Public Capital Spending in a Recession Post author By Philip Lane Post date May 19, 2009 Edgar Morgenroth assesses the role of public investment during a recession in this paper. Categories In Economic Performance, Fiscal Policy Tags Irish recession, public capital 43 Comments on Public Capital Spending in a Recession ← Somers at the Public Accounts Committee → John Cotter on the Irish Financial Crisis 43 replies on “Public Capital Spending in a Recession” Morgenroth is really right. We underspent in the 80s and 90s and overspent on capital projects in the naughties. Ultimately both mistakes come down to poor public sector investment decisions. If a good investment rule had been followed, then there would be (almost) no need to revisit capital spending commitments, regardless how bad the public finances get. This is so because, if an investment promises a good return, it should be possible to procure capital to pay for it, even if the budgetary situation is bad. But of course, the reality was we were “feeling flush” during the CT so we committed to all kinds of hair-brained spending projects of questionable investment value. The reason I say “questionable” is because of the confidentiality procedures (Dept of Finance guidelines) behind which certain massive projects were hidden, in the name of tendering and PPP. Metro, Port Tunnel, CIE Interconnector. In some cases, Cost-Benefit Analyses were not done, in others they were done, but kept confidential and then let go stale before the actual investment decision was ever undertaken. This is a massive issue and has still not received the political attention it truly deserves. We are not talking about small sums of money here. Rather than spending the proposed €6bn loan from the Pension Reserve on keeping an oversupplied labour market afloat, why not use the money instead to retrain those members of the construction force who are still, say, under-25? This training time should take between 2-4 years, and take the strain off unemployed labour in construction in the short-run, while ensuring we have a more diversely trained & youthful workforce graduating during our proposed recovery. This should ensure that long-run labour demand in all sectors will be addressed, while addressing the current short-run issues we have. Any leftover money can then be invested in the proposed infrastructure deficit, such as upgrading our school system, which again will safeguard Ireland’s future competitiveness, assuming that schools with better facilities produces better students. Sorry, that should read: This should ensure that long-run labour *supply* in all sectors will be addressed, while addressing the current short-run issues we have. I wonder how many genuine infrastructure projects (i.e those that would generate a return) actually remain. A metro might be nice but probably wouldn’t pass a cost benefit analysis. A rail link to the airport would make sense. The motorway network is supposed to be finished in 2010. There is excess airport capacity. We need money for schools, presumably communications…… Any other suggestions. @Stuart What kind of a rail link to the Airport would make sense? Light or Heavy? Note that during the early 1990s, those then planning Dublin’s transport noted that that “Of all the locations in the Study Area, the Airport is the one site where it can be said with high levels of confidence that there will continue to be, year-on-year for a very long period, high increases in demand.” However, the same group (Dublin Transport Initiative) did not follow this reasoning and did not make any recommendation whatsoever or give any priority to improving land-side access to Dublin Airport in the investment strategy that they went on to recommend. Since then, traffic through the airport has trebled, even if it is reducing somewhat now. What is it about our way of governing ourselves that we do not make public investment decisions based on evidence or reasonably well-informed projections of passenger flows? If a rail link to Dublin Airport makes sense now, why was it not the top priority when DART was decided on before the 1979 European elections or when the DART was extended to Greystones (with 50 per cent of the catchment area at sea!!) in fulfillment of a promise before a 1995 Wicklow by-election, which the Government of the day lost? Why was a rail link the Airport not a top priority when the LRT/LUAS lines were decided on during the 1990s? http://www.irishtimes.com/newspaper/archive/1995/0719/Pg012.html#Ar01202:6807EE70681D826A9E86DAB8 As for suggestions, I favour a complete recasting of the Greater Dublin Area(GDA) public transport system based on a core LRT mainly surface running coupled with buses running from nodal points, a stop-based real-time information system for all buses (regardless of who owns or operates them) and integrated ticketing. Transport21 does not provide this, based as it is on placating the baronies involved in transport in the GDA. @Stuart Im not sure we have usable excess airport capicty. It has always struck me that we have had furious debates on contestability in terminals when whats needed is competition between airports. We have Baldonnel lying idle, already effectivly on a train and close to ta tram to the city center, ideal for the south and west traffic and now easily transferable to Dublin via the no-more-jams M50. Upgrading that would be useful. @ Stuart B “There is excess airport capacity.” That’s just terminal capacity (once T2 opens, I mean). The main runway is apparently running near capacity. Assuming traffic grows again soon, we’re gonna be desperate for that second runway DAA have deferred… @ Brian Lucey It’s plainly obvious that the plain people of tallaght don’t like planes… Look how much they complain about the air corps traffic. No doubt they’d claim that the plains give locals cancer or chlamydia or something mad if they thought it would stir enough trouble to avert the plan you suggest… It’s be a third rail for politicians… The Irish are very poor at managing large projects; Oireachtas members have no interest in monitoring costs and there is no appetite for reforming the corrupt land rezoning and planning systems. During the roadbuilding projects of the past decade, local councillors – on some councils, almost half the members make a living from property related work – rezoned land before the NRA issued CPOs, to add to the farmers’ bonanzas. Cowen was in Finance for a year when he responded with tendering changes in Oct 2005, after an outcry over runaway costs for IT projects, which had been signed off by computer illiterates and cost plus construction projects. Given the record and for example 41 years since the completion of the Dublin-Naas dualcarriageway while a motorway to Cork is still a work-in-progress, what confidence can one have in in these people? I don’t believe that there has been one debate in the Oireachtas on the €8 billion + funded goal to become a “world class knowledge