QUANTIFYING THE COSTS AND BENEFITS OF CHANGE

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QUANTIFYING THE COSTS AND BENEFITS OF CHANGE

• --Towards a Methodology
• Christine Smith, Economics, Griffith University

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THE NEED FOR CHANGE

• Focus on economic factors, other symposium papers
  focussed on other factors

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FEDERAL-STATE RELATIONS

• Calls for Change
• Australias federation needs new life breathed
  into it for the benefit of the community and
  business. In just about every major policy area
  our approach to intergovernmental relations
  presents barriers and obstacles to getting
  sensible outcomes The time has come to take a
  more holistic approach to our system of
  intergovernmental relations so that our
  federation works for us rather than against us
  (Australian Industry Group, 2005)
• We should be thinking about untangling this
  mess, creating simpler lines of responsibility in
  our federal system And that means a serious
  debate the tertiary education sector, the
  possibility of the states transferring
  responsibility holus-bolus to the Commonwealth,
  or about a hospital system or disability services
  being better managed by a single level of
  government without all the perverse incentives
  for cost-shifting and finger pointing that exist
  today. (Bob Carr, 2004)

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FEDERAL-STATE RELATIONS

• Calls for Change (continued)
• Where two levels of government are responsible
  for different parts of the same system it is
  difficult or impossible to achieve coordination
  in policy and funding. Lack of coordination
  gives rise to significant overlaps and gapswith
  too much funding allocated to some types of
  service and not enough to others poor
  coordination of services in areas of shared
  responsibility creates major problems for
  customers, who become confused and frustrated in
  their efforts to deal with a multi-layered system
  that shuttles them back and forth (National
  Commission of Audit, 1998)
• Reform of Commonwealth-State Responsibilities
  for service delivery, and the associated funding
  adjustments, are the next area needing serious
  reform. National Competition Policy focussed on
  the way in which government interacted with
  business, and with the commercial activities of
  government. The next stage must focus on the way
  government interacts with its citizens and how it
  delivers services to them (Bolger,
  2005)

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FEDERAL-STATE-LOCAL RELATIONS

• Calls for Change
• Getting better results out of areas where
  Federal-State activities intersect is vital.
  Inconsistencies, duplication and additional costs
  associated with poorly coordinated or conflicting
  State-Federal (and local) government policies and
  regulations affect virtually every area
  (Access Economics, 2005)
• Cost shifting is, ultimately, a symptom of what
  has become dysfunctional governance and funding
  arrangements. It is time to combine the best
  efforts of governments and choose a better way.
  There have been many demands for the three
  spheres of government to work more closely and
  eliminate duplication and wasted resources. In a
  shrinking and increasingly competitive world, the
  luxury of three spheres of government, with often
  different agendas, in a country of nearly 20
  million people is straining our
  resources (Hawker Enquiry, 2003)

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EMERGENCE OF REGIONAL ORGANISATIONS

• A Fourth, Fifth, Sixth Tier necessary or
  response to inappropriate boundaries/size of
  other Levels?
• Calls for Change
• Empirical research pointing to regional bodies
  afflicted by inadequate organisational size, low
  (usually non-existent) recurrent funding, third
  world-style birth and death rates, poorly
  directed central funds and duplication and
  coordination problems between and within
  governments (Beer, et al., 2003)
• We recommend that the Australian and
  State/Territory governments clarify and
  articulate their respective roles and
  responsibilities in regard to the provision of
  support for regional bodies and determine the
  base level of core funding required to maintain
  an appropriate corporate governance framework to
  enable a regional body to meet conformance,
  performance and administrative requirements (T
  urnbull Report, 2005)

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MULTIPLE CHANGE AGENDAS

• Calls for abolition of states
• But not consensus on what replaces them
• Calls for new states
• But not consensus on how many or which ones
• Calls for local government amalgamations
• But not consensus on which ones or on what
  criteria
• Calls for new regional institutions
• But not what powers, functions, resources or
  reporting mechanisms

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NEED TO MOVE DEBATE ON

• Develop consensus around a concrete reform agenda
  or a limited set of such agendas
• Without flesh being put around reform agendas,
  detailed analysis and evaluation of costs and
  benefits associated with change cannot commence
• Public opinion surveys aimed at further
  verifying dissatisfaction with current system not
  helpful to generating this flesh

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NEED TO GET SPECIFIC

• What functions (or components of functions)
• currently exclusively federal, state or local
  better assigned to other level(s)
• currently overlapping in terms of responsibility
  better allocated to a single level exclusively
• necessarily overlapping but in need of better
  co-ordination between levels to avoid
  duplication, etc
• fall between gaps with current levels leading to
  formation of regional bodies how well do these
  bodies work, how might their performance be
  improved, could local government amalgamation be
  a better solution rather than creation of 4th,
  5th, etc tier?

