4. Identification of Relevant Policy Issues
4.1 Trends Affecting Infrastructure Services' Supply and Demand
The provision of services from infrastructural assets can extend for many years. Thus, infrastructure policy requires an assessment of economic conditions that will prevail in future. Establishing the drivers of demand for infrastructural services, monitoring developments in these drivers and forming expectations about future movements in the demand drivers should be a key component of infrastructure policy.
Appendix D contains a brief review of an approach to threat analysis and a list of some emerging "megatrends" that are important for infrastructure policy analysis.
4.1.1 Relevant Trends in New Zealand
The base trend material is widely available. Establishing the crucial elasticities9 between the fundamental drivers of demand growth, such as population growth and the demand for infrastructural services, is a critical part of policy development. As a general principle, future demands on infrastructure services will be a function of their price, availability and the price and availability of substitutes, and their own-price and cross-price demand and supply elasticities.
As an example, main telephone lines in operation between 1991 and 2000 increased by just over 28%, compared to an increase in New Zealand's population of under 12% over the same period. This implies a positive elasticity of above 2. These changes could have occurred as a result of many factors including, a rise in incomes, a reduction in household size, a rise in multiple line households, or a fall in the real price of telecommunications. Further, growth in main telephone lines may have been larger if it were not for the rapid rise in cellular mobile users over this period from 72,000 to over 2.1 million subscribers. Although it would be unwise for the policy to rely too heavily on such a crude elasticity estimate, simple indicators like these can highlight a broad trend, with implications for the evolution of enhanced monitoring related to infrastructure capacity that warrant further investigation.
Regional differences, such as the projected continuation of the northward and urban drift of the population, need to be taken into account when considering the adequacy of infrastructure configurations. A regional population growing faster than infrastructure capacity in the locality could signal a future brake on development in the region, and areas have different capability and resources to overcome such differences. Such regional variations have wider implications when local infrastructure constraints have potential impacts on the wider economy, in effect creating an externality for other regions.
To further complicate matters, such elasticities need not be constant through time, as many factors including demographic distributional shifts, or technological changes, alter aggregate figures. Understanding the changes in demand for infrastructural services as a result of the trends in key variables included in this report (after taking account of other relevant changes such as changes in demand side management, like pricing measures), and using projections of these key variables, can provide a baseline forecast of future demand. When compared to existing and pending supply, an assessment of whether a policy response is required or not can then be made.
Historically population growth has been a relatively good indicator of economic activity on which to base forecasts over the medium to long term. The population stock is relatively predictable in its growth patterns, and given assumptions about labour force participation and average labour productivity, aggregate growth can be forecast within reasonable bounds. Predicting for long term structural changes requires a more sophisticated approach, but these often fall in the realm of genuine uncertainty. This can be handled in various ways in an inter-temporal policy analysis: for instance, expected demand growth can be assessed through changing the forecasts of particular demands, or though changing the discount rate applied to the forecast to account for future risk and uncertainty.
These trends are relevant to supply and demand, and to sustainable development, because, other things being equal, they imply increasing pressure placed on infrastructure resources and the natural environment, and increasing constraints on availability of, and accessibility to, environmental services. In practice, other things rarely are equal, because of feedback loops and responses in the systems using resources, including both the economic system and the environmental system. In particular, growing demands and resource scarcities can be expected to result in rising prices, with either the adjustment of demands on, or use of substitutes for, the resources under pressure. Also the institutions that govern resource allocation and use can respond in various ways, through policy adjustments or provision of alternative supply. The ability of institutions to anticipate and respond to predictable trends, and their agility in rectifying or finding alternatives when unpredictable shocks occur, is a function of institutional design and of the policy settings for the particular sector.
4.1.2 International Trends
As a trading nation with an open economy, New Zealand is strongly affected by trends that emerge worldwide. Some that can be foreseen with reasonable certainty and implications for infrastructure are outlined briefly below.10 Demand for affordable goods and services from young populations growing in size and affluence in the developing countries will drive innovation of products and new business models. Cost structures to suit these large, emerging markets will shift the margin of choice between providing services through large scale infrastructure facilities and alternative technologies that provide the same services at smaller scale.
For example, this is likely to lead to new products and systems becoming available in services such as remote area power supplies, water sanitation, and mobile communications. Pressures on freshwater supplies in many parts of the world portend rising water costs, creating opportunities for suppliers of water-frugal processes and efficient infrastructure service providers.
