ARPA: Whatever happened to microeconomic reform?

Joshua Gans and Stephen King Finishing the Job: Real-World Policy Solutions in Health, Housing, Education and Transport, Melbourne, Melbourne University Press, 2004 (152 pp). ISBN 0-52285-146-0 (paperback) RRP $27.00.

In one generation Australia has come through a massive economic transformation. The walls of tariff protection have come down. Government business enterprises such as Qantas, Telstra, the Commonwealth Bank, and state government utilities providing water, gas and electricity have been corporatised, privatised and, wherever possible, exposed to competition. Financial markets have been deregulated to an extent unimaginable 30 years ago.

Underpinning these changes has been a bipartisan belief in the power of competition to drive economic progress. The impetus came from the Hawke Labor Government, and has been continued, with less zeal perhaps, by the Howard Coalition Government. In fact, with the significant exception of the present Government’s proposed changes to workplace relations, there is a growing notion that governments have become ‘reform weary’; the electorate is starting to resist further economic change.

This weariness is the starting point of a short work by two prominent economists, Joshua Gans from the University of Melbourne and Stephen King, formerly of the University of Melbourne and now a Commissioner with the Australian Competition and Consumer Commission. Their book, Finishing the Job, briefly reviews developments over the last twenty years, and looks forward to see what progress can be made in areas which have not been through so much change—specifically housing, health care, education, and transport.

Gans and King do not claim these sectors have been neglected; rather they say ‘where reforms have occurred, in health, housing and other sectors, they have often been a hotchpotch of compromises rather than well-designed policies that respect both social policies and economic imperatives’ (p. 3).

Microeconomic reform to date, through its concern with competition, has focussed on the supply side of the economy. For example, when tariffs are lowered, competition from foreign firms brings pressure on local firms to reduce prices or lift their quality. Utilities which, under public ownership, were high cost, overstaffed and unresponsive to customers’ needs, become much more efficient under the pressure of private ownership, particularly if they are also opened up to competition.

Gans and King suggest that competition policy has done its job where it has been applied, but that it is a blunt and inappropriate instrument to apply in the other four areas they identify. In these areas a response that takes into account consumer behaviour is required. Services such as telecommunications, airlines, water, and electricity can be looked upon in commercial terms; we don’t attach non-commercial values to these services. However, in housing, health care, education, and transport we are dealing not only with market values but also with a set of social values. We want our governments to deliver these services efficiently, but we also seek high quality and universal access and therefore, in many cases, free or subsidised services.

Therein lies an inherent policy problem, particularly in health and education. Because of the constraints of public budgets, it is in the interests of governments to provide no more than basic ‘vanilla’ services. Significantly, basic no-frills services are low-cost in themselves, and because they are basic, many of those who can afford a higher level of service will opt out, thus relieving pressure on the public providers. Gans and King come down on the side of opt out provisions.

Opting out is clearly attractive to a government wishing to impress the electorate with its fiscal responsibility. To dampen enthusiasm, however, they make a point that is so often overlooked by Treasury officials:

They go on to point out that opting out still incurs budgetary costs, for those who opt to use private health insurance or private schools have to be attracted with costly subsidies to keep them out of the public system. In fact, they could go further in such warnings, particularly in the case of health care, where, because resources (particularly medical staff) are constrained, the extra private finances which come with an opt-out system actually entice resources out of the public system and drive up prices.

This enthusiasm for opting out reveals a narrow view of why societies may choose to provide certain services universally; that is, to all citizens as a right. Certainly any society claiming to be civilised seeks to ensure that all citizens have access to a basic level of health care and education. Even apart from humanitarian concerns there are issues of market failure and externalities which justify universal access. But there are other arguments to do with the benefits of sharing these services. If all—rich and poor, the politically connected and the politically marginalised—share the same schools and hospitals, there will always be a vocal and powerful community making sure quality is maintained, and the risk of social fragmentation will be lessened. Also, in the case of education, many would see merit in social mixing in its own right, to promote tolerance and to ensure all people have at least some shared experiences, as a means of holding society together. The authors may not hold these values themselves, but it is unfortunate that they do not at least acknowledge their existence.

Their most valuable contribution relates to transport, where, in contrast to other chapters, they take a systems and network perspective. They understand some of the emerging technologies, which can help develop more of a market in transport. Transport, even if subject to user-pay charges, is necessarily shared. Road and rail congestion affect rich and poor alike—a new BMW is no more use in a traffic jam than a twenty year old Nissan. Therefore the notion of opting out, because it is unavailable in transport, does not detract from what is a very sound piece of policy analysis and prescription.

The main contribution of this work is that it emphasises what should be obvious but isn’t; economic policy is ultimately about people. Microeconomic reform is pointless unless there is some benefit in terms of human welfare; in fact it is questionable whether the term ‘reform’ should be applied to many of the policy changes that have taken place in its name.

Governments are prone to confuse means and ends. Competition policy should be one of the means by which welfare is improved through bringing benefits to us as consumers, but it is not an end in itself. We can open up our electricity markets to new firms, we can prosecute firms for price-fixing, we can prohibit mergers which lead to monopolisation, but all such activity is pointless unless it benefits people.

Gans and King have moved into areas where competition would clearly not work as a single policy instrument. It’s a clearly-written work, which can be easily read by non-economists. And perhaps economists too, should read it, to remind themselves that not all policy problems can be solved by abstract manipulations of arbitrarily constructed supply and demand curves. Those who specialise in the areas of housing, health, education and transport will find some shortcomings in the work, but it would be a tough call to ask any economist to have intimate knowledge of all four sectors.

The contribution Gans and King could have made but haven’t, is to look back at the ‘reform’ process to date, to ask if it really has brought all the benefits it was supposed to. Certainly there haven been extensive benefits; prices of once highly-protected consumer goods, such as clothing, cars, and entertainment equipment have tumbled, while quality has improved out of sight. In most states shopping hours have been restructured around the needs of shoppers rather than the traditions of the industry.

In telecommunications and other utilities the benefits are not so clear, however. Consumers legitimately wonder why they need a proliferation of retailers to bring to them the same water or the same electricity delivered through the same pipes and wires. They wonder why pay television required two rollouts of wires. They wonder why we have so many phone companies competing for the same high-value customers, while those in the peripheries are left behind. They know that telephone deregulation has brought some new options and bundles of services, but they wonder if they are getting any benefit from having a choice of phone companies; how can they possibly compare all the plans on offer, and, with the new technologies in telecommunications, would they have enjoyed price falls anyway from a well-regulated monopoly?

Perhaps those experiences in telecommunications and utilities have been the source of ‘reform weariness’. Unless ‘reform’ has more meaning for consumers than the confusion of tariff bundles and the choice of multiple firms to deliver the same molecules of water and energised electrons, they will rightly ask their governments to halt or reverse the process.

View other articles by Ian McAuley:

Public Debt: Another Perspective (Digest, 10 Jun 2003)
The Intergenerational Report (Digest, 3 Jun 2002)
Obsessed with Size (Digest, 2 Nov 2001)
Fiscal Guardians (Digest, 12 Apr 2001)