Executive Development Programme for Senior Government Officers

1
Executive Development Programme for Senior
Government Officers

• The Economic Basis of Public Policy
• Microeconomic perspective

2
EDPSGO 2005
PART ONE AN INTRODUCTION TO ECONOMICS AND THE
ECONOMY OF BRUNEI
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

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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

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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.

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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.

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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.

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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

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Brunei per capita GDP at current prices

• 1983 - B39,629
• 1984 - B38,167
• 1985 - B35,544
• 1986 - B22,805
• 1992 - B24,570
• 1998 - B21,111
• 2003 - B23,615

• Problem 1.
• Volatility of oil prices
• Problem 2.
• Calculations
• Problem 3.
• Over-reliance on oil and gas

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Brunei Citizen and PR only
Note this is unofficial data. The participation
rate is the percentage of the population that is
employed or actively seeking work
11
Brunei Citizen and PR only
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.
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The Brunei Public Sector

• For year 2003 (Department of Economic Planning
  and Development, Prime Ministers Office (2003)
  Brunei Darussalam Statistical Yearbook)
  Provisional data.
• 2003 GDP 8,236.9 million
• 2002 GDP 7,651.7 million
• Government expenditure 2002
• 4,736.14 million 62 of GDP

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The Brunei Public Sector

• Public Expenditure 2002 (Four largest
  departments)
• Education 10.4
• Defence 8.6
• Health 4.4
• Public works 3.1

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The Brunei Public Sector

• Revenue (2002)
• 4,267.83 million of which
• Duties, taxes and licenses 54.6
• Revenue from government property 38.3
• Commercial activities 6.7
• Other 0.4

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The Brunei Public Sector

• Revenue breakdown (Department of Economic
  Planning and Development, Prime Ministers 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

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EDPSGO 2005
PART TWO THE ECONOMIC BASIS OF PUBLIC POLICY
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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.

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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

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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

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The case for policy intervention

• National Development Plans
• Promoting and controlling development that is not
  happening in a free market
• Market failure
• When markets dont maximize economic welfare
• Monopoly, other forms of market power,
  externalities, public goods.

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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.

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Some policy instruments

• Regulations backed by penalties
• Control 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

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. Policy instruments

• Criteria for evaluation of policy instruments
  (Field 1995)
• Efficiency (and cost effectiveness)
• Fairness (equity)
• Incentives to innovate
• Enforceability
• Morality

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Three examples

• Externalities
• Public goods
• Natural monopolies
• Externalities 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

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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

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Public goods
Rivalry (exhaustiveness)
High
Low
Excludability
Toll good
Private good
High
Common Pool good
Public good
Low
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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
  (everyones tax payments) when only some people
  use them. User pays principle.

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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.

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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 persons consumption does
  not reduce amount available for others)
• Examples.
• Community service obligations

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Natural monopolies.

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

Per unit cost of production
Quantity
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. Natural monopoly

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

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. Natural monopoly

• What is the rationale for government ownership or
  control of natural monopolies?
• To avoid wasteful duplication of facilities
• One supplier has lower costs than two or more
  suppliers
• Because without government involvement the
  industry would monopoly price

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. Natural monopoly

• Is this monopoly pricing desirable from societys
  point of view?
• No,
• supernormal profits may be made
• too little output

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. 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)

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EDPSGO 2005
PART THREE AN ECONOMIC PERSPECTIVE ON
PRIVATISATION
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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)

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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.

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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 competition?
• What impact does greater efficiency have on costs
  per unit?

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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?

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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

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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

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Duplication?

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

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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 increase
• Jobs may be lost
• Maintenance may be insufficient to meet profit
  targets (see Energex)

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The Brunei case

• Is competition possible?
• Is regulation
• feasible?
• economical?
• Is increased efficiency possible with government
  ownership?

45
Contracting out or internal organisation?

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

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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

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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

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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

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The value of an enterprise to society

• Society the enterprise, consumers, the
  government
• The enterprise variable is net profit
• The consumer variables are price and output
  (quantity and quality)
• The government variables are required subsidies
  or net tax revenue
• Jobs?