1

Executive Development Programme for Senior Government Officers

The Economic Basis of Public Policy

Microeconomic perspective

Dr Roger Lawrey 2

EDPSGO 2005

Dr Roger Lawrey 3

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 4

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 5

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 6

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 7

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 8

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 9

Brunei per capita GDP at current prices

1983 - B$39,6291984 - B$38,1671985 - B$35,5441986 - B$22,8051992 - B$24,5701998 - B$21,1112003 - B$23,615

Problem 1. Volatility of oil

prices

Problem 2. Calculations

Problem 3. Over-reliance on oil

and gas

Dr Roger Lawrey 10

Brunei Citizen and PR only

2001 Population Labour Participation

Age Group force rate

15-24 47017 18662 39.69%25-34 36419 29097 79.90%35-44 31289 23917 76.44%45-54 20779 14170 68.19%55-64 9892 2667 26.96%TOTAL 145396 88513

Note this is unofficial data. The participation rate is the percentage of the population that is employed or actively seeking work

Dr Roger Lawrey 11

Brunei Citizen and PR only

2011 Population Labour Participation

Age Group Force rate

15-24 60285 23928 39.69%25-34 47017 37564 79.90%35-44 36419 27838 76.44%45-54 31289 21337 68.19%55-64 20779 5602 26.96%TOTAL 195789 116270

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 12

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 million2002 GDP $7,651.7 millionGovernment expenditure 2002

$4,736.14 million: 62% of GDP

Dr Roger Lawrey 13

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 14

The Brunei Public Sector

Revenue (2002)$4,267.83 million of whichDuties, taxes and licenses 54.6%Revenue from government property

38.3%Commercial activities 6.7%Other 0.4%

Dr Roger Lawrey 15

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 16

EDPSGO 2005

Dr Roger Lawrey 17

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 18

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 19

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 20

The case for policy intervention

National Development Plans Promoting and controlling development

that is not happening in a free marketMarket failure

When markets don’t maximize economic welfareMonopoly, other forms of market power,

externalities, public goods.

Dr Roger Lawrey 21

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 22

Some policy instruments

Regulations backed by penaltiesControl 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 23

……. Policy instruments

Criteria for evaluation of policy instruments (Field 1995)

Efficiency (and cost effectiveness)Fairness (equity)Incentives to innovateEnforceabilityMorality

Dr Roger Lawrey 24

Three examples

ExternalitiesPublic goodsNatural monopoliesExternalities 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 25

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 26

Public goods

ExcludabilityExcludability

Rivalry Rivalry (exhaustiveness)(exhaustiveness)

High Low

High

Low

Private good

Common Pool good

Toll good

Public good

Dr Roger Lawrey 27

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 28

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 29

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 30

Natural monopolies…….

Defined as having continually declining costs over the whole range of output covered by the market demand curve.

Quantity

Per unitcost ofproduction

Dr Roger Lawrey 31

……. Natural monopoly

Examples of natural monopolies are firms with large fixed costs such as water, telephony and electric utilities.

Dr Roger Lawrey 32

……. Natural monopoly

What is the rationale for government ownership or control of natural monopolies?To avoid wasteful duplication of facilitiesOne supplier has lower costs than two or

more suppliers Because without government

involvement the industry would monopoly price

Dr Roger Lawrey 33

……. 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 34

……. 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 35

EDPSGO 2005

Dr Roger Lawrey 36

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 37

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 38

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 competitioncompetition?What impact does greater efficiency have

on costs per unit?

Dr Roger Lawrey 39

Government fiscal position

Fiscal considerations may be just short-term.

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 40

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 41

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 42

Duplication?

An appropriate access regime allows competitors access to essential facilities without duplication, e.g. telephone lines.

Dr Roger Lawrey 43

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 increaseJobs may be lostMaintenance may be insufficient to

meet profit targets (see Energex)

Dr Roger Lawrey 44

The Brunei case

Is competition possible?Is regulation

feasible? economical?

Is increased efficiency possible with government ownership?

Dr Roger Lawrey 45

Contracting out or internal organisation?

Costs of internal organization Offices, secretaries, administrators, human resource managers pensions bureaucracy, inefficiency?

Dr Roger Lawrey 46

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 47

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 48

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 49

The value of an enterprise to society

Society = the enterprise, consumers, the government

The enterprise variable is net profitThe consumer variables are price and

output (quantity and quality)The government variables are required

subsidies or net tax revenueJobs?