Download Promoting productivity gains in regulated industries

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Promoting productivity gains
in regulated industries
Presented by Sarina Fisher
Senior Economist
Centre for International Economics
Summary

PART 1: Why are regulators concerned about
productivity
–
What is productivity?
– Why regulators are required to consider productivity
– The contribution of productivity to Australia’s strong
economic performance

PART 2:
Ways regulators can promote productivity
–
Consider efficient costs
– Making productivity adjustments
2

PART 3: Which type of productivity should be used for
the adjustment?

PART 4: Measurement issues: how much to adjust?
PART 1
Why are regulators
concerned about
productivity
3
Firstly, what is productivity exactly?

The ratio of input to output
–
Getting more from the same or less inputs
– Getting the same from less inputs
– Specifically, the difference between changes in inputs
and changes in outputs is productivity (table)

Not about producing more or working harder, but
combining resources efficiently to get more from less
Outputs, inputs and productivity
Inputs
Productivity
% per annum
1964-65 to 1973-74
1973-74 to 1990-91
1990-91 to 1998-99
3.4
1.9
2.0
Output
% per annum
(71)
(76)
(57)
1.4
0.6
1.5
% per annum
(29)
(23)
(43)
Source: PC estimates based on ABS data sourced from Productivity Commission (2000).
4
4.8
2.4
3.6
(100)
(100)
(100)
Competitive markets drive productivity gains So too should overseers of regulated industries

In a competitive market firms search out
productivity gains to lower prices/increase
market share

Monopolies and other regulated industries
face no effective rivals and weaker incentives
to improve productivity

Regulators need to step in to emulate the
market
–
Encourage productivity gains
– Ensure they are efficiently shared between
businesses and their customers
5
What can regulators do to
encourage productivity growth?

“Economic regulation” to encourage productivity
growth in regulated industries, via:
–
simulating the effects of competition
– encouraging efficiency and prudent investment
– E.g. incorporating efficient costs into building
block analysis

Incentive regulation: Using rewards/penalties to
emulate ‘survival pressures’ of a competitive
market to help induce productivity improvements
–
6
E.g. making productivity adjustments and allowing
additional gains to be captured by the business
Ignoring productivity foregoes gains
to businesses and customers

If inputs costs are only inflated by their cost in
regulated prices without consideration of
productivity gains:
–
gains will be lower and/or
– not shared with transport users

7
Providing efficient services is important to
demand and therefore the prospects for cost
recovery
Productivity has been pivotal to
strong economic performance

Australia’s economic miracle since the 1990s
–
–
–

Average GDP of 3.5% p.a. over the past decade
Fears of catching the “Asian flu” during the 1997
financial crisis proved unfounded and proved the
economy robust
Productivity growth has been remarkable by world
standards
Productivity has been a key driver of income gains
–
Worth 56% of average annual income growth (1.4 pp
to the 2.5% annual average)
– Up from 43% contribution in the 1970s and 1980s
(0.6 pp to the 1.4% annual average)
8
Australian GDP per capita
Index, OECD Average = 100
125
120
Index
115
110
105
100
1970
1975
Source: OECD (2006).
9
1980
1985
1990
1995
2000
2005
Australia outperformed other leading
economies throughout the 1990s

GDP and productivity growth in Australia stronger
than elsewhere throughout the 1990s

GDP stronger than the US and a third greater than
the OECD as a whole

Productivity growth around 20-60% higher than the
US and other OECD economies

Labour productivity gains stronger in the 5 years to
1998/99 than previous 30 years
–
Back to levels not seen since the 1960s when they
were a worldwide phenomenon
– Now Australian gains ‘stand out’
10
Productivity gains have occurred in
all regulated industries

Communication
services lead the
surge

Electricity, gas
and water
industry a strong
performer

Transport and
storage,
outperform the
market average
Labour productivity growth: Average p.a. 1974-75 to 1998-99
Communication services
Electricity, gas & water
Mining
Agriculture
Manufacturing
Transport and storage
Finance and insurance
Market sector
Construction
Wholesale trade
Retail trade
Accommodation, cafes & restaurants
Cultural & recreational services
-2
0
2
4
% per year
Source: Productivity Commission (2000).
11
6
8
10
Productivity growth in transport

Labour productivity growth doubled in the 1990s

On average (all industries), annual labour
productivity growth has eased from 3.2% annual
growth to 2.2% per annum (historical average)

Yet transport and storage industries defy the trend
with labour productivity continuing to rise
–
–
12
growth was 1.2 percentage points stronger in the 5
years to 2004/05 than the previous 5 years
Put another way, it is up 16% over the 5 years or 3%
average annual growth
Productivity gains expected to
continue in future years

Every expectation of continued productivity gains
in the future
–
–

More room for improvement with productivity
growth up but the level still below other developed
countries
–
13
Commonwealth Government forecasts 2% annual
productivity growth for the next few years
Reforms in regulated industries will deliver gains
In 2001, the relative level of productivity in Australia
was below the US, Canada and France, despite
outperforming these countries in annual productivity
growth since the 1990s
So what exactly is changing?
14

