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• 3. Analytical Framework

• Infrastructure Development

• Infrastructure Stocktake

• Infrastructure Audit
• Sustainable Development
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• A Policy Framework
• Stocktake Reportback
• Media Statements

• 3.1 Addressing Sustainability
• 3.2 From High Level Outcomes to Practical Policy Objectives
• 3.3 Is There a Problem in Infrastructure's Ability to Contribute to Maximising Well-being over Time?
  • a. Failure to Keep up with Current or Expected Demands for the Services It Provides
  • b. Failure of Capacity to Provide Headroom or Reserves to Keep Expected Value of Disruption by Shocks to Manageable Levels
  • c. Failure of Capacity to Adjust to Megatrends Like Decarbonisation
  • d. Persistence of Unaddressed External Effects
• 3.4 If There Are Problems, What Are Their Principal Causes?
  • 3.4.1 Market Dominance
  • 3.4.2 Information Failures
  • 3.4.3 Co-ordination Failures
  • 3.4.4 Externalities and Social Objectives
  • 3.4.5 Public Goods
  • 3.4.6 Merit Goods and Social Redistribution
  • 3.4.7 The Significance of Changing Technology
  • 3.4.8 Regulatory Failure
• 3.5 What Can Be Done to Fix the Problems?
  • 3.5.1 The Scope of Corrective Tools and Approaches
  • 3.5.2 Market Creation
    • a. Property Rights Definition and Trading
    • b. Competition
  • 3.5.3 Market Adjustment
    • a. Price Adjustment through Taxes and Subsidies
    • b. Price Adjustment through Regulation
    • c. Quantity and Standard Setting through Regulation
    • d. Structural Changes in Suppliers and Regulators
  • 3.5.4 Public Provision
    • a. Public Purchase of Privately Supplied Services
    • b. Supply of Services through Public Agencies
    • c. Joint Ventures, Partnerships and Franchise Arrangements
  • 3.5.5 Other Behaviour Changing Instruments
    • a. Education, Information and "Norm Shifting"
    • b. Arbitration and Facilitation
    • c. Direct Income Redistribution
  • 3.5.6 How Infrastructure Characteristics Affect the Use of Policy Tools
• 3.6 Principles on the Division of Responsibilities

3.1 Addressing Sustainability

As economics is the study of resource use choices, finding the best configuration of existing resources that maximises outcomes across the quadruple bottom lines is essentially an economic problem amenable to economic analysis. This does not mean putting effects on the economy ahead of the other bottom lines; the relative priority of each bottom line depends entirely upon the relative weights attached to each of these outcomes in analysis.

In the absence of a commensurable basis for comparing all these goals it is difficult to identify what is a sustainable development path that would advance economic, social, environmental and cultural goals simultaneously. An alternative, practical approach is to pursue measured GDP growth, subject to supplementary checks to ensure certain environmental, social and cultural targets are met, or critical limits respected.

Such an approach has similarities to an optimisation routine that maximises economic output subject to constraints, but this should not be interpreted as relegating the "non-economic" objectives as secondary considerations to growth in the economy - if something (e.g. rare habitat) is a constraint and decisions are changed to avoid encroaching on it, it is accorded a higher priority than the economic activity which incurs additional cost to avoid it. Nor should it be regarded as limiting the non-economic objectives to maintaining the status quo: constraints may include stretch targets, such as making certain developments conditional on remedial works that improve the condition of the adjacent environment.

There is a continuum of possible assessment techniques for considering the sustainability of particular policies at a micro-level. These include:

• Integrated policy analysis, in which all effects over time are assessed to ensure financial, social, cultural and environmental concerns are addressed: in practice this may entail a narrow monetary cost-benefit analysis supplemented by additional checks or a planning balance sheet to ensure that social, cultural and environmental impacts are given due consideration.
• Multi-criteria analysis, in which all effects over time are assessed and weighted by diverse techniques against financial, social, cultural and environmental criteria, to arrive at an overall "desirability score" for the policy or project.
• Social cost-benefit analysis, in which all resource inputs and outcomes over time are given monetary values to arrive at a net benefit in present value terms.