economy” by 2013, which was an absolute joke when the plan was launched in 2006. Basic broadband has improved in the interval but is still another work-in-progress. Science Foundation has the ambitious goal of 30 start-ups based on local research discoveries in the next five years and that produces about 6 successes at normal survival rates! Most of them would then eventually pass via a trade sale to American companies. @Marcus & Brian I would tend to agree the airport capacity is in the wrong place but presumably we’re stuck with that now. Otherwise your investment analysis would need to include moth balling T2 in Santry while Airport West gets the go ahead. @Donal Light rail link would do fine. It is nonsense we don’t have a direct rail link to the airport when every other country I’ve been to has one and it makes transfers very easy. Meanwhile we all drive to the long term car park (and Aer Rianta gets buckets of money – maybe that was the reason). As someone who lived in Greystones and didn’t have the DART we survived pretty well on the Rosslare route and a link train to Bray. It must have cost a fortune to do the extension through the tunnels and along the coast for as you say half a catchment that was reasonably well served anyway. Shameless self-promotion: http://ideas.repec.org/p/esr/wpaper/wp264.html The paper shows that light rail is really valuable. It would have been more valuable if the Luas had been designed by someone with half a brain. Other than that, Edgar is usually right and now he is voting with his feet! @ Stuart B: “Otherwise your investment analysis would need to include moth balling T2” I see what you mean, but I’d wager the cost of completing T2, the cost of building this new runway and the cost of not having competition (€???) may well outweigh the cost of making Baldonnel commercial-aircraft friendly…. In any case it’s hardly realistic! Competing terminals might be nice next year though 🙂 @Stuart T2 is needed anyhow. @Marcus T2 is needed anyhow ; most of the cost is sunk anyhow so irrelevant to the baldonnel decision. AFAIK Baldonnel is commercial aircraft friendly , its just that the Air Corps ! doenst want it used. I wouldnt worry about excess runway capacity in Dublin airport unless it becomes clear the world economy will boom again soon… Worldwide, airlines are contracting, passenger numbers down by somewhere around 20%. Any drop from near capacity will result in significant easing of bottlenecks, The bottlenecks are airport and geography dependent, so with reduced traffic it should be possible to help identify the bottlenecks. We got through the boom with the existing capacity, we’ll be fine for the next 10 years with it. Those green shoots would need to to be getting hardy first But I think the attention is in the wrong area… If youre not cold, hungry or in pain, its all good… investment should focus on those areas and it could be possible to get a return from it @Brian re. Baldonnel. How many airports does the GDA need? I have always considered the argument for a full commercial airport at Baldonnel to be the kind of thing that economists would flame. So I am so surprised to find that you raise it here that I wonder if I do not recognise a facetious comment when I see one! Why duplicate all the facilities of a commercial airport at Baldonnel eg. parking, baggage handling, immigration, air-traffic control? Is that really cost-effective for how many passengers? @Stuart I accept arguments for terminals being operated by different entities – provided the whole site has coherent and mutually reinforcing landside access. Have you ever looked at the landside origin/destination of passengers using Dublin Airport? Or the breakdown between business and leisure purposes of those passengers? @Marcus Whatever about the people of Tallaght, I can only imagine that flight paths over Foxrock, Blackrock, Dalkey, Dun Laoghaire, Donnybrook would effectively kill the idea of Baldonnel as a commercial Airport – even if the economics justify it! I simply find it very hard to believe that there is any kind of a case for a commercial airport in Baldonnel or that there ever was such case – when the GDA has less than 2m people. Leave it for the Air Corps – which is the only base they have, apart from helicopter pads at various military installations. I think the gormanstown airstrip was sold as part of the great disposal of state-owned properties etc. etc. While on Airports, how many do we, 4m or 6m people on the island of Ireland, need? I have always wondered why there has not been a more focused effort on improving landside access to Shannon – by road and rail. This is the kind of infrastructure that I would exppected to have been prioritised as part of any National Development Plan. Yet the Galway-Gort-Ennis road is only at the tender stage. Those campaigning for the Western Rail Corridor are not making a link with Shannon Airport a priority. If landside access were improved to Shannon from Galway, how strong a case would there be for the once-mooted new Airport at Galway – which is about half-way between Shannon and Knock Airports – not far from the Western Rail Corridor and national roads? @Richard thanks for that reference to the ESRI working paper on rail for the GDA. Perhaps it answers some of the questions I have posed above @Stuart. On airports : Belfast has two, at least. I agree that improving access to other places would be nice ; but lets be honest. We are in a country that builds two parts of a light rail system in its capital that a) dont jon up and b) are not interchangable. We have had shannon for 60 years and not a sign of a rail line to limerick (which would be no use anyhow as the rail system is a skeleton – where would they go?). Etc etc. We dont have an air corps. Even if we did, tons of airports worldwide share military and civil. IF B was a functioning airport as opposed to an expensive parking lot for the clapped out government jets, clapped out partially as they go from there to Dublin to pick up ministers, then I suspect that Mr O’Leary would look hard at it. That would force DAA to radically examine its business model. Cathal G may have views on this that he can share? @ Donal O: Dublin handles around 23mppa, which is A LOT of passengers for one airport. There’s very little by way of economies of scale for airports. They just need a long (say 5000ft+ for a 737, which is most popular) reinforced road and a shed for people to wait in. Baldonnel would be perfect. I fail to believe that the air corps a) need both runways given that they could confine themselves to the shorter of the two with such small aircraft and b) even need one runway exclusively, given the small amount of traffic. Basically, a competing airport would likely do fine even if it only took 2mppa or so from Dublin. In any case though, as I indicated I do agree it won’t happen! But be assured, the reasons are political, not economic! the beagle space shuttle was put on a planet