The 2020 emissions projections confirm our long stated position that Australia will not need Kyoto carryover credits to meet the Paris 2030 emissions target.
Much is made of whether the Federal Government will meet Australia’s 2030 emissions target or adopt a net zero target for 2050. But all States have announced net zero emissions targets by 2050, so the lack of formal acceptance of the target at Federal level is more symbolic.
For 2030, the combination of current State 2030 emissions targets should see Australia on track for a 33% reduction of 2005 emissions, which is more than required to meet the National target of 26-28% by 2030 and closer to the 36% 2030 target that we recommended in 2015[1].
State and Territory targets provide a floor on emissions reductions. For Australia to miss the 2030 national emissions targets, it would require failure at both Federal and State level to meet respective targets.
Australia currently has a national emissions target of 26-28% reduction on 2005 levels by 2030. However, almost all State and Territory Governments (with the exception of WA and NT) have announced more ambitious 2030 targets as pathways to net zero targets that all states and territories have announced for 2050.
Table 1 summarises the State and Territory ambitions and the implications of these targets for the national target. The combination of State 2030 emissions targets should see Australia on track for a 33% reduction of 2005 emissions, which is more than required to meet the national target of 26-28% by 2030.
The following are most noteworthy:
If all State and Territory targets are achieved, then Australia should comfortably meet the national target.
It follows that if Australia is to miss the national target then this would require failure at both the Federal and the State level in meeting applicable targets. More formal bipartisan collaboration on achieving common targets would be welcome in climate and energy policy in Australia.
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[1] https://www.frontier-economics.com.au/australian-targets-emissions-36-by-2030/
DOWNLOAD FULL PUBLICATIONGovernment policy is increasingly putting green infrastructure front and centre of its vision for the future cities where most of us will live. Urban green infrastructure refers to the canopy, parks, waterways, vegetation, wetlands and lakes in our cities. More than just urban nature: these features are assets which deliver valuable services. They can make our cities cooler, healthier, more ecologically sustainable, and attractive places to live and work. To realise a policy vision of greener cities and change our future urban landscapes, we need to start treating green infrastructure in the same way we treat traditional physical ‘grey’ infrastructure ─ by subjecting it to rigorous economic assessment and assurance processes.This isn’t easy, but it can be done. Right now there is significant opportunity to embed green infrastructure in growth areas as part of the urban fabric, especially in areas with large greenfield developments in the planning phases (such as in NSW). But the clock is ticking as development continues, and this needs to happen quickly. This bulletin explores how we can build green infrastructure into our infrastructure planning processes and what challenges still lie ahead for greener urban communities.
The NSW State Government in Australia recently released two documents that, together, indicate a policy vision for the role of green infrastructure in the urban environment. ‘Greener Places’ from Government Architect NSW outlines what green (and blue) infrastructure is in the urban context and how it can improve our cities. In addition, the discussion paper and draft ‘50-year vision for Greater Sydney’s Open Space and Parklands’ outlined four key strategic directions to grow and improve parks, open spaces, connectivity and greenery, and resilience.
Both documents convey a fundamental shift in thinking which considers urban nature as genuine infrastructure that delivers valuable services to the community and which merits policy and planning priority. They recognise that the natural green (and blue) assets of a city can deliver real public benefits like mitigating the urban heat island effect, protecting and restoring ecological health, promoting active lifestyles, and providing beautiful places to live, work and play. These benefits can be measured and quantified in dollar terms such that they are no longer an incidental bonus of investment, but part of the baseline justification and cost-effectiveness of green infrastructure in delivering critical services to the community.
A clear government policy vision for green infrastructure is a good (and necessary) start. But for green infrastructure to be funded it must be robustly integrated into formal proposal, evaluation and assurance processes. Realising a vision for greener cities will depend on how effectively we can develop rigorous processes, methods, resources, datasets, and capabilities to value and assess green infrastructure as an ongoing, long-term package of service-delivering investments.
There are different ways we could embed active consideration of green infrastructure into our planning and decision-making processes on a more equal footing with traditional ‘grey’ infrastructure options.
For example, government policy could mandate investment in green infrastructure. But green infrastructure will not always be the best option in all circumstances and prescribing a one-size-fits-all approach does not guarantee smart investments. The alternative approach is to assess green infrastructure proposals on their individual merits—by requiring a fair, rigorous, quantitative assessment of the economic, environmental and social impacts of each investment—as we do with traditional physical ‘grey’ infrastructure. Investment would then occur where and when it can be demonstrated to deliver genuine community value relative to the alternative levers available.