The feasibility of each technique varies with the circumstances of each analysis. Each technique allows explicit consideration of the dimensions of sustainable development: effects occurring in different time periods, effects on productive sectors and effects falling outside them (e.g. environmental externalities), social impacts like service affordability, accessibility and the inclusion of measures to protect natural and cultural heritage.

Each of these techniques allows the application of common criteria to the policies assessed:

• Efficiency can be assessed through the cost-benefit analysis component found in each technique, supplemented by "backwards analysis" that asks whether unmeasured effects are likely to be big enough to overturn the result of analysis of measurable effects;
• Effectiveness of the policy, or its likelihood of achieving the desired effect or behavioural change, is a technical issue and essential input into the policy assessment;
• Equity, or the distributional impacts of the policy, can be illustrated by the analysis, although whether a given distribution is good or bad is a political judgement beyond the scope of such analysis to determine.
• Practicality, or ease of implementation, as indicated by avoiding undue changes in existing legislation, regulation and industry structures.
• Sustainability, as indicated by the likelihood of uncompensated negative impacts on one of the quadruple bottom lines.
• Fiscal implications, as reflected in the monetary commitments and risks borne by government.

In the absence of clear policy settings or guidance as to what are the desired weights to be attached to social, environmental and cultural outcomes, an infrastructure policy framework may consider the adequacy of institutional coverage of such wider issues. Framed in resource use terms, key policy questions are, "Are there institutions in place to dynamically take account of environmental and social externalities associated with this infrastructure?", and secondly, "How well do these work?"

It is not the role of infrastructure policy to create measures of achievement across the quadruple bottom lines - these should be determined by broader environmental, social and cultural policy settings. The role of infrastructure policy is to monitor whether infrastructure practices are in compliance with these settings, and if not, to assist in determining what can be done to correct that.

3.2 From High Level Outcomes to Practical Policy Objectives

Given an overarching objective of maximising infrastructure's contribution to well-being over time, infrastructure policy needs to focus on some key questions about the performance of infrastructure sectors and their policy settings in delivering services.

These broadly surround the following issues:

• Is there a problem?
• If so what causes it?
• What can be done to solve it?
• Who is best placed to remedy it?

3.3 Is There a Problem in Infrastructure's Ability to Contribute to Maximising Well-being over Time?

This depends on an assessment of the state of current capacity and its rate of renewal or upgrade in face of expected future demands, both those that are predictable (such as those driven off population growth) and those that are genuine shocks. There are a number of ways in which such a problem may be manifested.

a. Failure to Keep up with Current or Expected Demands for the Services It Provides

If infrastructure services are to be provided without the disruption caused by radical changes in price or rapid technological transformation brought about by force of circumstances, capacity needs to expand in line with expected demands and/or demand management practices adopted. Demand growth may be broadly driven off a relatively predictable measure (such as projections of population, or GDP) but it may also be augmented by new uses for current capacity brought about by changes in technology (as in the use of voice-lines for electronic data transmission).

Addressing these issues may involve monitoring the drivers of trends in population, GDP, infrastructure sector investment and prices. It may also warrant careful modelling of the likely determinants of infrastructure demand, including own- and cross-price elasticities of demand for infrastructure services. There will also be sector specific issues to monitor, such as, in energy infrastructure, the adequacy of generating capacity and hydro storage to deal with peak demands, and the rate of discovery of new gas reserves to make good the depletion of existing fields.

b. Failure of Capacity to Provide Headroom or Reserves to Keep Expected Value of Disruption by Shocks to Manageable Levels

Evidence of failure of capacity growth to provide sufficient headroom for changes in demand could arise from:

• Increasing incidence of periods of service supply shortfall caused by shocks or other unexpected supply and demand pinch;
• Increasing variability in the price of services caused by periodic disruption;
• Stalling in the rate of investment in new capacity.

