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Executive Development Programme for Senior Government Officers The Economic Basis of Public Policy Microeconomic perspective 1 EDPSGO 2005 Dr Roger Lawrey 2 EDPSGO 2005 Part One: An Introduction to Economics and to the Brunei Economy Part Two: The Economic Basis of Public Policy Part Three: The Economic Rationale for Privatisation in Brunei Dr Roger Lawrey 3 What is Economics? “Political Economy or Economics is a study of mankind in the ordinary business of life; it examines that part of individual and social action which is most closely connected with the attainment and with the use of the material requisites of wellbeing" Alfred Marshall Dr Roger Lawrey 4 The most fundamental concept Because resources (time, money, oil etc) are limited, using them in one way precludes using them in any other way. “Opportunity cost” is the forgone benefit from not using a resource in its best alternative use. Dr Roger Lawrey 5 What is economic welfare? Somewhat philosophical, but generally to do with the “well-being” achieved from economic activity. Economic welfare could include: Real Gross Domestic Product (GDP), household production, leisure time, economic equality (absence of poverty), environmental quality. Dr Roger Lawrey 6 What is GDP? The market value of all final goods and services produced in an economy in one year. Real GDP: GDP adjusted for inflation so that it reflects changes in production, not just prices Real GDP per capita: GDP divided by population. Dr Roger Lawrey 7 Trend real GDP Over the long-run real GDP increases because: Growing population But this will put downward pressure on per capita GDP Growing stock of capital equipment Growing stock of human capital Advancing technology Dr Roger Lawrey 8 Brunei per capita GDP at current prices 1983 1984 1985 1986 1992 1998 2003 - B$39,629 B$38,167 B$35,544 B$22,805 B$24,570 B$21,111 B$23,615 Problem 1. Volatility of oil prices Problem 2. Calculations Problem 3. Over-reliance on oil and gas Dr Roger Lawrey 9 Brunei Citizen and PR only 2001 Population Age Group 15-24 25-34 35-44 45-54 55-64 TOTAL 47017 36419 31289 20779 9892 145396 Labour Participation force rate 18662 29097 23917 14170 2667 88513 39.69% 79.90% 76.44% 68.19% 26.96% Note this is unofficial data. The participation rate is the percentage of the population that is employed or actively seeking work Dr Roger Lawrey 10 Brunei Citizen and PR only 2011 Population Age Group 15-24 25-34 35-44 45-54 55-64 TOTAL 60285 47017 36419 31289 20779 195789 Labour Participation Force rate 23928 37564 27838 21337 5602 116270 39.69% 79.90% 76.44% 68.19% 26.96% Note: these are my calculations, not official. Everyone is 10 years older in 2011 than in 2001. The 15-24 age group shown here was 5-14 at the 2001 census. We will need nearly 28,000 more jobs in 2011 than in 2001. Dr Roger Lawrey 11 The Brunei Public Sector For year 2003 (Department of Economic Planning and Development, Prime Minister’s Office (2003) Brunei Darussalam Statistical Yearbook) Provisional data. 2003 GDP $8,236.9 million 2002 GDP $7,651.7 million Government expenditure 2002 $4,736.14 million: 62% of GDP Dr Roger Lawrey 12 The Brunei Public Sector Public Expenditure 2002 (Four largest departments) Education 10.4% Defence 8.6% Health 4.4% Public works 3.1% Dr Roger Lawrey 13 The Brunei Public Sector Revenue (2002) $4,267.83 million of which Duties, taxes and licenses 54.6% Revenue from government property 38.3% Commercial activities 6.7% Other 0.4% Dr Roger Lawrey 14 The Brunei Public Sector Revenue breakdown (Department of Economic Planning and Development, Prime Minister’s Office (2004) Brunei Economic Bulletin Volume 3, Issue 1) Data for Q1, 2004 Total revenue $1,398 million Oil and Gas contribution $1,240.5 million of which: taxes $758.4 million royalties $160 million dividends $322.1 million Dr Roger Lawrey 15 EDPSGO 2005 Dr Roger Lawrey 16 What is social welfare? Social welfare is the concept of the general level of well-being of an individual, family or society. It includes economic welfare, plus health, peace, justice etc. If economic welfare increases and there are no other negative effects, social welfare will also increase. Dr Roger Lawrey 17 In practical terms Thinking economically means thinking about how we can increase economic welfare Because resources are, usually, limited, actions will have both benefits and costs, even if these are opportunity costs Dr Roger Lawrey 18 In practical terms Think in terms of maximizing net benefits Think at the margin. Incremental benefits and incremental costs of a change JPMC Short-run and long-run decisions Dr Roger Lawrey 19 The case for policy intervention National Development Plans Promoting and controlling development that is not happening in a free market Market failure When markets don’t maximize economic welfare Monopoly, other forms of market power, externalities, public goods. Dr Roger Lawrey 20 The basis for policy recommendations If a problem is perceived to exist (markets have failed, maximum net benefit is not being achieved) then government should intervene. Economics is then concerned with finding the “best”, most efficient solution. Dr Roger Lawrey 21 Some policy instruments Regulations backed by penalties Control of prices, volume of production, imports/exports, rates of return on investment, entry of firms to an industry, licensing, output of pollutants Public enterprises/direct provision Dr Roger Lawrey 22 ……. Policy instruments Criteria for evaluation of policy instruments (Field 1995) Efficiency (and cost effectiveness) Fairness (equity) Incentives to innovate Enforceability Morality Dr Roger Lawrey 23 Three examples Externalities Public goods Natural monopolies Externalities are effects from economic activity that are external to all the direct parties of the activity. A negative externality imposes an external cost • Pollution A positive externality results