Thursday, April 12, 2012

Cost reflective, defective?

We keep hearing it: “cost of living increases will be the downfall of the current State Government.”

This really isn't news - the Opposition and numerous media outlets in Western Australia have been suggesting it for sometime. Indeed, the Premier himself even agreed with the premise this morning when he spoke with Geoff Hutchinson on 720 ABC Perth radio.

But if this proposition has merit and everyone including the Premier knows it, why doesn’t the government just stop increasing the price of water and energy?

The solution isn’t quite that easy - unless we had a Labor government that is.

In fact, one of the truths in Premier Barnett’s explanation of why his government has savagely raised water and electricity tariffs over the past 3 years is because the previous government did what only a Labor Government can - subsidised utility charges.

As a former Chief of Staff to both a Water and an Energy Minister in this government, I’m only too aware that this is a genuine problem for Mr Barnett and his (small L) liberal colleagues. The previous Labor government’s decision to repeatedly freeze tariffs and let the gap between the true cost of supplying our utilities and what we all pay for them increase was political genius. Regardless of whether it was done strategically or not, this move was destined to become a mighty large thorn in the side of any conservative government that followed them – and it has.

The key to this quandary is that any Labor government is acting well within the realm of its core ideology to take money from one part of the budget and use it to subsidise utility charges - or education, health, police - whatever. That's exactly what die-hard Labor voters want their governments to do.

In contrast, a pure liberalist view is that each element of the budget should be cost neutral. In a perfect liberal world, school fees would fund teacher's salaries, police would carry a mobile eftpos machine to charge anyone they help, people would pay the full cost of any health services they might use and yep, you guessed it – we would all pay the true cost of every drop of water and watt of power we use. In short, blue-blooded liberals believe in a “user-pays” system.

But the problem is that neither theory works in its pure form. To the average voter, too much government cross-subsidisation smells a bit too much like communism and on the other extreme, the public would simply refuse to pay $25 for a bus ticket to work just to ensure the public transport service breaks even.

So over time, both sides of the political divide have compromised their core values a little in order to appeal to the increasing number of voters who sit somewhere in the middle of each school of thought. For example, successive Liberal governments in WA have ruled out introducing toll roads (which should theoretically be OK with their supporters) and Labor governments have implemented various user-pays policies (that normally wouldn't be supported by its supporters).

So given that the voting public seems fairly comfortable with this fuzzy grey blob between the red and blue edges, why does the Barnett government keep telling us that we should all pay a true cost for our utilities?

Hmmm… to start with, our Economist-turned-Premier and his very (small L) liberal Treasurer Troy Buswell started their term with very big plans. The then Treasurer was eager to prove his economic credentials by lowering taxes and duties and our statesman-like new Premier had grand visions of an infrastructure boom under his watch. They knew that to achieve these goals, they would have to keep recurrent costs low and reduce any unnecessary drains on the government's coffers. It’s also only fair to recognise that they also knew they had to deliver a truck-load a of cash to their new "partners" every year in the guise of the Nationals’ Royalties for Regions scheme.

So when Mr Barnett and Buswell sat around the big table with treasury geeks and started to frame their first budget, they were somewhat shocked to learn that the former government had made the conscious decision to spend hundreds of millions of dollars keeping the prices of water and energy low.

Immediately, the little L liberal in both men came to the fore. The Premier and Treasurer agreed that not only were these subsidies contrary to core liberal philosophy, they were also tying up wads of cash the new government could use to help deliver the big ticket items they had been dreaming about.

As the first budget got closer, the Premier and Treasurer finally took the brave decision to boldly set an agenda of eventually removing all subsidies from utility tariffs – and agreed to big jumps in prices across the board.

So, like any budget decision - positive or negative - a couple of media people bounced it around and soon after, devised the amazing, brilliant, happy, happy "cost reflectivity" plan. As time went by and the budget day media was finalized, this spin was refined to include lines about the need to get tariffs up to cost reflectivity in order to attract more competition, which in turn would put downward pressure on prices (go figure).

Now, I've had a bit of fun with that but in all seriousness I don't think the first decision (or even the resulting spin) was much of a mistake for the current government. Tariffs hadn't increased for a number of years and the government did have some big plans for the extra cash. In any case, the bill shock was only 6 months into a 4 and a half year term and if the government had slowed its increases from then on, I suggest we wouldn't be talking "cost of living issues" now.

But unfortunately old habits die hard.

As we know, every year since, the government has implemented more increases and then reinforced the same old explanation: cost reflectivity is vitally important in order to increase competition - which will eventually reduce costs. The decision to continue to ‘sell’ cost reflectivity as a holy grail has left the government in a very ugly position with only one budget and 11 months before the next election.

An Economic Regulation Authority (ERA) report released only last week confirmed that residential electricity tariffs are still 23% away from being cost reflective. In spite of this, the Premier said on radio this morning, “the big hits in electricity prices are behind us” and went on to reassure the public that there would only be a “modest increase” in this year’s budget.

Old habits do indeed die hard.

This is an ugly problem for the government and creates two very uncomfortable questions that the Premier will no doubt have to try to answer sooner or later:
  1. If the tariffs are raised by only a nominal amount this year, doesn’t that mean we are no longer closing the gap to cost reflectivity - and with further increases in the cost of fuel and labour expected over the 12 months following this year’s budget, isn’t it possible that a small increase could even take us further away from cost reflective prices?
  2. If cost reflectivity is no longer a priority and the government has decided that cross-subsidies are now ok, why do we need to have any price rise at all? In fact, couldn’t we cut tariffs a bit?
Talk about a rock and a hard place.

They say it isn’t easy being green, but I reckon the next 11 months will prove it’s probably tougher being blue.

1 comment:

  1. "cost reflective" is a nonsense term created by a spin consultant to help NSW Labor justify power price rises in preparation for sale of electricity assets.

    I have asked a number of economists if they ever heard the term until recent years, and the answer is 'no'.

    Remarkably, it is now being used by the the ERA whose economic purity must now be diminshed.

    Efficiency used tomean lwer cost yet the ERA and otehrs now adocate efficieny to mean higher prices and fatter profits.

    Yes, the plot has been well adn truly lost.