However, green infrastructure impacts can be tricky to evaluate because:
We look at each of these issues below.
Decisions to invest in infrastructure by governments or other parties are (or should be) determined by the relative weight of benefits to costs. A cost-benefit analysis is the formally preferred evaluation tool of state treasuries and infrastructure agencies around the country and is essential to ensure that limited public money is used as wisely as possible.
Although measuring the costs of green infrastructure is (mostly) straightforward, many of its benefits are not as easy to identify or measure. This can lead to a cost side of the equation that looks robust, ‘real’, and in many cases relatively large, but a benefit side of the equation that looks vague, unreliable and risky.
Take the example of a neighbourhood park. The costs of building and maintaining it are easy to estimate. We could look at what other, similar parks have actually cost. Or, a landscaping firm could provide an estimate of the cost of design, earthworks, materials, park benches, tree planting, tree trimming, etcetera. But how do we measure the benefits of that park to the local community? It’s irrefutable that we value relaxing, exercising, and socialising in parks. Parks clearly provide a range of identifiable community services for mental and physical health, amenity, and aesthetic enjoyment (and others). But none of those benefits are directly paid for per use or otherwise traded directly in a market (for most parks). This means there’s often no observable price to provide some indication of the value of park visits – a so-called ‘non-market’ benefit.
But this does not mean those benefits aren’t real. It does not mean that the community will be better off if we choose not to build that park, or preserve urban canopy, or restore an urban waterway. It simply means that we have to work harder and smarter to identify the end-use benefits of these investments, quantify these (with scientific and engineering tools), and convert those benefits to a robust and fair estimate of value in dollar terms.
Economics has a range of methodologies that can assist (e.g. willingness-to-pay methods, hedonic pricing modelling, productivity cost methods, and more). While these methods require assumptions and are affected by uncertainties, they are a great deal better than nothing and can be refined over time as more and better data become available. The key is executing these methods well. This means exploring (rather than shying from) core uncertainties in the modelling, be those assumptions or data inputs.
To ensure a consistent and systematic treatment of non-market impacts of green infrastructure, it is also important to understand what effects green infrastructure actually has in the urban environment.
A core principle of good cost-benefit analysis is that we only compare costs and benefits that are clearly and exclusively caused by the proposed investment, and not those which would happen anyway, or which would happen under every alternative option. This is the incremental impact of investment, and this is the end measure we convert to a monetary value to tally up different types of costs and benefits.
Nailing down the incremental impact of an investment with rigour can be the most difficult, resource-intensive step in the evaluation process. This is because it requires both a) a defensible case that green infrastructure causes the impact, then b) a defensible measure of how big that impact is.
Demonstrating causal links for green infrastructure is challenging, partly because scientific research and data cannot always readily establish a) and b) above. Further, green infrastructure evaluation can require multiple causal chains to be articulated and linked in a sequence to establish the final incremental impact of investment. This can be extremely complex.
A key policy concern is the risk to health, life, and urban amenity of extreme city temperatures. Climate change will likely increase the number of ‘very hot’ (over 35 degrees) days, exacerbated further by the urban heat island effect. This heat can have serious consequences for health, and is a contributing factor for mortality, especially among the elderly and infants. It is also an extreme (and expensive) stress on our electricity infrastructure.
Urban canopy is one form of green infrastructure that can help reduce these impacts. The natural evapotranspiration processes of trees can cool surrounding air temperature. But the first step to evaluating the cooling benefits of urban canopy is to estimate, for the specific site and proposed investment (including what kind of trees, in what numbers, in what kind of environment, at what scale, etc.), the amount of cooling caused by increasing urban canopy. This is a non-trivial exercise, heavily reliant on the state of scientific research and site-specific modelling. Even once achieved, this will only establish one quantified causal chain – how much change in air temperature will result from additional urban canopy (a similar process applies to the case of cooling from retaining water in the landscape).
The second step involves quantifying the causal link between air temperature changes to human health, electricity infrastructure requirements, and potentially other recreation-related outcomes. Again, this would require scientific research and is a data-intensive task.
But both steps are required to eventually establish the benefits, in monetary terms, that result from investment in urban canopy. Recent work in Western Sydney indicates that these benefits can be significant, and more than outweigh the additional costs.
This example demonstrates that that if this process is to be applied as the standard for green infrastructure proposals, it will require developing, accessing and expertly using high-quality, localised primary research and data. Much of this data will be scientific in nature. However, empirical economic data is also critical. Economic research using best-practice research methods is required to uncover the best possible estimates of what value the community places on alternative possible services provided by green infrastructure.