The focus here is not on the shocks themselves but on the adequacy of infrastructure capacity to deal with variability in supply and demand conditions. Shocks have diverse causes, including environmental variability (such as low hydro-lake inflows), external trade disruption (as in the supply and price of oil products) or internal arrangements (such as the capacity to deal with traffic diversion from temporary closures of other infrastructure facilities). It would be efficient to provide headroom capacity to the point where the marginal cost of extra capacity equals the expected value of disruption costs avoided by that capacity, so changes in the adequacy of headroom provide a prima facie case that a market or co-ordination failure may exist for particular infrastructure services.

c. Failure of Capacity to Adjust to Megatrends Like Decarbonisation

Evidence of failure of capacity to adjust to megatrends like decarbonisation would primarily arise from an observed shortfall in the rate of reinvestment in carbon reducing technology. How such a shortfall would be defined is problematic: current activity (or inactivity) towards decarbonisation may be a rational response by industry to their expectation of the future cost of carbon, reflecting scepticism about whether Kyoto policies will come into force or not, and maybe also the hope that carbon sequestration technologies will emerge to make decarbonisation superfluous.

The timing of adjustment to long term trends is crucial, as there is a positive option value in delaying adjustment until more is known about the potential risks and techniques to counter it. For instance, the rate of technological advance in developing alternatives to carbon-based fuels, or sequestering carbon emissions, will affect the optimal timing and extent of decarbonisation.

d. Persistence of Unaddressed External Effects

The existence and persistence of unaddressed external effects from infrastructure use can be expected to detract from the advancement of quadruple bottom lines.

As improving infrastructure's contribution to well-being over time means reducing the expected value of infrastructure failures, prioritising policy attention across and within infrastructure sectors can be guided by the likelihood and consequences of failure in different sectors, the ability to remedy the causes of those failures, and focusing policy adjustments on those which can achieve the biggest expected benefit in averted failures per unit of cost from policy change.

Prioritisation also needs to allow for diminishing returns and mis-pricing of services that may cause additional investment to be inefficient. This implies a policy role for monitoring the trends that are driving pressures on infrastructure systems, monitoring the headroom and resilience against shocks, and focusing on the institutions and their ability to respond to both predictable and unpredictable changes.

3.4 If There Are Problems, What Are Their Principal Causes?

While there may be technical causes for particular infrastructure problems (e.g. cables too small, or too few to handle overloads) a more fundamental policy issue is why the system allows them to persist. In a mixed economy such as New Zealand's, the private self-interest of firms and individuals is a powerful motivator of activity, so a role for policy is in aligning private incentives with public interests. In line with international practice, a useful approach involves identifying the role of various forms of market failure in creating problems in service supply, as a way of homing in on possible improvements to market operation.

3.4.1 Market Dominance

Market dominance arises where there are extensive economies of scale (high fixed costs relative to variable costs, average costs declining over the range of output), which in the extreme leads to natural monopoly under which the unit costs of supplying the market will be minimized by a single supplier, rather than with multiple suppliers. As a single supplier has an incentive to charge prices in excess of marginal costs, and may also not be responsive to changing market demands and supply technologies, such markets may not be efficient without some regulation or other policy intervention.

The existence of natural monopolies deters new entrants because of the ability of the incumbent to drop its prices to ward off threat of entry by new competitors. A contestable market which is easy to enter or exit by a "hit and run" competitor may provide sufficient discipline on incumbent operators, but these conditions are not prevalent with network infrastructure with high sunk costs.

Economies of scale and sunk costs are characteristic of a wide range of infrastructure facilities across the four sectors covered by this report, particularly in long distance energy transmission, local water reticulation and sewerage networks.