The implications for New Zealand are that well-established worldwide trends seem likely to strengthen the demand for New Zealand's traditional export products (meat and dairy foodstuffs), but also present a range of opportunities for those involved in supplying infrastructure services. These include both opportunities for direct export to these countries of services and technologies incorporating intellectual property developed here, and also opportunities for acquiring and adapting for local use new technologies that may have proved successful in these other markets. This has potential to shift the margin of choice between large, lumpy infrastructure and smaller-scale alternatives for providing the same services, and also raises questions about the ability of participants in the infrastructure industries - owners, managers, consultants - to mobilise and take advantage of the openings that emerge. To make the most of these opportunities, infrastructure policy needs to be flexible and open to new ways of providing services that emerge in New Zealand or elsewhere.
The report from Maarama Consulting also notes some longer term trends, such as decarbonisation and dematerialisation (i.e. reducing the material input in valued production). Regardless of what happens to current international agreements like the Kyoto Protocol, it is likely that companies will move towards being more frugal with environmental resources, both to take advantage of green marketing opportunities and also to limit potential future liabilities in an increasingly litigious world. A question for policy is whether this process is moving fast enough, and whether there is any change to policy that could improve on the rate of change. For such a policy to be successful it would depend on policy setters having better information about opportunities and risks for particular activities, than those in the affected industries themselves.
4.2 Pointers from International Literature and Practice
The economics of infrastructure has many facets. In order to put a practical boundary on this review and provide the basis of a useable synthesis of best practice, some fairly coarse filters were applied to the literature search, focusing on "infrastructure policy."11
Policy questions to be illuminated by this search fall under the following broad headings:
- What are problems and risks facing New Zealand infrastructure?
- Can government interventions solve/mitigate them?
- How can this most practically be achieved?
4.2.1 Common Trends and Issues from International Experience
With infrastructure expenditure and investment accounting for declining shares of GDP since the 1970s, infrastructure systems have been showing signs of strain in recent years across all OECD countries.12 Road traffic growth in particular, has been more rapid than expansion of road space, and the effects of traffic congestion at particular places and times are highly visible. Energy growth has been lower but steady, and although expansion of capacity has been more closely aligned with demand growth, many countries also face structural changes in their energy systems in face of shifting environmental, health and safety expectations. There are potentially huge financial implications in changing capacity to meet anticipated demands, but the bulk of infrastructure in most countries is provided by the public sector whose finances are often ill-placed to meet new infrastructure investments. Central governments also have new socio-economic issues making demands on their attention and resources, such as the looming bulge in their populations approaching retirement age.
The infrastructure issue has three broad fronts:
- How to maintain current infrastructure so as to sustain the level of service it now provides?
- How to upgrade current infrastructure to accommodate the changing demands and the requirements of new technologies?
- How to provide new capacity to meet both increased volume demand and new requirements?
There are three broad responses that governments can make to this situation of demands outstripping supply of infrastructure services. They can reassess the mix of public sector outlays, to find more resources for investment by cutting back on other (poorer social return) expenditures, particularly in the consumption area. This however is difficult because of the absence of a clear way of assessing the adequacy of social returns across all categories of public spending, other than through political processes.
They can try to attract greater private sector involvement in provision of infrastructure, both for financing and operations, and seek new, more flexible ways of co-operating with private organisations. And they can try to reduce the requirements for new infrastructure by finding more efficient ways to operate and use existing facilities.
Through the 1980s and 1990s various changes were attempted to improve the efficiency of infrastructure use. One has been to increase private sector involvement to take advantage of enhanced incentives for operational efficiency in private sector organisations. Another approach has been to deregulate the infrastructure sectors to make them more open to new entrants and improve their competitive characteristics, both as a way of maintaining quality and avoiding excessive pricing. A third approach has been to introduce specific efficiency incentives and performance targets into those parts of infrastructure that are still provided by public sector organisations. Fourthly there have been a number of moves to introduce smarter pricing into infrastructure services, so that users face the full costs of their use and investment signalling is improved. This fourth approach has been more talked about than applied, and inefficient pricing is still widespread in infrastructure services across OECD countries: e.g. funding roads through fuel and vehicle taxes rather than specific charges for time and place; applying flat charges rather than volumetric prices to water services; and various cross-subsidies across user groups imposed for social or political purposes which may have outlived their original justification.
There is also a widespread perception that the lead times in creating new infrastructure are lengthening, as projects become larger and more complex and need to deal with greater expectations of environmental quality maintenance, and increased consultation with interested communities. Traditional divisions of public administration are perceived to have added to delays and co-ordination issues: local authorities with responsibility over land use planning may have a different perspective than regional or national authorities about the configuration and placing of national network facilities. Increased consultation has placed new emphasis in infrastructure policy and planning on clarifying objectives, stipulating and enforcing deadlines, and finding ways to resolve disputes.
A central theme from recent international literature on infrastructure policy is that realising the overall aim of maximising net social benefits from infrastructure is complex and difficult to implement directly, but can be approached by exploring more market-based solutions. Paradoxically this may require government to be more active than formerly, but in different ways. It requires government leadership in initiating regulatory reforms to permit greater competition, leading by example in areas such as roads, that have traditionally been difficult to subject to market disciplines, and streamlining decision processes to focus on the things that inform and improve the development process.