in an external benefit • Education Dr Roger Lawrey 24 Externalities Pollution is a cost of economic activity borne by those not involved in the activity The result: Too much output of the polluting good at too low a price The solution? Regulation, taxes, property rights/permits Dr Roger Lawrey 25 Public goods Rivalry (exhaustiveness) Excludability High Low High Private good Toll good Low Common Pool good Public good Dr Roger Lawrey 26 Toll goods These goods can be provided by the market because they are excludable. It may be unfair to provide them out of general government revenue (everyone’s tax payments) when only some people use them. User pays principle. Dr Roger Lawrey 27 Common pool goods The danger is that, unregulated, these good will be depleted. There will be over use. The solution is to make them private goods by issuing licenses, quotas etc as a form of property right. This gives owners the incentive to conserve. Dr Roger Lawrey 28 Public goods Pure public goods will not be provided by the market because they are non-excludable (provide for one and you provide for all) non-exhaustible (one person’s consumption does not reduce amount available for others) Examples………. Community service obligations Dr Roger Lawrey 29 Natural monopolies……. Defined as having continually declining costs over the whole range of output covered by the market demand curve. Per unit cost of production Quantity Dr Roger Lawrey 30 ……. Natural monopoly Examples of natural monopolies are firms with large fixed costs such as water, telephony and electric utilities. Dr Roger Lawrey 31 ……. Natural monopoly What is the rationale for government ownership or control of natural monopolies? To avoid wasteful duplication of facilities One supplier has lower costs than two or more suppliers Because without government involvement the industry would monopoly price Dr Roger Lawrey 32 ……. Natural monopoly Is this monopoly pricing desirable from society’s point of view? No, supernormal profits may be made too little output Dr Roger Lawrey 33 ……. Natural monopoly So, with natural monopolies, traditionally governments have either left them privately owned but heavily regulated (US, Canada) or had them owned and operated by government - “public ownership” (UK, Europe, Australia, Brunei) Dr Roger Lawrey 34 EDPSGO 2005 Dr Roger Lawrey 35 Negative aspects of government ownership Crowds out private sector Legislated monopoly State-owned enterprises get preferential treatment from government Output subsidized so private firms cannot compete Incomplete accounting of costs and revenues Poor performance (low productivity) Dr Roger Lawrey 36 Privatization What is the rationale for privatization? Improve efficiency by exposure to competition Improve government fiscal position Allow use of private sector capital Less natural monopoly than imagined. For example, electricity generation Access to natural monopoly facilities without duplication. Dr Roger Lawrey 37 Efficiency Technical efficiency refers to getting the most output per unit of input. Production efficiency refers to producing at lowest per unit cost Does private ownership on its own result in efficiency? What about competition? What impact does greater efficiency have on costs per unit? Dr Roger Lawrey 38 Government fiscal position Fiscal considerations may be just shortterm. Price should reflect future earnings low earnings = low price high earnings = high price but future earnings are forgone Can private firm transform low earnings into high earnings? Dr Roger Lawrey 39 Private sector capital Private firms can tap huge global financial markets, which may be needed for investment Government agencies may be restricted to applying for government funds Dr Roger Lawrey 40 Natural monopoly or not? The extent of natural monopoly may have been exaggerated. Some aspects of industries may be natural monopolies and others not, e.g. in electricity, only the transmission and distribution networks are now considered natural monopolies Dr Roger Lawrey 41 Duplication? An appropriate access regime allows competitors access to essential facilities without duplication, e.g. telephone lines. Dr Roger Lawrey 42 Negative aspects of privatization Private monopoly may be worse than government monopoly (regulation) Country may lose control of the pace and direction of development Prices may increase Jobs may be lost Maintenance may be insufficient to meet profit targets (see Energex) Dr Roger Lawrey 43 The Brunei case Is competition possible? Is regulation feasible? economical? Is increased efficiency possible with government ownership? Dr Roger Lawrey 44 Contracting out or internal organisation? Costs of internal organization Offices, secretaries, administrators, human resource managers pensions bureaucracy, inefficiency? Dr Roger Lawrey 45 Internal organisation Benefits: workers have no direct claim to profit (2 divisions of same firm) less self-interested behaviour? Feeling of belonging to organisation may induce cooperative behaviour Internal auditing Management can resolve disputes between divisions Dr Roger Lawrey 46 Contracting out Costs costs of searching for suitable suppliers and choosing between them lack of performance due to incomplete specification of contracts breaking a contract and subsequent actions monitoring costs loss of knowledge by not learning by doing potential for corruption Dr Roger Lawrey 47 Contracting out Benefits: cost of internal organisation saved promotion of private enterprise development of other related skills entrepreneurial, managerial secondary effects may be greater than those when a function is done internally Dr Roger Lawrey 48 The value of an enterprise to society Society = the enterprise, consumers, the government The enterprise variable is net profit The consumer variables are price and output (quantity and quality) The government variables are required subsidies or net tax revenue Jobs? Dr Roger Lawrey 49