in space for cheaper than we put a tram on the road and last time i checked the ‘tram’ wasn’t a prototype concept. municipal bonds would be a choice but then you might see more toll roads/bridges/actual returns required. our reliance on the state funding focuses too much on the ‘national level’ when perhaps projects might be better managed by county councils and done in a way to give investors a return for the projects rather than trying to allocate elements of the tax take across more projects than there is money to fund. the problem with many projects if funded from tax only is that there is no need for meaningful results once started hence the port tunnel went over budget and was leaking away and finished years late hence luas went over budget and over time and as @michael hennigan stated – the road to cork isn’t done @Stuart Blythman: “I wonder how many genuine infrastructure projects (i.e those that would generate a return) actually remain.” Well, of course, there’s the Ulster Canal …. It’s got a feasibility study by a Well-known Firm of Accountants, so it must be a good investment. See http://www.waterwaysireland.org/index.cfm/section/article/page/TheUlsterCanal with a link to the study at the bottom of the page. @Brian Lucey: The trams (Sandyford and Tallaght lines) are in fact interchangeable. It was an urban myth – highly believable, unfortunately, given our record with transport – that took currency a few years ago, but is definitely wrong. I have seen Tallaght trams on the Sandyford line with my own eyes. The gauge is the same, etc etc. @Brian “Well, of course, there’s the Ulster Canal …. It’s got a feasibility study by a Well-known Firm of Accountants, so it must be a good investment.” I took a look, please let this be one of the projects that gets knocked on the head forever. Thankfully it was PWC who made the recommendations not my old alma mater (KPMG) though I’m sure they did a few of these – once the consultancy fees come in they’ll say anything! @Donal The idea of developing an airport away from Dublin makes sense. Shannon might not be the best spot as it has only half a catchment. Is there an airstrip in the Midlands? Btw I was travelling back via Holyhead over the weekend from the UK and even Anglesea has an airport sharing the local RAF base. I once flew into Newquay and it was an RAF base, the airport building was literally a shed. Other countries seem to be able to develop small bespoke airports, surely we should be able to. @Brian I am not convinced that Belfast having two airports is a good example for us in Dublin, given the way in which public expenditure decisions are made in NIreland. How many international airports for Helsinki or Copenhagen or Oslo or Vienna or Vilnius or Zurich etc have within what distances from the city centre? There is a train line from Limerick to Ennis (with about 8 services per day during the working week). I do not know whether a link from this line to Shannon Airport/New Town/Industrial Estate has been looked at in any detail. @Marcus You are simplifying. International airports also need immigration control, customs clearance, aircraft loaders/cleanersbaggage handlers, refuelling facilities, security etc. Why duplicate that current cost infrastructure even for 23mppa? IMO, better to improve landside access to Dublin Airport than spread resources thinly @Karl D How many trams are “on the road” in Dublin? What is their estimated lifetime? How does this compare with the “use-once and throw away” beagle space shuttle? Whatever about the Dublin Port Tunnel being late and over budget, I do not think it leaks anything like the free-to-useJack Lynch Tunnel in Cork. Listening to traffic reports, leaks are not often cited as reasons for the tolled-for-non HGVs Dublin Port Tunnel being closed. The road to Cork may not be done, but the rail service has been upgraded. So people have options on how they travel between Cork and Dublin. The National Roads Authority (NRA) was set up specifically to take planning, construction and investment in national roads away from County Councils. NRA also led PPP for road investment as part of the effort to get kilometers of road built by one principal contractor, once the alignments has been decided, crossing more than one county, the land acquired by one agency and a uniform finish to the surface. This contrasts with the actual results when the county councils were responsible for all roads. Whatever about the merits of municipal bonds etc, I suggest that the centralising powers-that-be will not revert to the previous way of having national roads built – in a piecemeal way by councils who were sometimes thought to pay for other road investment with some of the funds allocated for national roads. We now have tolls on many of the new national roads – much to the distress of people living in places like Slane, as many trucks still avoid the M1 to avoid paying tolls. @Stuart Small bespoke airports? In this republic, we have Carrickfinn in Donegal, an airport in Derry that we have funded, Sligo, Knock, Galway, Kerry and Waterford – in addition Dublin, Cork and Shannon. the midlands is surrounded by airports. So why built another one there? In many other places, the small bespoke airports are, as you suggest, disused military facilities eg. one of Gothernberg’s two small international airports. That said, I am still not convinced that there is a case for another international airport at Baldonnel. We need more quiet competence and less grand gestures in how we decide on and build infrastructure. Some discussion below from John Quiggin on the employment stimulation measures in the recent Australian budget. Its worth keeping a close eye on Australia’s employment response as they seem to have a more activist instinct than in Ireland and may provide some interesting data. http://johnquiggin.com/index.php/archives/2009/05/16/unemployment-reprint-from-crikey-coverage/ @ Brian L Niall Murphy is right about the LUAS trams. Not only are those on the Red and Green lines interchangeable, they were also built to run underground, in terms of fire rating etc. I have given the reasons the non-joining of the original LUAS lines in another posting – ignorant expertise which the governmental system did not overrule. It seems that the fault lies squarely with the FF/PD cabinet of May 1998 and the Inspector for the Public Inquiries who dealt with what was in front of him. I asked that Inspector (a Circuit Court Judge, now deceased)- in formal sworn public hearings – that he make it a condition of his recommendation that both the original LUAS be interconnected from the start. He did not and neither did the Ministers when they made the railway orders for the existing LUAS lines and the extensions. But of course, Metro North is yet another free-standing line – not interconnected with the rest of the LUAS system. It remains to be seen whether An Bord Pleanala’s inspector and/or the Bord itself decides that enough is enough of non-interconnected transport projects in Dublin. @Stuart Blythman on the Ulster Canal: “I took a look, please let this be one of the projects that gets knocked on the head forever.” I’m in favour of canals myself but I don’t understand how, even allowing for the government’s desire to show off to the Unionists, this project got approved. Interesting discussion on airports – did you know that we have 9 international airports (who can name them all?)