4.2.2 Capital Investment and Economic Development
Infrastructure is a major component of capital in the economy, and as such has often been subsumed in more aggregated examination of capital and labour productivity as sources of national wealth. There is an extensive literature on capital investment and economic development, some of which has been reviewed here. Much of this is either very aggregated, for instance failing to distinguish between public and private capital, or else very context specific, and not closely matched to the focus of this study.
Until the 1980s economists paid relatively little attention to the role of infrastructure in growth. Aschauer (1989) and Munnell (1990) published work that calculated very high rates of returns from infrastructure investment, and attributed the US economy's slowdown from the 1970s to declines in public infrastructure investment. Later work challenged this conclusion as capturing reverse causality, given the likelihood that high growth stimulated government investment, rather than the other way round.
While empirical studies have generally found infrastructure investment to be positively related to a country's economic performance, they have not provided clear guidance for infrastructure policy or its effects on macro-economic performance. Most aggregate studies do not differentiate between different types or qualities of infrastructure, there are methodological questions about the macro-economic production functions used in practice, and alternative approaches such as vector auto-regression modelling, or micro-economic cost benefit analysis give very different results. Much of the empirical work is predicated on infrastructure being a form of public capital, which obscures the privatisation of areas of operation in recent years (power generation, water supply).
Economists often assume that public capital is another factor of production for entering into aggregate production functions alongside private capital. But Romer's endogenous growth framework suggests an alternative view in which public capital is a cost-reducing technology, whose effect is to encourage specialisation and efficiency gains by private agents. Infrastructure accumulation is very productive when tax rates are low, but when it depends on high tax rates it can be counter-productive. There is a trade-off, in that government spending has a negative impact on short term growth, but a positive impact on long term growth.
Some macro-level studies have been undertaken to estimate the requirements for infrastructure maintenance and expansion across many countries to meet expected economic growth (e.g. Fey and Yepes 2003)13. Such studies provide a means of estimating the business as usual case of what investment would be required to attain a forecast level of economic growth. For instance, such an exercise could be undertaken for New Zealand to identify what investment is implied to achieve current targets for sustained growth in line with improving New Zealand's position on the OECD country rankings. The results of such studies are qualified by the weaknesses of available data and the implicit assumptions they make about the technical ratios between infrastructure and growth. Such studies provide no guide to changing service quality (as in the recovery of deferred maintenance) or changing supply technologies - in short, the dynamic influences that policy crucially needs to allow for.
Expressing a more micro-economic perspective, Kessides (1993a, p.2) notes that contributions to economic growth derive not from the mere existence, or creation of the physical facilities, but from their operation and the value of the services thereby generated.
Yet very little of the empirical research which has attempted to establish the linkages between infrastructure and economic growth examines the infrastructure variable directly in terms of characteristics of a flow of services (such as the actual availability, diversity, quality, reliability, and prices of services obtained by users.)
4.3 Systems Analysis of Infrastructure Sectors
The overview analysis above worked on a set of general diagnoses of potential problem causes. Another approach is to use a systems approach to consider sectoral infrastructure policy as it is institutionalised at a fairly high level. This style of examination provides a means to address structural questions about the major elements of the existing sectoral infrastructure policy framework in New Zealand, such as:
- how responsive is it to trends and shocks, and
- where are the systemic gaps or weaknesses?
One method that allows the analysis of existing arrangements at a high level is the viable systems approach. This14 is based on work that demonstrated that certain features of a system are necessary to its sustained viability (i.e. an independent purposive existence). This analysis does not presuppose the specific type of arrangements that are necessary for each of these components, merely whether there is any such mechanism charged with the function.
Irrespective of whether the context is a complete organisation, part of an organisation, or some other system, a viable system is divided into two parts (in turn comprising five complementary sub-systems):
- The operational elements, which exist to undertake the system's basic activities, and
- A collection of four high level sub-systems - co-ordination, control/audit, intelligence, and policy functions which exist to "look after", to "regulate" or to "manage the system of operational elements". This becomes the meta system or "brain".
All five systems are closely connected through information, communication, and control links. The model is one of systems viability - which could, for application to the consideration of infrastructure, be broadly interpreted as to do with sustained dynamic efficiency. It should not be construed as a theory of organisational structure or design.
One vital underlying feature that needs to be carefully considered is that in order to become, and remain, viable, an organisation or system must achieve requisite variety with its environment. This feature reflects the need to maintain the capacity to "match" (i.e. appropriately respond to) the actual and potential systemic states within its operating environment that may impact upon its purpose or reason for being. In systems language, variety engineering is the process by which requisite variety is maintained. This may be accomplished through increasing the system's variety (amplification), reducing that of the environment (attenuation) or both.
