19 Dec 2013

Productivity Commission's issues paper on public infrastructure poses some intriguing questions

by Brad Vann

Although the time-frame is quite tight, participants in infrastructure should ensure they make submissions to the Productivity Commission's inquiry into public infrastructure.

Following the release of terms of reference for its broad-ranging inquiry into public infrastructure that considers both the provision, funding and financing of major public infrastructure and the scope for reducing the associated costs, the Productivity Commission has released a detailed Issues Paper.

Interestingly, given that most infrastructure is delivered by the States, the Issues Paper takes a centrist approach to the inquiry.

Trends in infrastructure

The Commission states there are competing views:

  • either there is an underinvestment in public infrastructure caused by barriers to project funding and financing and the costs of construction; or
  • Australian investment in public infrastructure is at a historically high level relative to the size of the economy meaning the potential for high-returning projects may be diminishing.

This is quite surprising.

According to the Commission, the characteristics of public infrastructure mean that without government facilitation there may be no market mechanism to act as a signal for when new investment is warranted to meet current and future demand. The Commission asks:

  • What mechanisms are in place to identify and measure the infrastructure needs of the community? How effective are they and what other mechanisms could be used?
  • What are the circumstances that might lead to governments over- or under-investing in infrastructure?

Decision-making and institutional arrangements

The Commission recognises that despite improved decision-making in planning and providing public infrastructure, for example through Infrastructure Australia and the COAG Standing Council on Transport and Infrastructure, improvements can still be made.

In particular, decision-making processes and institutional arrangements need to be able to effectively assess and weigh up competing interests and incentives. The Commission asks:

  • What are the strengths and weaknesses of the current institutional environment within which decision about public infrastructure are made? How does this differ between types of infrastructure? How does this influence how efficient investments are prioritised?
  • What decision-making and policy frameworks do governments and the private sector use to evaluate the risks and determine whether to invest in public infrastructure?

It is interesting to think about whether a better focus may be more on the co-ordination of the current bodies involved in the infrastructure chain, rather than considering whether to redesign it.

Funding mechanisms

A central issue to the funding of public infrastructure is determining the appropriate balance between different funding mechanisms and the principles that should apply to the selection of the funding (revenue) stream in light of the associated risks.

For example, privatisation or "capital recycling" has been raised as an alternative source of funds to reduce the reliance on taxation or government borrowing.

The Commission asks:

  • What are the interrelationships between project-specific risks (such as construction or demand) and funding and financing decisions? How are these different for greenfields development as opposed to projects that augment existing facilities or networks?

Financing mechanisms

The Commission is also interested in the different PPP models, asking:

  • To what extent is the unavailability or cost of PPP infrastructure projects an impediment to efficient investment?
  • What are the relevant costs and benefits to consider when weighing up the choice of PPP financing mechanisms?
  • To what extent does the early commitment of financing reduce or eliminate the potential development of efficient funding mechanisms (charges or taxes), particularly user charging systems?

The Commission recognises that the complexity and long-term nature of PPP contracts mean they may take longer to negotiate and involve higher transactional costs than standard government contracts, and may therefore limit competition in the bidding process. The Commission asks:

  • What is the extent of market competition for PPP projects and what factors influence this?
  • What are the impediments to greater PPP projects by institutional investors, such as super or pension funds? What is the scope for these types of funds to benefit from financing more public infrastructure and why are they not already doing so?

Costs of infrastructure projects

While there are a number of costs are associated with infrastructure projects the Commission has found conflicting evidence on the aggregate costs of infrastructure construction. In particular, the Commission asks:

  • What are the major drivers of overall infrastructure construction costs in Australia?
  • What factors have kept aggregate infrastructure construction output price rises to similar levels observed for all goods and services in the economy and how can this be reconciled with the micro-evidence on raising construction costs for major projects?

These are very interesting questions, given the rhetoric associated with increasing cost pressures in the construction industry.

Finally, the Commission makes two interesting observations:

  • Australian infrastructure projects have come to be dominated by two key players, Leighton Holdings and Lend Lease; and
  • the influence of unions on the construction industry, in particular their bargaining power, can be problematic and result in increasing the costs associated with delays, inflexibility and inefficient use of capital.

It therefore asks:

  • Does the current market structure lend itself to the efficient provision of infrastructure?
  • Do the divisions of the bigger market players effectively compete against one another?
  • Does the Australian market have any appreciable barriers to entry? If so, does this apply to both domestic and foreign firms?
  • What is the unions' impact on costs and how to they compare with other factors creating costs pressures?

Next stages of the inquiry

Given the time constraints surrounding the inquiry, initial written submissions are to be provided by 23 December 2013. The Commission will provide a final report to the Australian Government by 13 May 2014. This is a very tight timeline given the inquiry's extensive nature, but the importance of the issues it canvasses should spur infrastructure players to get involved.

Thanks to Noni Nelson for her help in writing this article.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.