Source: NZIER adapted from Kessides 1993b

Policy responses have been different according to the structures of each industry and their evolution.

• Energy networks (electricity and gas) have attempted to create markets of competitive suppliers delivering across common transmission networks. Natural monopoly characteristics reside particularly in the transmission networks, which have been controlled by various regulatory measures.
• Water reticulation and sewerage networks are local natural monopolies, whose ownership is vested in local authorities or council controlled organisations. There is no competitive benchmark and no regulation other than scrutiny through local political processes and the reporting and auditing requirements in local government legislation.
• In telecommunications the natural monopoly and sunk cost are concentrated at the local loop landline, the response to which has been to try to secure common access over the incumbents' networks for competitive service providers.
• Roads have high sunk costs but no risk of monopolistic pricing under current funding arrangements, which are entirely controlled by government agencies.

Source: NZIER adapted from Kessides 1993b

Figure 1 and Figure 2 illustrate an assessment of different infrastructure facilities according to economies of scale and the extent of sunk costs. A task for policy is to periodically review the accuracy of such assessments in light of changes in market conditions and technology change. In particular, economies of scale can change radically with technological change, shifting the relative advantage away from, for instance, centralised electricity generation with long transmission lines to more localised distributed generation with transmission more for back up and periodic peak capacity.

3.4.2 Information Failures

Information failure may arise because information is not costless to procure, but once it is created it may be easily copied, leaving it prone to free-riding and under-recovery of costs by private suppliers. So information that may be valuable for a range of different parties may never be commissioned by any one party, because no-one wants to bear the cost that others will benefit from. Hence some information (though not all) has characteristics similar to public goods, and may require similar levels of support.

Information failures commonly arise in fragmented markets (farmers, households etc) and suppliers who service those markets, and hence miss opportunities for adopting new techniques, energy efficiency measures and so on. For infrastructure policy, a question is whether there is any generic information that would improve operation and use of infrastructure that is not being procured because of fragmented beneficiaries, or is already in the hands of suppliers who have no incentive to share it. Information failures are more likely to emerge in highly dispersed facilities, such as water system management, rather than the more concentrated energy and telecommunications systems.

3.4.3 Co-ordination Failures

In infrastructure systems with interlocking networks across which traffic flows, explicit rules and formal co-ordination between operators is required to some extent to ensure smooth operation of the network. Co-ordination is related to natural monopoly to the extent that there may be economies of scale and scope in having a single co-ordinator of a mixed system, setting minimum standards of equipment and operation. Co-ordination failure occurs when there is no clear set of operating rules, or no single operator in a position to enforce those rules, exacerbating congestion and bottlenecks and other localised blockages across the network.

Source: NZIER adapted from Kessides 1993b

Figure 3 illustrates one assessment of the co-ordination requirements between different types of infrastructure facilities. As with economies of scale, technological change can have significant impact on co-ordination possibilities and the range of rules it is possible to apply to manage the flows across a network (e.g. electronic road charging, real time metering).

3.4.4 Externalities and Social Objectives

Externalities occur wherever the benefits or costs of producing or consuming a good affect persons other than the individuals involved in a transaction, but those individuals have no incentive to take these effects into account in their decisions. They can impact on other production or consumption processes, impact on the natural environment, or impact on social and cultural arrangements in the surrounding community. Some infrastructure also provides external economies of consumption (network externalities) whereby all users benefit when a new subscriber gains access to a network because it increases the range of service they can all enjoy (e.g. because of more potential contacts on a telephone network).⁶ If the benefits of enlarged network are nevertheless paid for by the beneficiaries, the network effect is not a true externality, and network effects should not be used uncritically as a justification for expanding a particular network if this creates competitive advantage for one network over alternative suppliers.

In a similar vein, certain social or political objectives valued by the community, such as universal access at a minimum level of service, may be considered to have a social benefit beyond that accruing to individual users.⁷ That is, consumption of infrastructure services may be considered merit goods that generate positive social externalities.