?! In that context I wonder whether we need one (Baldonnell) or two (strange proposal for a new midlands airport) more ore 5 fewer?? One thing that is clear from the discussion and which I have raised loads of times over the last decade or so is the lack of proper evaluation. The other thing that comes out is that once the major inter urban roads network (the only real transport network we have) is finished the number of potential projects is not that large – there will be fewer jobs here. @ Liam – In that context and in light of the evidence of the cost of a publicly funded construction job I would be careful about using active employment stimulation measures through infrastructure investment. In the paper I make the point that either we need this stuff (infrastructure) in which case it will have a decent return in the long run or we don’t – employment must be a secondary consideration. That is not to say that we do not need to do anything about the obvious unemployment crisis – I would suggest retraining a lot of the younger builders will have a far better return than anything else. Edgar – I take your point but I should be clear that I have not yet put down my thoughts on what the active response should be and I have read closely both your paper and the US literature on the high cost-per-job of various construction projects. I do not want to be associated yet with the argument that large construction projects are a sensible active labour market response though I am quite sure that some element of light “shovel-ready” construction projects will have to feature in a rescue package for some areas in the country unless we want to go for a full big-bang adjustment, which to me seems like playing with very dark forces. If construction is to be part of an active labour market programme then both cost-per-job and the potential return on investment should both be considerations. But there has also to be some realisation that a big-bang adjustment has unpredictable and dangerous features that are not being discussed properly. You have ruled out some silly responses but we need to start generating some that are not silly and the training suggestions from you as well as the Active Labour Market conference are clearly part of that. Retraining to do what though in the next two years? @ Liam – I alrgely agree with you. Training for what?? In the first instance completing the Leaving Cert might be a good idea? That would probably take 2 years for starters. At that point we should know more. One way or another we will need fewer construction workers – keeping them in the sector is likely to be very expensive. My example of the German black coal industry is instructive – the arguments were well known for a long time but the politicians could not bring themselves to the point where the plug was pulled which would have been better all round. The kept coming up with arguments about ‘dark forces’ or something like that. Of course I do make the point that we should keep on investing in good projects but that we need to get value for money (we can actually keep the volume at historically high levels if we puch the price down). We are probably drifting Edgar – I am clearly not going to write a document advocating anything like a German “black coal industry” solution. I think there is such a fear that the government is going to start a building spree on the back of a daft pork-fest document written by a lobby group that people are getting too blinkered about developing a portfolio of responses, some of which might involve labour intensive construction projects. Lets not rule out that some of these might pass a cost-benefit test. Your broad suggestions are (i) do some projects provided there is sensible long-run cost-benefit (ii) dont do stupid pork projects with high cost-per-worker (iii) retrain a lot of construction workers as there is not going to be sufficient long-run demand for their current skills. Point (iii) is such a tough one and you dont give it sufficient credit by saying “go do the Leaving Cert”. Seriously Edgar, tell that to a guy with a recent mortgage and a couple of young kids going to school. I know this emotional argument doesnt mean that we just build to bail the guy out but lets not forget that these are real people getting really whacked. The people in real trouble are also likely bunched in space (as you would know more about than most people) and the regional implications just haven’t been thought through. @Edgar As part of the proper evaluation, a key element is to assess the total journey time from origin to destination. Part of this actually means asking people actually travellling, including their choice of transport mode and why they are travelling. When was this last done for any of the major road/rail/bus corridor/airport decisions? re. Airports – I suggest that there are few places in Ireland that are more than 100km from an international airport. But this tells us nothing of total travel times or purpose of travel! Edgar, Well done on the publication of your insightful and timely paper. The wide-ranging discussion on this thread suggests that it should provide the basis for a sustained programme of research to inform policy in this important area. I realise that your primary focus is on public sector capital expenditure, but I believe that this should be expanded to address the provision and expansion of the infrastructure supporting the supply of a broader range of services such as electricity, gas, water, waste water, telecoms. Across this entire range (from public sector investment in roads and transport facilities – as well as in social infrastructure (schools and hositals, etc), through semi-state (and private sector) investment in the supply of the traditional utilities to local authority investment in the provision of other services) four simple questions have to be answered: 1. What should be built? 2. Who decides? 