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MERITS OF FOCUS ON FUNCTIONS

• An evaluation framework that works with
  ill-defined models of change and at an aggregate
  all of government level will not stand up to
  scrutiny by federal/state treasury officials
• Substantial amount of data available at a
  functional level of disaggregation from
  government finance statistics, state and federal
  grants commissions, etc
• When advocating revised assignment of functions
  between levels need to also address machinery for
  shift of resources between levels necessary to
  carry out these functions

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PREVIOUS ESTIMATES OF NET BENFITS OF CHANGE

• Numerous government/consultancy reports and the
  like quote various estimates made by Drummond as
  to the costs of duplication and coordination
  inherent with current arrangements
• These estimates vary from 10-40 billion dollars
  per annum, depending on which Drummond
  calculation is chosen for quotation
• Most often quoted figure is the 20 billion
  claimed to be able to be saved from moving to a
  two tier system that abolishes the states

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DRUMMOND METHODOLOGY EXPLAINED

• Assumes government expenditure of any level of
  government can be divided into a fixed cost
  component and a single variable cost component
• The single variable cost component is calculated
  as a function of aggregate population level in
  the jurisdiction
• The fixed cost component is assumed to be
  associated with overheads or administration of
  the level of government in question, and hence
  able to be avoided or eliminated if this level of
  government is phased out
• The single variable cost component is seen as
  solely a function of population levels and so
  shifts between jurisdictions unaltered in
  magnitude should responsibility for that
  population shift to another jurisdiction
• The size of these components is estimated by
  fitting a simple linear regression model to
  pooled time series/cross section data relating to
  3 years and 8 states/territories

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PROBLEMS WITH PRIOR METHODOLOGY I

• Assumption of a single variable cost component
  flies in the face of large volume of data
  relating to determinants of inter-jurisdictional
  variations in costs
• Eg. federal and state grants commissions have
  long recognised in their horizontal equalisation
  grants that aggregate population size is only one
  relevant factors
• Other factors of relevance include population
  composition (age structure, ethnicity, indigenous
  status,etc), population dispersion (number of
  townships/density), climate and terrain,
  non-resident service provision
• Ignoring these other factors leads to an
  overestimation of the fixed costs component
• In technical terms the regression equation is
  inappropriately specified due to omitted
  variables, such that at the very least there is a
  need to move to a multiple regression equation
  that includes other variable cost terms
• In Drummonds estimation the effects of all these
  other variable cost factors are being
  inappropriately attributed to the fixed costs
  component, leading to its overestimation

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PROBLEMS WITH PRIOR METHODOLOGY II

• While Drummond reports the coefficients related
  to his fixed and variable cost components he does
  not report the associated standard deviations
• In addition he does not report results of any
  regression diagnostic tests conducted and
  previous modelling experience suggests that the
  equation as estimated has some problems that
  suggest the need for re-specification
• In particular, as other critics have pointed out
  it is more usual to estimate models relating to
  government expenditure in per capita terms
  because of serial correlation between total
  expenditure and population
• More substantively, however, to assume that
  functions currently carried out by a state
  government could be transferred to the federal
  government without altering either the fixed cost
  or the variable cost component associated with
  population size is arguably unrealistic

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PROBLEMS WITH PRIOR METHODOLOGY III

• Similarly, by using pooled time series/ cross
  section estimation the assumption is being made
  that ALL state governments host equal fixed and
  variable costs so that amalgamation of two
  states, for example, is argued to liberate cost
  savings equal to one quantum of fixed costs.
  This assumption is unrealistic.
• Finally, the assumption was made that individual
  state deviations around the regression line were
  accounted for by higher or lower FC and not
  higher or lower VC the associated
  recalculations resulting in a near doubling of
  the estimated cost savings
• Yet via use of a more extended time series of
  expenditure data and the use of dummy variables
  for the different states, the validity or
  otherwise of this assumption could be readily
  tested

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TOWARDS A MORE SOUND APPROACH

• Could adopt an aggregate level of analysis for
  each level of government and improve Drummond
  like econometric analysis
• However, this ignores previous case made for a
  focus on functions
• Also, it works best for an abolish the states
  agenda, not other more realistic agendas
• A sounder approach would
• Take a particular function, analyse costs of
  current mode(s) of delivery, identify potential
  net cost savings from a small set of change
  proposals
• Repeat this for major functions seen as
  problematic
• Sum results across functions to identify order of
  magnitude of savings for each change proposal
• Develop a ranking of change proposals on criteria
  of net economic benefits

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FURTHER COMMENTS ON SUGGESTED APPROACH

• Not all functions need be covered, only major
  ones or ones seen as problematic currently in
  first instance
• The change proposals, while needing to be
  reasonably detailed, need only be representative
  of possible directions of change in first
  instance
• What needs identification is which types of
  change can potentially reap net economic benefits
  and which seem likely to generate net economic
  costs
• With this information to hand, change proposals
  can be better developed and refined
• debate can then progress to a level likely to
  lead to achievement of the type of changes public
  opinion surveys suggest is desired by the
  electorate

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CONCLUSION

• Aim of paper not to provide answers to whether or
  not change to current federal structure and/or
  financial arrangements will generate net economic
  benefits
• Rather to point to directions debates surrounding
  federalism and regionalism need to move in order
  to permit a framework capable of providing such
  answers to be developed