Figure 4 illustrates some of the externalities and social objectives that may be associated with different types of infrastructure operation, spanning externalities in production, environment and socio-cultural conditions. These assessments will change as technology develops, and a role for policy may be to identify whether any significant shifts in externalities and their coverage by institutional arrangements emerge as conditions change. As internalizing externalities improves resource use efficiency and can generate complementary benefits, a key role of infrastructure policy is to ensure all externalities are identified, quantified (where possible) and incorporated into resource use decisions.

Source: NZIER adapted from Kessides 1993b

3.4.5 Public Goods

Public goods are those which are non-rival and non-excludable in consumption, so that the public would demand more than private suppliers could supply while still recovering their full costs of supply. Infrastructure services are generally not pure public goods as they display varying degrees of rivalry in consumption (congestion), but both their large scale and low marginal costs give them characteristics similar to public goods. In addition some infrastructure may provide spin-off benefits that more closely fit the public good definition, such as river management that is adapted to maintain natural habitats in particular conditions.

Source: NZIER, adapted from Kessides 1993

Figure 5 illustrates a division of infrastructure facilities in terms of their varying degrees of rivalry and excludability in consumption. Those towards the bottom right hand corner of the figure are close to private excludable goods and provide little basis for provision as public goods. Those towards the top left hand corner have more of the collective characteristic of public goods and have been provided as if they were public goods. Common pool goods are those that have high rivalry but low excludability, i.e. it is impractical to charge for individual use, but they are still subject to congestion. Toll goods are more in the nature of "club goods", in which use is excludable at reasonable cost and they are less likely to suffer congestion.

A function for infrastructure policy is to monitor the appropriateness of such distributions in face of changing conditions, particularly changes in technology of exclusion (e.g. electronic road pricing) and its applicability to different conditions (high volume/urban or low volume/rural roads etc).

Even where infrastructure services have characteristics similar to public goods, this does not mean they are necessarily best provided through a public agency. Taxpayer subscription may be necessary to obtain the socially desired level of service, but whether this is best provided through a publicly owned entity or contractual arrangement with a private supplier depends on assessment of the capabilities, costs and risks of the various options, and on their likely effectiveness, efficiency and equity in practice.

3.4.6 Merit Goods and Social Redistribution

Merit goods (like cultural events, or museums) are those which Government supports because it believes consumption should be greater than is currently observed, and this type of social redistribution involves changing the distribution of costs, benefits and impacts according to politically determined notions of equity or universality.

Various measures could be devised to monitor the performance of infrastructure services in terms of distribution - social indicators like accessibility could be measured by the proportion of households connected to a particular service, affordability could be measured by the price of services relative to income levels - but this depends on particular policy objectives the services are supposed to meet. Explicit interventions such as the Telecommunications Service Obligation provide some restraint on prices to particular groups in the community.

3.4.7 The Significance of Changing Technology

As indicated in the above sections, the extent of market failure in infrastructure services is critically dependent on prevailing technologies of supply. For general policy purposes across infrastructure sectors there is a role for monitoring the emergence of feasible new technologies that promise to:

• Reduce the conditions for natural monopoly, e.g. by reducing economies of scale or providing new substitutes for incumbent systems (e.g. cell phones for landlines).
• Permit lower cost supply options, though changes in design parameters of equipment that enables more efficient use of resources (e.g. sprinklers which achieve irrigation objectives while using less water).
• Increase the range and quality of service by enabling additional value-added services down the same pipe or cable.
• Facilitate the unbundling of assets and services, enabling more efficient pricing for particular service use rather than lump sum subscription.
• Expand options for demand management, e.g. through water metering or time-specific electronic road pricing.