Labour productivity: not about how much or
intensely we work, but how efficiently we work

Such as how much technology and other capital is
invested per worker (sometimes referred to as
“capital deepening”)

Such as work and management practices and the
allocation of resources (combining labour and
capital to produce more output, also called
“multifactor productivity”)
Other improvements
15

Productivity gains are be made, even if they
cannot be specifically attributed to labour or
capital

Sometimes referred to as “total factor
productivity”, which is a residual after changes to
the inputs to labour and capital are taken into
account

Usually based on an efficient benchmark firm

Not specific to a particular business
PART 2
Ways that regulators
promote productivity
16
Productivity has always been a
consideration for regulators

All regulated industries have been encouraged to
promote productivity for some time
–
Eg. In gas, capital and operating expenditure are required
to be prudent/efficient or else costs are not ‘allowable’ for
the purpose of recovery through prices

In transport, the focus has tended to be on cost recovery

Encouraging productivity is important to make
sustainable inroads to cost recovery
–
Productivity gains need to be achieved
– Productivity gains need to be shared with transport
businesses (for profitability) and passengers (for demand)
17
Techniques used to encourage
productivity gains

Consider only ‘efficient’ costs in determining
recoverable revenue from fares
–

E.g. level of efficient costs considered for multi-year
price paths or access agreements
Make productivity adjustments to changes in input
costs to recognise actual/potential productivity gains
–
Private buses (2005)
– Taxis (2006)

18
Combine these approaches in pricing decisions
Advantages of productivity
adjustments
19

Shares the gains (and possibly losses) that have
been experienced between transport businesses
and users

Additional productivity gains beyond the
benchmark allowance can be captured by the
firm to encourage firms to outperform the
benchmark
PART 3
Which type of productivity
should be used for the
adjustment?
20
Partial or total productivity
adjustments?

Identifying appropriate productivity indicators depends
whether gains can be attributed to certain factors
and/or measured most accurately
–
Have the gains come from labour?
– Have the gains come from the combination of labour and
capital?
– Have the gains come from things other than labour and
capital

21
Either way, positive and negative changes should be
reflected, resulting in a ‘net’ change
Need to know the source of gains to
make adjustments more effective

Have investments been made in capital equipment that
improves operations
–
from a technical perspective and/or
– from a labour efficiency perspective?

Is the use of more efficient capital and/or labour
practices new or longstanding?

Are further reforms required to improve organisational
and operational efficiency? Are businesses able to affect
these reforms or are they external to the business?

These questions can be addressed in your submission
to help IPART understand your industry
22
IPART has adjusted only labour cost
components to date
23

A conservative approach

Maybe because evidence suggests the gains have
related to changes in work and management practices
– Referred to as multi factor productivity, such
productivity gains have more than doubled in growth
terms over the previous productivity cycle

However, capital changes can also benefit labour
productivity (referred to as ‘capital deepening’)
– Eg. ICT investment per worker has also had a
positive impact on labour productivity
PART 4
Measurement issues
24
How much to adjust?

Measuring productivity is usually controversial

However this doesn’t mean measures are imprecise

Challenges in making growth estimates include:
– How to account for changes in quality. Changes in
quality could themselves be a productivity indicator
such as on time running
– What if the benchmark firm is not ‘efficient’ and costs
reflect overstaffing or inefficient capital use. Regulators
must consider efficient costs.
– Measuring labour inputs is difficult in businesses with
flexible working hours and varying skill levels
– Need to define the outputs of the business. Passenger
kilometres, an index of timeliness and other quality
indicators, or some other measure or combination?
25
How much to adjust? (continued)

Need to take account of + and - productivity factors in
assessing revenue adjustments and cost pass through

Changes in productivity (positive or negative) need to
be incremental
–
For instance, has congestion become worse on average
across the networked business? This needs to be
demonstrated
– Default is measured and verified industry-wide
productivity performance
– Any deviation from the default requires evidence of
difference in productivity

26
May need to benchmark the firm against itself, look at
the distribution of productivity and the mean.
What does IPART do?

Not a long history of productivity adjustments for
transport businesses

Recent productivity adjustments have been
made for private buses (2005) and taxis (2006)
–
Adjusted only those components of costs that
were likely to have experienced productivity gains
(e.g. labour costs)
– Adjusted by a lesser amount than economy wide
productivity gains to be conservative
– Other cost components fully inflated by expected
cost driver (such as CPI, actual costs, other)

27
IPART also commissions studies to estimate
efficient costs for transport businesses
Ensuring that adjustments are
robust and transparent

Use the verifiable industry-wide averages as the
benchmark productivity adjustment

Examine the unique circumstances of each
transport business or industry through a public
consultation process to ‘adjust’ the industry wide
result
–
28
Consider industry and public views about how and
why the business should be expected to do better
or worse than the measurable industry-wide
performance