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 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. 1983 - B$39,629 1984 - B$38,167 1985 - B$35,544 1986 - B$22,805 1992 - B$24,570 1998 - B$21,111 2003 - B$23,615 Problem 1. Volatility of oil prices Problem 2. Calculations Problem 3. Over-reliance on oil and gas Brunei per capita GDP at current prices Dr Roger Lawrey

10. 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 Dr Roger Lawrey

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. 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 million • 2002 GDP $7,651.7 million • Government 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 which • Duties, 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 PART TWO THE ECONOMIC BASIS OF PUBLIC POLICY 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 market • Market failure • When markets don’t maximize economic welfare • Monopoly, 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 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 Dr Roger Lawrey

23. ……. Policy instruments • Criteria for evaluation of policy instruments (Field 1995) • Efficiency (and cost effectiveness) • Fairness (equity) • Incentives to innovate • Enforceability • Morality Dr Roger Lawrey

24. 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 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 Rivalry (exhaustiveness) High Low Excludability Toll good Private good High Common Pool good Public good Low 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. Per unit cost of production Quantity 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 facilities • One 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 PART THREE AN ECONOMIC PERSPECTIVE ON PRIVATISATION 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 competition? • 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 increase • Jobs may be lost • Maintenance 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 profit • The consumer variables are price and output (quantity and quality) • The government variables are required subsidies or net tax revenue • Jobs? Dr Roger Lawrey