines such a framework and approach with a high level cross-sectoral focus and looks to a set of principles to guide future policy.

Grouping infrastructure to develop a common policy framework, and thus guide appropriate policy interventions has its limits. High level similarities between the infrastructure sectors covered here are sufficiently striking to generate some significant insights along the following lines:

the broad impact of "sustainability" on infrastructure policy;
the consideration of the implications of a variety of threats;
the development of sound principles for decision making; and
what issues systems analysis of whole institutions can raise.

Turning these general ideas into specific decisions for specific pieces of infrastructure is more complex. Differences between the relative importance of the services offered, the technologies available, and perhaps most important, the actual physical structures of the infrastructural systems, mean individual decisions are best made case by case.

We sketch below a set of implications from analysis and experience. These suggest issues and ideas to condition choices when made. The principles are followed by the implications. Finally, in selected places, we briefly pull together the key ideas as developed and highlight critical operational matters for consideration.

Policy Framework

Government's goals include returning New Zealand to the top half of the OECD rankings (requiring sustained GDP per head growth faster than the average over the past 20 years) while meeting sustainable development aims - enhancing economic, social, environmental and cultural goals at once.

Sustainable development is not basically at odds with approaches to policy that have applied hitherto, provided the analysis does not leave out attributes important for sustainability. The principal attributes are: taking a longer term view of effects on future generations, and extending the boundaries of consideration beyond the immediate resources used in providing infrastructure. In policy terms, these are both types of "externality," effects arising from a market failure, for which there is are established policy responses to be applied, if the effects are well defined. Long-standing approaches to policy analysis can include sustainability with modifications to policy appraisal and interpretation of results, achieving an integrated policy framework reflecting issues other than those commonly in economic frameworks.

Infrastructure supports growth and sustainable development by providing services (inputs) to other productive processes, and (outputs) to consumption. In telecommunications and transport it also improves the efficiency of markets by reducing transaction costs and extending the area across which goods, people, ideas, and other services can be moved or exchanged. It facilitates specialisation within the economy and raises the productivity of other capital and labour; it broadens social exchange and enhances accessibility. Additional infrastructure investment's effectiveness depends on its place in the overall network of infrastructure, the efficiency with which the overall network is operated, and the capability of other factors of production to use infrastructure to raise their productivity.

An infrastructure policy, thus must concern efficiency of resource use to obtain more from less and reduce waste. This supports sustainable development, a concept still unfolding in local and international literatures.

There seems to not be an accepted "best practice" in infrastructure policy. Economic literature is clear that infrastructure's value is its services, and its ability to work with labour and capital to raise their productivity.

This report proposes a policy framework addressing all aspects of sustainable development, by examining infrastructure's effect on national welfare over time. National welfare can, in principle, be defined to include all dimensions of sustainable development - economic, environmental, social, cultural. But, if in practice these goals cannot be quantified, they may be sought by pursuing economic growth, subject to indicators of the other aims being maintained or enhanced. Policy in this framework seeks to enhance the contribution of infrastructure to welfare advancement, or to reduce the risk of welfare disruption caused by avoidable system failures.

The proposed policy framework involves a number of discrete activities:

monitoring external opportunities and threats to service supply, through changes in supply and demand, environment, technology etc;
using systems analysis and institutional analysis to assess the capability and resilience of infrastructure to respond to changing conditions;
devising remedial measures and policies to address weaknesses in current systems and institutions, as long as the costs of these do not exceed the likely benefit through enhancement of, or reduced disruption to, welfare - in economic, environmental, social and cultural terms.

Many empirical questions need to be answered to implement this policy framework in practice - some of these are under action by officials, in parallel with this report. The infrastructure audit may improve the information base and provide new avenues for empirical analysis.

Another crucial element to implement this infrastructure policy framework is firming up policy settings to express sustainable development. Choices like, the extent infrastructure pricing policies should be used for wider social goals such as accessibility, require clarity about those goals, and case by case analysis to decide whether they are best advanced through infrastructure policy or by other means (e.g. income support policies). Infrastructure policy cannot define these goals; it uses those decided in policies towards environmental, social and environmental advancement.

This discussion and analysis has developed a series of principles that together form a series of action guidelines. A summary form of them follows, to provide the basis of an action framework.

Principles

The underlying principles of the policy framework are:

Sustainable development is about improving the outcomes from use and configuration of available resources (physical capital, natural capital, social capital, cultural capital). It is amenable to the use of economic analytical frameworks. Such approaches, including the wide national welfare aims sought, can guide infrastructure policy, particularly relating to institutional analysis, externalities, and operations of networks.
Well-functioning markets are the best way to allocate resources to their most socially valuable uses, but market failures and externalities can limit their success. Improving efficiency by remedying market failures and externalities is a primary means of improving infrastructure's welfare contribution, via economic growth and sustainable development.
Policy must focus on the most important externalities that policy can affect, rather than on total levels of resource use or impacts. For problems like congestion, this means focusing on the marginal impacts of additional congestion, and on the marginal benefit of congestion reduction, rather than the aggregate impact of congestion as such.
Policy must support a macro-economic climate conducive to effective resource allocation and use, and avoid inducing expenditures that exacerbate business cycles and inflationary pressures.
Flexible policy allows different responses to varying conditions in different sectors/regions, rather than a "one-size-fits-all" approach leading to distorted incentives and varying compliance costs.
Distributing risks from infrastructure development or non-development, means striking a balance between placing risk on those who have most influence (avoiding moral hazard) and placing it on bodies best placed to spread and bear the risk (avoiding excessive precaution).
Similar principles apply in distributing responsibilities across those supplying services via infrastructure. Effects demanding a group policy response can devolve to the lowest level of collective authority able to deal with it (subsidiarity), recalling that more localised authorities face resource constraints because of their size.
Infrastructure policy is only one part of the set of broad socio-economic policies, and while it works within their institutional arrangements and objectives, it is not a substitute for them and depends on them to set their own targets.