3. How will it be financed? and 4. Who will pay? The mix and match of public sector, semi-state, private sector and local authority participation veers in a haphazarded manner between central co-ordination and a competitive market in infrastructure investment. A particular model of regulation has been established in some sectors (e.g., electricity, gas, telecoms, airports) and have varying degress of authority to require investment and to approve investment. But, in most cases, these regulators are primarily regulating state or semi-state bodies. These regulators operate in sectors where “point-of use” charges are levied, and, in relation to infrastructure, these are, ostensibly, designed to ensure full recovery of efficient investment. In other sectors, where public sector investment dominates and there is a presumption of tax-funding of investment, the evaluation and decision-making process, as you point out, is inchoate. At first sight, it would make sense to extend this “regulatory revenue model” to other sectors, but major reform is required. In general, these regulators have been captured by the state. In some cases, infrastructure usage charges are set to compel users to finance up-front a large share of investment (thereby avoiding direct Exchequer financing). High infrastructure usage charges have contributed to excessively high final prices. In these straitened times, the possibility of direct Exchequer financing of investment is non-existent, so the requirement for the privatisation of the semi-states is now compelling and urgent. Regulation will have to be reformed to ensure that there is a robust contestation of proposed infrastructure usage charges and revenues between, on one side, the service provider and, on the other, service users and final consumers which is adjudicated upon by the regulator. With these reforms and semi-state privatisation this regulatory model could be extended to other sectors where tax-funding of investment is currently used. The benefits in terms of efficient investment and recovery of investment would be significant and would provide the basis for enhanced economic activity and productivity. @ Liam I appreciate that those who loose their jobs (not just in construction) are the real loosers from the recession and that we do noeed to think about sensible ways of supporting them. Keeping construction jobs via artificial demand above long-term levels is identical to the German response to the crisis in the coal industry. these jobs can only be sustained by keeping pubic investment above optimal levels. In the long-run that did not help anyone except a few who got to retirement. You rightly point to the spatial dimension – I think here again we will suffer from the failings of past policies. We now have people stuck in commuter towns, on negative equity where employment opportunities will be limited. Unravelling this will take a lot of time (I will have more on this in due course as I am working on a paper on this). @Donal We actually now have the data for commuting fromt he Census (check out POWCAR – http://www.cso.ie/census/Working%20pop%20of%20large%20towns.htm) which of course leaves out all other reasons of travel. There are also some traffic surveys done on national roads. The problem with evaluation is more that the counterfactual is usually the do nothing scenario rather than the do something else scenario. Furthermore, I find it difficult to take any CBA done by or for the sponsoring agency serious. @Paul I agree that we need to take a good look at the regulatory frameowrk for our utilities and how this impacts on investment decisions – see my responses on the thread started by Colm McCarthy “Goodbye to All That” http://www.irisheconomy.ie/index.php/2009/05/06/goodbye-to-all-that/ Edgar, Thank you. And yes, we did cover this in the thread to which your refer. However, with the current focus on the banking mess and the inevitable contractionary impact of the curent budget squeeze I am very conscious of the need (eloquently highlighted by Liam Delaney and others) for a quasi-Keynesian stimulus to boost economic activity. I fear that a rising international tide may not, on its own, be enough to lift our little boat; we must do more ourselves or risk being stuck in the mire. In that context, I believe that the State should focus its limited resources on investment in human capital (re-training, up-skilling, redeployment, etc.) and facilitate private sector investment as much as possible in fixed capital formation. That’s why I’m pushing the case for the expanded use of a reformed regulatory revenue model across all public infrastructure areas. However, apart from your acceptance that this is an area worth examining, I have detected little interest from other quarters. My principal focus is on energy in a wide variety of countries, but this has, increasingly, pulled me into regulatory issues and the development of competitive markets in infrastructure investment across a number of sectors. I don’t really have the time or resources to push this much further, but I remain convinced it is fruitful territory. Any takers out there? @Paul. I have to disagree on your point that in order to facilitate investment, the privatisation of semi-states “is now compelling and urgent”. In fact, it is semi-state companies such as the ESB that are currently investing large sums of money (the ESB plans on investing some €22 billion and creating close to 4,000 jobs between now and 2013). This investment is financed by the companies themselves and requires no direct Exchequer financing. Selling our commerical state-owned enterprises (SOEs) would not only fail to provide value for money for the exchequer (since any sale is likely to be at a discount), it also has the potential to damage our competitiveness. We need only look at our disastrous experience with the privatisation of Eircom which has experienced a number of changes in ownership (and another likely to occur in the near future) that have only served to increase the debt of the company while lowering the capital investment required in the network. These developments have had severe consequences in terms of the development of broadband and next generation network infrastructure which are vital in the context of a ‘smart economy’. The delay in the rollout of these services has already had a negative impact on Ireland’s competitiveness, with the cost of broadband services among the highest in Europe (for services which are far behind our European counterparts in terms of speed), and will severely hinder our ability to attract foreign direct investment and stifle economic growth. Remaining SOEs such as the ESB, Bord Gáis and CIE operate as dominant players or near monopolists in their relevant markets. The reason for their market dominance can be explained by the ‘natural monopoly argument’ which states that the characteristics of network industries (e.g. gas network, electricity grid, rail network) are such that competition is incompatible with efficiency. Without accompanying measures of liberalisation the sale of such enterprises has the potential to damage the interests of the country (as in the case of Eircom). But creating competition in such industries is easier said than done. Take for example the Irish electricity industry where liberalisation was phased in since 2000. Contrary to the hopes and expectations of policymakers real competition has been slow to materialise with Ireland paying among the highest prices in Europe for household and industrial electricity (ironically it is another semi-state – Bord Gáis – that is now competing heavily with the ESB in the domestic electricity market). The privatisation of British Rail provides another stark example of difficulties encountered when privatising a network industry. In this case the complicated arrangements put in place to mimic competitive markets had disastrous consequences and the rail network, Railtrack, was effectively re-nationalised. The government must resist the temptation to plug holes in the public finances by conducting a firesale of strategically important state-owned assets without a comprehensive analysis of medium to long term implications for competitiveness. While the sale of companies operating in competitive sectors merits consideration, the fact remains that the majority of Ireland’s SOEs are necessarily dominant in their sectors, having been established as monopolies in network industries. Recent experience at home and abroad has shown that privatising (and in some cases liberalising) such industries does not work. Irish policymakers must take heed of these lessons and resist calls for privatisation that fail to take account of these realities. Donal, Thank you for such a comprehensive response. I seem to have touched a nerve. This topic deserves a strand of its own. Given my inability to kick one off, it’s only fair to respond here. I realise that you have researched this area thoroughly and accumulated valuable insights. Some initial responses to the points you have made: 1. ESB Investment: much of the ESB’s investment is network-related. And yes, it is financed by the company itself with direct Exchequer financing. But, as I have pointed out previously on this and other threads, the CER is awarding excessively high network revenues to the ESB so that the ESB can finance over three-quarters of this revenue from retained earnings and customer capital contributions. About a quarter comes from borrowings – which is considerably below the debt percentage of investment financing for network businesses internationally. As a result, final prices are much higher than they need be. A similar situation arises on the gas networks. The high Best New Entrant prices awarded by the CER to encourage competition in generation have raised costs in the Irish electricity market. The additional revenues awarded to the ESB and BGE allow them to empire-build outside of Ireland to compensate for any loss of supply market share in Ireland. In BGE’s case they allow it to “compete” with the ESB to the detriment of other competitors who do not have that advantage. “Ring-fencing” of network revenues is entirely ineffective. 2. Firesale: is there any evidence that the gas and network assets would be valued less than their current book value (rather than the inflated regulatory valuation)? The global liquidity glut that fed the financial crisis may have diminished, but it hasn’t gone away. Investment and pension funds are looking for secure, low-risk, regulated revenues – and the CER is becoming internationally renowned for the exercise of its statutory powers to gouge consumers. 3. Eircom: this was, and is, a disaster. However, the lesson should not be that privatisation is everywhere and always bad, but that there are good and bad ways of privatising businesses. As the EU’s Third Legislative Package for electricity and gas moves towards enactment, the pressure will increase to unbundle networks fully. Much to the ESB’s chagrin, the Government is moving, ever so slowly, to transfer the transmission network from the ESB to Eirgrid. Why not sell it off and empower the CER to mandate investment to provide transmission capacity, as it is empowered to do for the gas networks? 4. Competition: reducing network tariffs would enhance Ireland’s international competitiveness and the attractiveness of Ireland’s energy market for new entrants, but the Government doesn’t have the funds to invest to allow this happen. Ergo privatisation, but not as an IPO. Trade sales are the order of the day. In fact there is no reason why the existing managements of the ESB and BGE networks could not source pension and investment funds to buy out the networks. In addition to unbundling and selling off the networks it would make sense to roll the ESB and BGE supply businesses into one and let it compete (unsubsidised) with all comers. Furthermore, integrating the Irish and British electricity and gas markets (the East-West electricity interconnector should have been built years ago) – which is consistent with EU energy market policy – would push Irish prices down to UK levels. 5. British Rail: the privatisation of industries which require a public subsidy to ensure continuing viability is fraught with problems – as the UK Government discovered, but this does not diminish the benefits of competitive markets in investment provision. It is the design of these markets that matters – and there is considerable international experience of how these markets work, particularly in the US gas industry. Finally, we are at a point where the State is struggling to finance infrastructure investment and where consumers will no longer be able to pay excessively high, and increasing, point-of-use charges to finance a share of this investment. Our banks are broken and the private wealth-generating sector is struggling, but with a reformed and modified regulatory revenue model we can give the international capital markets good reasons to invest in Ireland by selling assets that the State has no reason to own any longer. Donal, I should have written “without” Exchequer financing, Paul, Thank you for an even more comprehensive response! I agree with most of your comments in relation to the networks of the ESB, Bord Gáis etc. The vast majority of the investment required in the electricity, gas (and telecoms) markets is network related and it makes sense to fully unbundle this element of the business from each company. However, I’m not sure if I agree that the unbundled network businesses should then be sold off and would argue that the networks should remain state-owned. Given the strategic importance of the network element of our public utility companies, I cannot see any rationale for the transfer of these networks, and consequently significant economic power, to the private sector. Such a loss of control would require effective regulation and policy responses to deal with the potential problems arising from the transfer of economic power, requirements which I am not confident would be met (e.g. Eircom and the telecoms market). A loss of control over strategic national assets is one of the reasons why countries such as France and Germany are against the ownership unbundling element of the EU’s Third Legislative Package for electricity and gas. Furthermore, most of the cost of constructing / upgrading network infrastructure is related to civil engineering works. If the Government creates a new holding agency for State-owned network companies (Eirgrid, Gaslink and eventually a national