Monday, December 16, 2013

How six states became one economy

It's been a year of anniversaries: 50 years since The Australian Financial Review became a daily, 30 years since the floating of the dollar, 21 years since the Council of Australian Governments replaced the special premiers' conference and 15 years since the start of the national electricity market.

In the Fin Review's self-congratulatory anniversary edition - apparently, the paper brought about micro-economic reform single-handedly - one of my old bosses, Vic Carroll, made a point most of us have forgotten, if we ever knew.

Before Paul Keating began opening Australia to the world in the 1980s, we first needed to break down the barriers between the six states to get one national market. In theory we've had a common market since Federation; in practice it didn't start until the 1960s.

We had separate stock exchanges and even big companies tended to stick to their own state. Coles and Woolworths didn't start to invade each other's home states until the 1960s. The big banks were concentrated in their home states until eight merged to become four in the early 1980s.

For many years the brewers defined much of the Riverina as part of Victoria and thus out of bounds to Sydney-based Tooth and Co. It took the Trade Practices Act of 1974 to make agreements on competition-reducing territorial carve-ups illegal.

A main role of COAG has been to gain agreement between the states to align their regulation of markets and in other ways facilitate cross-border trade. Progress has been painfully slow and at Friday's meeting it gave up trying to introduce a national occupational licensing scheme.

But that makes COAG's initiative of establishing a national electricity market (covering all states bar WA) in 1998 the more remarkable. Before then, we had six separate, state-owned vertically integrated monopolies.

The Australian Energy Market Commission has celebrated the national market's 15th anniversary by commissioning KPMG consultants to prepare "a case study in successful micro-economic reform". The idea was to record the insights of key players before they were carted off to retirement homes.

It took eight years of preparation before the market began. Step one was for each state to break its monopoly electricity commission into separately owned power generators and separately owned electricity retailers, leaving the transmission and distribution network ("poles and wires") as the irreducible natural monopoly.

The generators could be made to compete with each other (and probably privatised) and the retailers made to compete with each other (and privatised) by giving them equal access to the network.

The hard part was setting up the continuously trading wholesale auction market in which competing generators supply power to competing retailers. Once the state networks had been physically connected to a single grid, this was made possible by the "fungibility" of electricity. If one unit of power is identical to any other, I don't have to actually generate the power I end up selling you.

That's handy, but it makes the market, with all its derivative contracts, horrendously complex. Its smooth operation is a notable tribute to the economist's art: it's a quite artificial, geek-designed, government initiated and regulated market. T. Abbott and other sceptics please note.

The case study should prove a useful guide to would-be reformers. One tip is that this radical change was achieved through many small steps. Each state set up its own market before they merged into one after many trial simulations.

Though the federal government had no responsibility for electricity, it was deeply committed to micro reform and, since it would benefit from higher tax collections, transferred these to the states as incentive payments for reforms achieved.

No business people or economists need telling that many people find money highly motivating. Premiers more than most. But the study warns "there are risks that the incentive becomes payment maximisation rather than policy optimisation".

Likewise, establishing a competitive industry structure must take precedence over doing things to maximise the proceeds from privatisation. "Incentive payments are not a substitute for mutual commitment to policy outcomes," we're told.

Careful planning, widespread consultation and good processes are all necessary, but the study emphasises the key role of committed leaders. At the political level, reform was pushed by Bob Hawke and Nick Greiner, by Paul Keating and Jeff Kennett, then by John Howard.

But the person who deserves greatest approbation was the chairman of the National Grid Management Council, John Landels, formerly of Caltex. His strengths were he was beholden to no one, kept the board focused while letting the technocrats get on with the details, and he had pull with prime ministers and premiers. And I doubt he was doing it for the money.