4.3.1 System Elements
The role of each of the high level elements is described as follows in Brockelsby et al (1995).
- The operational elements of the system can best be thought of in terms of transformation of inputs into outputs. Thus, a telecommunication company employs technology to enable people to communicate more immediately across distances. There may be several operating units which interact with the environment (e.g. customers, suppliers, regulators etc.) Each of these operating units is divided into operations and management of operations.
- Co-ordination functions are required due to the independence and autonomy allocated to operational units. Without co-ordination, the legitimate self-interested activities of the various activities could lead to disharmony, particularly in situations where they compete for scarce resources.
- The viable system's control functions are incorporated in a third element. These are responsible for the internal stability of the system, using unobtrusive tests and checks to regulate and balance in the light of feedback, rather than control in the sense of dominating and direction.
- The audit function is represented by an offshoot of this third element. This is required to ensure that each operating unit is effectively implementing the system's overall policy. "Audit" here refers to any mechanism that tests an operational unit's performance against the guidelines from the co-ordination element and in relation to the resources allocated by the control element.
- Intelligence and policy comprises two sub-systems. Whereas the control element performs an "inside and now" role, the intelligence and policy component is responsible for the "outside and then" of the organisation or system. Its role is to collect and analyse salient information from the total (not localised) environment and consequently help model the environment and define its boundaries, facilitate extrapolation, and future environmental trends. The intelligence element should have enough variety to meet the needs of the control and policy setting components, and cope wit the variety it is expected to monitor in the total and future environments.
- A final element is responsible for policy setting and defining the system's identity. It accepts the responsibility for the development of agreed purposes that serve to bind together the various system components.
4.3.2 Relevance to Infrastructure
Infrastructure policy is concerned with both the relevant set of institutions and their functioning. The set of institutions surrounding each category of infrastructure can be seen as systems which:
- Contain the full set of sub-systems to support the ability of the whole to meet the requirements due to trend growth in demand, or to long-term changes in social or environmental tastes/preferences; and
- Have the capacity to allow the system to respond to (unpredictable) shocks or challenges.
We are interested here in terms of examining the institutional arrangements for each of the four components. These sub-systems could be thought of as one possible template for an "audit" of the system - are all the necessary elements there, and how well are they functioning, and adapting to the changing market, technological, and social environment?
For example, to be particular, are all the necessary elements of co-ordination in place within the institutional structure for electricity generation, to provide medium-term viability of the system, and responsiveness to economic, environmental, and social concerns?
The following table is a template that would allow the reporting of an audit of the current state of "policy systems" with respect to the four main infrastructure categories under review. Once fully filled out, it would reflect the differences between the different infrastructure service delivery systems. Including the various distinctive sub-components providing the system's elements. Each of these has its own peculiarities in terms of institutional arrangements, "systems links" and policy imperatives.15 The challenges to each of these is different, and thus so is the "value" of the various sub-components - depending on the real responses required. The table is structured to incorporate economic, social, environmental and cultural aspects of these systems and of agencies' responsibilities.
When completed the cells would provide indications of weakness or missing elements. For example, under electricity generation, how well is the system able to adjust, in a policy sense, to low hydro lake storage levels, and to coordinate resource shifts (e.g. among coal, gas, oil) to maintain the viability of the system between dry periods? The market provides certain information and there might be profit opportunities thereby signalled, but questions remain about whether robust arrangements yet exist to assess the possible impact and judge the appropriate system response.
Figure 6: Template for Institutional Analysis| | Operational/Investment | Coordination | Control/Audit | Intelligence/Data | Policy/Requsite variety |
| | So | En | Ec | Cu | So | En | Ec | Cu | So | En | Ec | Cu | So | En | Ec | Cu | So | En | Ec | Cu |
| Road | |
| Rail |
| Airports |
| Seaports |
| Elec Gen |
| Elec Dist |
| Gas Gen |
| Gas Dist |
| Telecom Land |
| Telecom Cell |
| Water - Portable/waste |
| Irrigation |
Source: NZIER
The systems review would show whether there were high level potential weaknesses in the mechanisms of infrastructure provision. It is generic, rather than sector specific or threat focused.
To probe below this level of generality demands a far higher degree of specificity than was intended for this particular examination. Nevertheless the way that such a probe would proceed can be sketched.
4.3.3 Outline of An Institutional Audit
The discussions earlier in this document give the framework for the assembly of a realistic set of threats that can be particularised in terms of their salience to national objectives. In other words, the framework allows a set of general and specific threats to be identified for each of the different types of infrastructure that are of concern.
The systems review could then be used to develop a specific examination of the institutional capabilities of each of the infrastructure sectors to deal with the individualised threat listing for that sector. This would provide an indication of areas of potential weakness specific to each sector.
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