telecoms network company) as put forward by Paul Sweeney and others, the civil engineering costs of constructing and maintaining utility networks can be minimised through the coordination of overlapping state-owned infrastructural projects. So while I don’t agree that the network element of out utility companies should be sold to the private sector, I definitely agree that they need to be fully separated from their respective companies and operate independently with full ownership of their transmission assets. However, achieving such a separation is easier said than done. Since the precedent-setting Eircom Employee Share Ownership Programme (ESOP) in 1998, ESOPs of 14.9% were established as part of almost every privatisation since then. The employees of any remaining SOEs that are likely to be privatised will expect similar deals and will attempt to block any attempt to unbundle the most valuable asset (network) on the balance sheet from their companies, thereby reducing the value of any shares they are granted (see the reaction of ESB employees at the end of 2007 when unions voted overwhelmingly in favour of strike action in a bid to prevent the Government from splitting up the company). Donal, I get the impression you are unpersuadable, but I feel compelled to take issue with a few of your contentions as they are frequently mouthed by policy-makers and politicians who lack the knowledge you possess and the analysis you have performed that leads you to make them. 1. Strategic assets: I have to suppress an expression of black humour when I contemplate the way the State has deployed and developed these “strategic assets”. For example, the option of LNG import was shot down more than 10 years ago with what seems limited investigation of its potential (the relevant report by the French consultancy, Sofregaz, has not been published). A macho chest-beating competition then ensued between BGE and the then owners of the Northern Ireland transmission network to see who would win the right to build a third interconnector between Britain and Ireland (two already existed – one to the North, one to the South). BGE won. Shannon LNG has emerged as a viable LNG import project. Corrib will come onstream. The second Britain to Republic of Ireland will be little used and the use of the first may be curtailed – yet consumers will continue to pay the full cost. Another example. In its desire to promote competition in electricity generation, the 1997-2002 Government decided that the ESB should not be allowed to build new plants. Electricity demand was growing rapidly and the CER was under pressure to attract new entrants. When prospective generators failed to turn up in hordes to invest in this island paradise the CER started to panic and very high guaranteed bulk electricity prices were used as bait. (The precise details of these deals, of course, are confidential.) The prospective new entrants knew they had the Government and the CER over a barrel and we’ve being paying for it ever since. Of course, the option of building an electricity interconnector to Britain (which would have reduced the pressure to build new capacity) rarely figured as an option. It would highlight the high costs, low availability and inefficiencies od the ESB’s plants – as documented in the Deloitte report – and we might be getting some of that nasty nuclear-generated electricity. In addition, the Government hoped that the private sector would finance an construct a merchant interconnector eventually – the ability to squeeze consumers to pay up-front for a share of network investment is not inexhaustible. The Eirgrid interconnector may come on stream in 2012. The Government has made much of its ability to squeeze €100m out the EU in grant aid, but like most capital grants, it is likely this has been absorbed in the €600m price tag which seems to increase continuously. 2. Economic power: network owners only have the economic power they are allowed to have. Again, I would caution against using Eircom as a bludgeon to silence rational argument. It provides an almost perfect case study on how not to privatise, but it would be unwise to draw the conclusion that privatisation doesn’t work. For example, the CER has the power to assess the sufficiency of transmission capacity and security of supply arrangements and to mandate investment. It retains the ultimate sanction of licence revocation. There is no reason why it should not have this power for electricity transmission and generation adequacy; nor why Comreg should not have it for communications networks. Alternatively, a competitive market in network investment is even more effective in curtailing economic power. The following is a link to a paper by a former collegaue of mine, Jeff Makholm, who looks at these issues in both the US and Europe: http://www.nera.com/image/PUB_CESSA_May2007.pdf It is quite remarkable that very little analysis of the US gas industry has been published, despite the fact that it incorporates efficient and competitive markets in gas and pipelines. Jeff is currently writing a book which recounts the reasons for this spectacular success. It may be that the participants got on with their work without involving the academics. It may also be the case that electricity and telecoms/IT is considered more sexy than gas – which has always been seen as a bit boring. Just because France and Germany are against network unbundling doesn’t make it right. France and Germany are promoting pan-European (even global) energy behemoths (GdF/Suez, EdF, RWE, E.on) to counter Gazprom and that have the balance sheet heft to pursue profitable opportunities internationally. Under pressure from DG COMP E-on has agreed to sell of its electricity network assets. Other, smaller players, are following suit and the other behemoths will succumb eventually. Vertical integration along the gas and electricity supply chains, even without network assets, generates enormous market power. 