3.4.8 Regulatory Failure

While justification for Government intervention generally rests on identification of market failure, there may also be reason for new policy adjustment in cases where government or regulatory failure is identified. Sources of government failure may include unresolvable conflicts among policy objectives, inability of policy makers to interpret the public interest, and the interplay between the concerns of particular constituencies and the private interests of officials. A role for infrastructure policy is therefore to monitor the performance of government policy and public agencies, and assess the likelihood of new policy interventions, or the removal of existing measures, achieving an improvement on the existing situation.

Ensuring costs of policy adjustment are less than the benefits they are intended to achieve is a generic test relevant to assessing the worth of all intervention, whether that is prompted by regulatory failure or market failure. This entails explicit consideration of what a new policy measure implies for administration costs on the regulator, compliance costs on the regulated, allocative costs of unintended responses to new incentives, and the difficulties of design created by information asymmetries. It also requires consideration of the effect of regulatory change on long term confidence in a jurisdiction as a place for investment. Worldwide models of regulation have evolved rapidly over recent years, and effective regulation may involved restraint in regulation, doing well only what is necessary".⁸

3.5 What Can Be Done to Fix the Problems?

If market failures are identified, there are a number of ways they may be tackled through market creation, market adjustment, public provision or other behaviour changing approaches.

3.5.1 The Scope of Corrective Tools and Approaches

A standard approach to market failures is to employ various tools and approaches for market correction. Such approaches include creating a market where none previously existed; modifying the operation of a market through applying regulation, taxes, or subsidies; directly providing services through public agencies (substituting political choice processes for market choices); or applying other instruments to change behaviour. All of these may be appropriate for particular infrastructure issues. We discuss them briefly below.

3.5.2 Market Creation

The idea here is to take advantage of the economic and social features of the ability of individuals to trade by putting in place the necessary fundamentals. The focus is on building a working and effective market.

a. Property Rights Definition and Trading

A property right is a socially enforceable right to select uses of an economic good. The minimum requirements are that the specific use of interest is clear and that there is no ambiguity about the identity of the owner.

There are a number of aspects of the specific use that militate in favour of property rights (as they create a more effective market). The features are:

• The specific use is capable of being distinguished from other uses;
• The use can be insulated from wider effects (e.g. it does not involve running down a stock to the detriment of the rights of others); and
• The use right allows for low costs of enforcement.

Trading means the ability to alienate the use in return for a consideration. Given reasonably well defined property rights, trading will generally be possible as long as the transaction costs are not too high. Trading is also desirable as it creates incentive and provides a mechanism for resources to be reallocated to higher value uses, raising the overall return from available resources.

b. Competition

To ensure effective markets it might be necessary to intervene to counteract market dominance and improve competition. This could take various forms, from direct intervention through structural regulation to the operation of specific legal rules.

3.5.3 Market Adjustment

The approach here is to work within the market, by providing an intervention that changes the outcome that would otherwise prevail, towards a more nationally sought one.

a. Price Adjustment through Taxes and Subsidies

Changing the prices that prevail by taxing or subsidising will have the effect of changing the quantities traded, to an extent depending on price responsiveness. This still allows the normal favourable incentive and innovative effects associated with markets to occur. It can also directly affect the affordability of products or services, with implications for social outcomes.

Such interventions can have their impact mitigated by actions taken within the market - traders might choose to absorb taxes or subsidies rather than pass them on, for instance. They can have unforeseen consequences (e.g. by hastening technological change). They also have budgetary implications for the authority that imposes them.

b. Price Adjustment through Regulation

Prices can also be adjusted through regulation, which has no direct fiscal or budgetary implications for the regulatory authority. Regulations which restrict the use of a particular resource will affect the interplay of supply and demand and raise the price of resource use, in the absence of readily available substitutes.

A more direct route is to directly regulate prices. This allows those in the market some latitude in adjusting to the regulatory constraint. It may however, create a "straight jacket" for the prices involved, preventing their normal fluctuations (e.g. in response to shifts in supply and demand), distorting their signalling characteristics and thus reducing the favourable incentive effects these movements usually have.

c. Quantity and Standard Setting through Regulation

More indirect is to create quality and other standards through direct regulation. This saves the costs of any market related development, including the potential uncertainty associated with the process of emergence of non-regulated standards.

