Appendix E: Possible Policy Framework: Identifying Appropriate Government Intervention
The following material suggests a policy framework to help answer the questions: "Are infrastructure policy settings "right"". The framework is intended for use in the four economic infrastructure sectors identified as part of the Infrastructure Stocktake, namely: energy, transport, water and telecommunications.
The policy framework has been based on the NZIER report. It also draws from the report Sustainable Development and Infrastructure, prepared by Maarama Consulting. The framework takes into account the ten principles of the Sustainable Development Programme of Action, and is designed to assist in achieving the infrastructure policy objective:
to enhance infrastructure's net contribution to economic growth and societal well-being over time, while reducing the incidence and severity of service failures.
The framework is built around a series of "tests" designed to help ascertain, on a sector by sector basis, whether market failures18 exist that might require government intervention. Each "test" is followed by potential causes of market failure and identification of some sector-specific "policy tools"19 for use if indicated.
To apply a test, one would ask, for example, "are there public goods and/or market dominance concerns?" in the infrastructure sector under review. This would be followed by a description of the nature of the goods (rival, non-rival, etc), and of market characteristics that might impact on dominance (for example, many infrastructure services are provided by natural monopolies). This would be followed by a judgement as to whether current policy settings are adequate to address the concerns, or whether a better means of handling the "failure" is available.
The question in the report: "Would a sector-specific intervention be better from a national viewpoint than a generic response?" also needs to be addressed. By a "generic" response, is meant that implementing an overarching tax, environmental, or social policy may be a sufficient response to the issue. An industry-wide carbon tax is an example of a "generic" response, as opposed to specific sector requirements to limit carbon emissions. If a sector-specific response is desired, the framework offers some guidance on possible policy tools and/or settings for addressing particular issues.
A further, but non-trivial, question is assigning roles between local and central government. This requires the consideration of two factors:
- the principle of subsidiarity: wherein a collective policy response is devolved to the lowest level of collective authority capable of dealing with it
- the area of geographical impact (e.g. local air pollution issues are generally best dealt with by local government, while greenhouse gas emissions may need to be addressed at the national level).
The assignation of responsibility for different types of infrastructure may require a case-by-case assessment as much depends on the nature of the failure and the desired outcome of the intervention. Sections 3.4, 5.2 and 5.3 of the report provide some guidance on this issue.
The policy framework does not explicitly consider funding issues. These may need to be addressed once it has been determined that there should be a central or local government intervention, and they may be influenced by the nature of the intervention itself. The framework also does not address ownership issues.
Test: Is There Sufficient Infrastructure Sector Monitoring / Information For Government to Know If and When to Intervene in a Timely Fashion?
This is a fundamental test in the framework, providing the basis for assessing all of the remaining tests.
Decision makers (and their advisers) should have access to high quality information that allows informed decisions. Information may be needed to:
- Establish drivers of demand for infrastructure services, monitor trends in these drivers and form expectations about future movements ("futures analysis")
- Identify possible "bottlenecks" or pressure points
- Enable an assessment of infrastructure security and reliability, with a particular focus on meeting current and anticipated demand (this might entail attention to supply, capacity, condition, uptake of infrastructure alternatives and efficiency)
- Monitor the appropriateness of provision of goods currently deemed as "public" in face of changing conditions, especially technological change (e.g. the advent of GPS technology may create opportunities for confining access to certain roads to those willing to pay)
- Ascertain that infrastructure is making a positive contribution to (and minimising adverse impacts on) sustainable development
- Monitor the performance of Government policy and public agencies
- Establish the community's redundancy requirements (e.g. dry-year security of supply)
This will require the provision of a range of quantitative and qualitative information. Information gaps may prevent early identification of problems
Test: Are There Public Goods and/or Market Dominance Concerns?
Potential Causes of Market Failure
- Public good (non-rival, non-excludable goods)
- Market dominance: natural monopoly (e.g. where high sunk costs and very large economies of scale exist)
Sector Specific Policy Tools to Mitigate Failure
- Policies to establish competitive markets where possible (including definition of property rights and regulation to promote fair competition)
- Contestable service operation, e.g. bidding with government monitoring of performance
- Regulation to allow other service providers fair access to use of the facility
- Price regulation
- Public sector finance and ownership
Test: Are Externalities Present That Require "Internalisation"?