3. Economies of scope: it doesn’t need state co-ordination and owenrship to encourage the capture of economies of scope. Private sector businesses with appropriate incentives and regulation are perfectly capable of achieving this. 4. ESOTs: I simply can’t understand why these ESOTs can’t be split to ensure that the value of each worker’s individual share-holding remains unchanged. And I must confess to being a little amused at the profit-maximising behaviour of these budding capitalists being defended by the forces of socialism. And finally, I’m not a privatisation fanatic. If the State can do something better than the private sector I’m all in favour. I think we are at opposite ends. When you contemplate the Eircom debacle, you damn privatisation. When I contemplate the lunacy in the state-owner energy businesses, I reach for privatisation. Paul, Thanks for your response and the link to Dr. Makholm’s interesting paper. While I take your points in relation to economic power, as your former colleague points out, a competitive market for network investment is unlikely to develop in Europe without resolving a number of challenging administrative, legal and political issues such as the synchronisation of network capacity across EU member states and the structural separation of network utility companies. He also makes the point that “the US experience points to the critical nature of a number of regulatory, contractual and ownership institutions that are new or untested in Europe” and that “given the evident challenge of creating an institutional basis for Europe-wide pipeline contractualisation” the continued use of national utility monopolies is a reasonable option. While it is definitely worth mentioning the US gas industry experience the fact remains that such a system would be highly unlikely to develop in Europe. The European experience with network investment in the telecoms industry highlights this fact. After over ten years of market liberalisation in that industry, market failures originating from pro-competitive policies between private operators have emerged in relation to broadband infrastructure provision. While private telecommunications operators in many European countries have invested in more lucrative urban markets with dense populations they have neglected rural areas. Consequently an inequitable distribution of access to broadband exists, creating a digital divide. Governments across Europe have had to intervene in telecoms markets in order to correct this market failure (in Ireland through the MANs and NBS, in other countries through PPPs and other methods). In the case of Ireland, the implementation of what you are suggesting relies on the Government successfully unbundling the network elements of companies such as the ESB and Bord Gais and ensuring the CER is given sufficient power to regulate these network companies effectively in order to ensure adequate investment. It also relies on better interconnection with European energy markets. Given that much of this is unlikely to or cannot be achieved in the short term it will be some time before the Government will be in a position to privatise our energy utilities. Finally, to mirror your final point, I’m not a nationalisation (or privatisation) fanatic. If the private sector can do something better than the public sector I’m all in favour. That said, in relation to utility industries I fail to see how private sector provision will be superior. Such an outcome relies heavily on proper restructuring of the industry prior to privatisation and effective regulation post-privatisation. Given the considerable risks if restructuring is flawed or regulation fails, and the difficulty for the government to intervene in the industry after privatisation, governments must be cautious when reforming such strategically important industries. Donal, Thank you. I have found this exchange extremely useful and informative, but I expect we have lost most other readers. I engage with a number of people internationally on these issues, but I have found it difficult to drum up interest in Ireland. It might be good to continue this exchange off-line (my e-mail is firstname.lastname@example.org). The decentralised, competitive investment model seems to work for gas transmission and, while Jeff and I see the obstacles preventing its adoption in the EU, that isn’t going to stop us (and others) from advocating its adoption. It doesn’t really work for electricity transmission and is likely to be less relevant in telecoms. (It, however, has some potential for expansions and in-fills of electricity and gas distribution networks.) And I’m advancing its relevance in some work I am doing on CO2 pipelines in the CCS chain. In the meantime it seems we will have to make do with this strange combination of centralised policy and regulatory oversight of investment plans generated by the network owners/operators. In this context I can understand your difficulty in seeing how private sector provision will be superior. Only in one area do I see an unambiguous benefit and this has motivated much of my work on energy networks in Ireland. This is the efficient financing of investment. The current aprroach to financing electricity and gas network investment, enforced by the CER, relies on a mix of borrowings, retained earnings, capital grants and capital contributions from customers. In the face of huge investment in the networks since the turn of the century (particularly in the elctricity networks – well over €4 billion), in the absence of any euqity injections and with borrowing limits that have been relieved gradually over time, the CER has been compelled to set high network charges to generate sufficient retained earnings. Consumers have being paying up-front for a share of investment (that should, in a normal commercial context, be financed by the shareholder) and then paying for the full return of, and on, all investment. In effect, consumers are paying twice for a share of the investment. This double-charging has helped to push Ireland’s electricity and gas prices to being among the highest in Europe. It is gloriously inefficient to continue to compel Irish consumers to pay up-front for a share of future investment (in particular the enormous investment programme being advanced by the ESB) – and their ability to do so is being constrained. The State, currently, is not in a position to provide equity and it is for this reason – and this reason alone – that I am advocating private sector ownership and investment. And there are a variety of ways that this may be achieved without diminishing policy and regulatory control. The result would be more efficient financing of investment, lower network charges and lower final prices. And I think an appropriate modification of this approach would be relevant for telecoms and water services. I’m convinced it’s a prize worth striving for. Just a small point where it is recommended that Metro North be postponed for 1 or 2 years, the private funding mechanism means that postponing it will have little effect on spending. My understanding is that the government funding will be paid in annual instalments over 30 years and will only begin once the project is up and running. That is not to support the PPP process as it’s obviously more expensive. @ Ciaran While this thread has run out of steam, I would still like to reply to you. Yes you are right, the funding mechanism will mean that the exchequer bears the cost of the Metro in the future. But even though this liabliity is off the balance sheet, if I were to consider lending to the government I would still consider it a liability. In that sense it does not matter that the Metro is a PPP. Indeed I would worry that the total cost will be higher than if it were a conventionally procured project, since project finance for the private sector would costs significantly more now than it would the government, and the private sector will want to make a profit. Comments are closed.