It does tend to "cement in" a view of the product or service concerned and normal regulatory processes inevitably find it difficult to adjust in response to shifts that can happen to the tastes and technology that normally underpin standards. Moreover, it often puts the regulator in the position of having to choose between several potential technologies, at a time when it is unclear which is most appropriate.

d. Structural Changes in Suppliers and Regulators

To achieve certain goals it might be appropriate to direct structures in the market. Thus, in New Zealand recently it has become unlawful for electricity lines companies to also be retailers of electricity, and previously there were restrictions on the joint ownership of petrol wholesale distribution and retailing outlets.

This type of rule can have unforeseen consequences - as did the enforced sell-off of electricity retailing, which resulted in the generators taking them over as a way of internalising their risks.

3.5.4 Public Provision

In addition to interventions that support or modify and enhance the market's operation, other strategies that supplement or bypass markets can be considered. There are a number of these.

a. Public Purchase of Privately Supplied Services

It may be thought appropriate to organise the supply side of the provision of some good or service by having a public agency purchase the supply from a private provider. For instance public transport can be organised this way. It has the advantage of separating the provision from the production, and gives the state the information that comes from being engaged.

On the other hand, unless contracting is undertaken carefully, this arrangement can create difficulties in ensuring continued supply. Investors may not be interested in chancing their arms in bidding tournaments to occasionally gain contracts to sell high fixed cost services to single purchasers.

b. Supply of Services through Public Agencies

Many goods or services are supplied through public agencies. This was more common prior to the 1980s, but still is the predominant format for other public services such as education and health in OECD countries. It has been perpetuated for roads, water and energy infrastructure by the current Government's decisions on retaining public utilities in public ownership. It has the advantage of overcoming difficulties associated with market dominance as the public agency can be directly regulated by a variety of means including instruments not readily available to regulate private firms.

But there are difficulties associated with public monopolies. Without real prospect of competitive entry, they can be unresponsive to customer needs and lacking in innovation.

c. Joint Ventures, Partnerships and Franchise Arrangements

Many jurisdictions have recently been experimenting with various more innovative joint arrangements. These can be tailored to the particular market circumstances, and if well designed provide the flexibility and scope for the partners to specialise on their comparative advantage and contribute their particular strengths, thereby raising the overall result above the sum of what individual partners could achieve on their own.

3.5.5 Other Behaviour Changing Instruments

Beyond these traditional interventions lies a suite of assorted instruments of different types.

a. Education, Information and "Norm Shifting"

Focused on behavioural change are a number of ideas related to information or creating social pressure. These can be effective where the behavioural changes sought depend on the inculcation of new attitudes by individuals. This in turn depends on the provision of data or information being influential in changing attitudes, and/or the importance of social pressure as a factor in the relevant behaviour.

While occasionally rapid attitude shifts have been discerned (e.g. honking at speedsters in the 1973 energy crisis) this does not seem to endure unless part of a sustained follow up campaign. The social attitudes to "driving under the influence" have definitely changed here over the last 25 years, driven by steady reinforcement and a flow of information. But we are still struggling with the centre of gravity of social attitudes to "speeding," despite longer running and often very intense publicity campaigns. The effectiveness of education and information in "norm shifting" is highly variable according to particular circumstances, and in most instances requires a long time to achieve a lasting effect.

b. Arbitration and Facilitation

Interventions to resolve disputes through methods generally accepted as reasonable and fair, can play a part in producing desired outcomes. So, in the case of a monopoly transport node wishing to raise its charges, the intervention of a public arbiter, with a reputation to lose, might play a significant role in showing the various parties that there is an acceptable outcome that allows for both a reasonable price to consumers and a return to the owners that ensures investment continues.

c. Direct Income Redistribution

Redistributing income (including via vouchers) is a direct way of influencing accessibility. It compensates (selected) consumers for the price of the good or service without influencing the producers from competing to lower costs and keep up quality.