Potential Causes of Market Failure
- Externalities can be created in the production of an infrastructure service (e.g. air pollution from coal generator) or in its consumption (e.g. congestion arising from use of roads)
- May be local, national or global
Sector Specific Policy Tools to Mitigate Failure
- Regulation (e.g. zoning, technical standards)
- Fiscal instruments (e.g. taxes, fees, subsidies)
- Promoting behavioural / attitudinal change (e.g. through education, information provision, voluntary agreements, QBL reporting)
Test: Are Societal Objectives (Quality of Life, Including Access and Equity) Being Achieved?
Potential Causes of Market Failure
- Existence of merit goods
- Social redistribution needs
Sector Specific Policy Tools to Mitigate Failure
- Regulation (e.g. universal service requirements)
- Investment planning (e.g. of regional spread)
- Public financing of non-commercial services deemed socially important
- Empowering all New Zealanders to participate in decisions affecting them
Test: Are the Institutional Arrangements Structured to Avoid Information or Coordination Failures and Permit the Uptake of New Technology?
Key issue: Are the institutions able to promote smooth provision of services in the face of new technology, supply shocks, demand changes, etc.?
Potential Causes of Market Failure
- Information failure within and across sectors (e.g. information may not be available from market sources, perhaps because of potential free-riding or where no single party has an incentive to collate the required data across a fragmented market)
- Coordination failure within and across sectors (e.g. this may occur in networks when there is no clear set of operating rules, or no single operator in a position to enforce those rules, possibly exacerbating congestion and bottlenecks across the network)
- Uptake of technological change (e.g. ensuring that institutional arrangements do not impede adoption of "innovative" solutions such as use of smaller-scale alternatives and alternative supply sources)
Sector Specific Policy Tools to Mitigate Failure
- Coordinate or regulate for provision of information - may be publicly funded or through levy / tax
- Regulation of investment or operating standards to improve coordination in service provision
- Monitor the emergence of new technologies for their contribution to infrastructure provision
- Maintain policy flexibility to allow uptake - changing policy if required to maintain ability to adopt "innovative" solutions
Test: Is Risk Being Handled Appropriately?
Adhering to sustainable development principles means that particular care must be taken to ensure that risk is appropriately assigned.
Demand Risk
Issue: Revenue /financial return is less than expected
How Can Risk Be Mitigated?
- Where services are delivered through markets and commercially priced (e.g. telecommunications, ports, airports), it may be most appropriate for facility owners to bear the financial risk
- Where common pool or public goods are involved, it may be appropriate for government to share risk
- Demand and construction cost guarantees have weak justification in terms of risk sharing. A developer or operator usually has more control over construction costs than government, and government is only one of many influences over future demand, and not necessarily the dominant one
- Guarantees for infrastructure investment may create a long-term potential liability (open financial transactions are generally more transparent)
Political and Regulatory Risk
Issue: Future government actions subsequently undermine return from facility
How Can Risk Be Mitigated?
- Careful judgement, by government, costs and benefits of intervention
Quasi-Commercial Risk
Issue: State-owned supplier or purchaser may default on contract with investor under political influence
How Can Risk Be Mitigated?
- Government guaranteed returns
Environmental Risk
Issue: Environmental pollution (externalities) as a result of infrastructure construction or service provision
How Can Risk Be Mitigated?
- Borne by provider - performance bonds & liability rules
Social and Cultural Risks
Issue: Social & cultural outcomes are less than expected
How Can Risk Be Mitigated?
- Impacts are borne by communities affected, thus "communities of interest" are most suitable to manage
Test: Are There Sufficient Systems in Place to Preempt Regulatory Failure?
Types of Failure:
- Information asymmetries
- Regulatory uncertainty and undue reduction of expected rates of return
- Creating allocative and dynamic inefficiency by distorting price signals, e.g. when intervening to promote equity for target populations
- Use of inappropriate financing/funding mechanisms, e.g. those that "crowd out" more efficient investment by the private sector
How Can Risk Be Mitigated?
- Government needs to be aware of potential regulatory failures when making the decision to intervene and in selecting instruments; should explicitly consider whether the costs of policy adjustment are less than the benefits they are intended to achieve
- Steps to ensure good performance of government policy and public agencies
Test: Are Trade-offs and Complementarities Being Explicitly Considered?
Issues: Fiscal and environmental constraints imply the need to prioritise investment decisions
- Different policy tools to address a failure may generate distinct complementarities and call for attention to different tradeoffs
- Short run v long run impacts (what appears as a trade-off in the short term may be a complementarity in the long term)
How Can Risk Be Mitigated?
- Government requires sufficient information to make effective trade-offs and decisions
- Infrastructure policies which advance more than one dimension of sustainability, for example both economic and social outcomes (e.g. policies supporting more "livable" cities), are of special interest
- Attempts should be made to decouple economic growth from pressures on the environment.
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