Infrastructure policy requires a demand orientation in evaluation and operation of infrastructure investments, with performance indicators reflecting quality of service and user satisfaction, not just measures of assets and finance. Sustainability also requires attention to changes in long-term wealth stocks rather than just annual income flows. This implies that a sustainability policy framework needs information to monitor and analyse:

Trends in population, economic activity and other influences on the demand for infrastructure services, including predictable trends and shocks to the supply system. This is a "business as usual" setting to compare infrastructure supply and susceptibility to change against.
Infrastructure capital stock, not just current state and quality but also rates of depreciation, renewal and upgrade, and prospects for prices, to explicitly show long term sustainability of infrastructure services.
Supplementary indicators of externality effects falling on the natural environment or on society, to explicitly include environmental, social and cultural impacts and assist in managing them appropriately.
Macro- and micro-policies and their role in ensuring an open and competitive economy allowing efficient resource allocation, specialisation and firm contractual agreements, so as to encourage free association and partnerships in economic activity.

Choice of Interventions and Tools

The initial question is whether to look at a generic or a specific course of action. A criterion is proposed:

Would a sector specific intervention be better from a national viewpoint (assessed on the four aspects of interest) than a generic response?

International practice in applying policy interventions to infrastructure has used the following tools to deal with particular problems.

Activities with public goods, natural monopoly, or capital with high sunk costs - e.g. network or trunk-type facilities - use public planning, policy making, public finance and perhaps ownership. An alternative may be private sector financing and ownership under public regulation.
Operation of such facilities may still be contestable, and capable of being competitively tendered to specialist private operators, subject to public monitoring of performance, and allowing other firms access to facilities.
Activities without high sunk capital costs and natural monopoly provide little economic justification for impeding entry by private operators, subject to government ensuring fair competition.
Externalities (e.g. environmental impacts) of infrastructure can be addressed by regulations (zoning, technical standards) or fiscal instruments (taxes, fees or subsidies).
Distributional objectives can be met by regulation (e.g. universal service requirements), investment planning (e.g. regional spread) and/or public financing of socially needed non-commercial services.
Significant co-ordination issues among facilities and services may justify regulation of investment or of operating standards.
Characteristics of market demand, such as low availability of substitutes or low price elasticity may warrant price regulation to protect consumers against monopolistic suppliers. Demand for a high diversity of services indicates policies to liberalise production and promote competition.

MED officials and Pinnacle Research have suggested a framework which brings together the material set out in this report. The framework sets outs a series of "tests" designed to ascertain if there are market failures or other characteristics associated with the infrastructure sector under observation that might require government intervention to alleviate / address those failures. Potential policy tools are then set out that could be used to address failures. This material is attached as Appendix E.

Responsibilities for Dealing with Issues

The established literature provides guidance on:

The split between private and public provision, balancing a private operator's ability to avoid problems under their control, with a larger public body's ability to bear persisting risks.
The appropriate division of responsibilities between different levels of government for problems with effects at different scales.
The way system responsiveness is affected by central and local government legislative and policy settings, in creating a climate and in particular decisions.
Risk bearing in large long-lived investments. Previously these were seen as governmental, but capital market developments shifted ideas here.

Risk is a feature of infrastructure policy, and the application of risk management principles to infrastructure has the following implications:

Demand risk (revenues are less than budget) is better borne by the facility operator, where service attraction is under control of the operator.
Political and regulatory risk (future government actions undermine the return on the facility) are more under the control of government.
Quasi-commercial risk (state-owned supplier or purchaser may default on contracts under political influence) may suggest a government guarantee.
Demand and construction cost guarantees, although commonly sought from government, have weak justification in terms of this risk sharing approach.
Government guarantees for infrastructure investment provide short term fiscal relief but create a long-term potential liability for government; open financial transactions are more transparent and effective.
Sustainable development must avoid risk shifting that creates liabilities for future generations, or pushes effects beyond the boundaries of market transactions, on the environment, on social cohesion and on cultural integrity. Risk spreading is like other externalities, which provides guidance on how such risk can best be shared.
The optimal distribution of risk from financial affairs resembles the optimal allocation of goods and services to private or public good provision. So, for services delivered through markets and commercially priced (e.g. telecommunications, ports and airports), financial risks are most appropriately managed by the facility operators themselves.
Services that are more in the nature of common pool facilities or public goods, have a stronger case for government to share part of the risk.
Large infrastructure providers can spread risks over a wide pool of stakeholders. Local government bodies are not well placed to do this.
Environmental risks can be shifted to infrastructure providers (e.g. using performance bonds and liability rules). Social and cultural risks can only be borne by the communities affected.