It has well known practical design and execution difficulties, but is already widely used in welfare states to achieve a variety of goals.

3.5.6 How Infrastructure Characteristics Affect the Use of Policy Tools

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

• For activities involving public goods, natural monopoly, or capital with high sunk costs - e.g. network or trunk-type facilities - there is a case for 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 nevertheless be contestable, and capable of being let to specialist private operators on the basis of competitive bidding for the right to operate, subject to government monitoring of performance under its contract, and conditions allowing other services using the facilities fair access to them.
• For activities that do not involve high sunk capital costs and natural monopoly there is little economic justification for impeding entry by private operators, subject to government ensuring fair competition in such activities.
• Externalities such as 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. of regional spread) and/or public financing of non-commercial services which are deemed of social importance.
• Significant co-ordination issues among facilities and services may justify regulation of investment or 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. Where a high diversity of services is demanded, policies that liberalise production and promote competition would allow a wider range of substitutes to emerge.

MED officials and Pinnacle Research have suggested a framework which brings together the preceding sections on failures, their causes and possible fixes. 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 to that could be used to address failures. This framework is set out as 6 Appendix E.

3.6 Principles on the Division of Responsibilities

The established literature provides guidance on the division of responsibilities between private and public sector in service provision, balancing the infrastructure operator's ability to control the source of problems with the wider community's ability to bear the risk of any persisting problems. The theories of externalities, fiscal federalism and subsidiarity also provide guidance on the appropriate division of responsibilities between different levels of government for problems with effects at different scale.

The principle of subsidiarity suggests collective solutions are most likely to succeed where they are devolved to the lowest level of collective authority able to deal with them, as they are likely to be more responsive to what is needed to remedy the particular problem. Externalities are best addressed by the collective authority most affected by it: thus where there are significant cross-boundary effects and co-ordination issues between different local council activities (e.g. catchment management), it can be efficient to internalise these issues into a larger regional authority. Other issues, such as responses to greenhouse gas emissions, are best handled by national policy and standards, both because this avoids inconsistencies in approach which distort investment decisions to no effect, and because such issues often emanate from international agreements to which only national governments are party. But as local authorities may not have resources to deal with issues thoroughly, fiscal federalism indicates it may be more efficient to raise the revenue at a national level (where it is more difficult for taxpayers to evade contributing by relocating) and redistribute it to districts according to their requirements (as in the current road funding arrangements).

Central and local government can also look to how their legislative and policy settings assist or detract from infrastructure system responsiveness; for instance, the combined effect of policy on confidence for investment in infrastructure and other business activity, or the extent to which inadequate pricing of water allocation and devolution of resource management responsibilities to local government level affects the choices and national benefits obtained from allocation to water supply, agriculture or hydro generation. Local government in particular has a mixed role as both regulator and operator of some infrastructure (roads, water supply) and may need to re-examine possibilities for more effective use of the various instruments available to it if infrastructure is to move to a more sustainable and efficient level of supply.

The long life of infrastructure imposes considerable risk on the likely returns for new investment. Governments in the past have been viewed as better placed to handle such risk than private investors, by virtue of their ability to spread risk across the community of taxpayers, but this can impose substantial deadweight cost on the economy, detracting from well-being. These days capital markets are broader, more diversified and better able to handle risk than most governments of small countries, and recourse to government funding should be done only sparingly. (An exception to this arises where government tax is the charge mechanism used to recover costs of a service, as is currently the case with roads).

⁶Conversely there can be negative effects from addition of new subscribers, i.e. congestion. If this is reflected in the price of subscription through congestion charges, there is no externality.

⁷Kessides (1993b), page 7

⁸See Kessides (1993b) p. 45