Being able to assess good green infrastructure options from bad is critical. Valuation is a key element and as we have seen, can be a difficult process. Too often this step is avoided, with the focus on ‘how to invest’ (e.g. funding, delivery, governance etc), prior to answering the question ‘should we invest’.
This may be accomplished more easily in some sectors than others. Water utilities, for example, already have experience in the kind of robust green infrastructure evaluation processes described above. This is because many of the ‘assets’ they build and manage include multi-service delivering natural features. For example, from a traditional water industry perspective, an urban wetland might be one way to manage stormwater quantity, quality and floodplain issues. This is one manifestation of Water Sensitive Urban Design (WSUD), which is now a standard industry concept that prioritises smarter use of nature and its materials to provide services in all stages of the water cycle.
But that wetland is also a piece of green infrastructure that delivers open space, recreational opportunities, wildlife habitat, and possibly other services (for example, large water in the landscape might also be able to cool urban temperatures). The water industry has developed capability because of the regulatory framework that requires scrutiny of spending by utilities. The resultant expertise, datasets, and experience includes quantification of impacts of green infrastructure and the values placed on these impacts by the community (for example, impacts of WSUD options on water quality and species diversity). Sharing and accessing the information held by various sectors will be a key part of unlocking the data and skill required in the valuation process across different forms of green infrastructure.
Government policy encouraging different industry sectors to view our future urban environments with a green infrastructure focus invigorates the approach to infrastructure development and broadens the horizons for what our future urban landscapes can become. Policies should encourage industry players to factor in liveability, amenity, sustainability, the circular economy and a range of other urban policy goals in infrastructure development. However, demonstrating the value that could result from these investments (or broader interventions) is critical. If we genuinely see these investments as value-enhancing community infrastructure, this step must come first. Further, it must be done well if the case is to be made convincingly and for the long-term that multi-servicing delivering green infrastructure is a sound use of the community’s resources.
DOWNLOAD FULL PUBLICATIONStandard techniques used to appraise commercial and government investments often ignore the value of flexibility to adapt investment strategies as circumstances change. Misvaluation of this kind can result in suboptimal investments being chosen. This problem can be particularly acute for infrastructure projects, which typically involve large sunk costs and uncertainty over long asset lives. Real options analysis addresses this shortcoming by valuing flexibility explicitly, thereby promoting better decision-making.
The 6th of June 1944 marked the beginning of the Battle of Normandy, a decisive turning-point in World War II that led to the liberation of Western Europe. Under General Dwight D. Eisenhower’s bold plan, 160,000 Allied troops would cross the English Channel under cover of darkness, land on several beaches in Northern France and push deep into German-held territory. The Normandy landings remain the largest seaborne invasion ever recorded, and one of the most successful Allied campaigns during World War II. However, the whole endeavour was nearly scuppered by the most mundane of things: bad weather.
The landings were originally planned for the 5th of June. However, it became clear by the 4th that heavy winds and rough seas would make the audacious landings impossible. Meteorologists advising Eisenhower forecast that conditions would improve sufficiently by the 6th for the invasion to proceed. The Allied Commander wisely heeded the advice to delay, changed plans that had taken months of meticulous preparation—and the rest, as they say, is history.
Flexibility when making decisions is valuable not just in military strategy. All of us adjust our plans in response to changing circumstances and new information—whether that entails taking a different route home from the usual one to avoid traffic, or more life-changing choices, like whether to buy a house when the outlook for the property market is highly uncertain.
Commercial and public investment decisions are no exception. Businesses and governments making major investment choices often do so in the face of significant uncertainty about the future. Rarely are the investment choices completely fixed. Investment plans can often be adapted—for example, by waiting to see what happens rather than taking a decision now, or by pursuing a different investment strategy—when confronted with new information that affects the value of the investment.
Bizarrely, even though many investors do in practice change their behaviour in response to new information, the techniques typically used to value investments ignore this flexibility. For example, standard Net Present Value (NPV) analysis used in commercial investment appraisals and cost-benefit analysis (CBA) used to assess the net public benefits of government investments generally assume fixed investment plans that cannot be revised, regardless of how circumstances change.
If the flexibility to change investment strategies is valuable—and it can be materially so in many situations—then standard NPV analysis and CBA will understate the value of investments. Investors who realise this often resort to ad hoc, qualitative judgment in order to take account of the value of flexibility—usually an excellent way to make bad decisions.
Worse still, what happens if two competing investment options are being considered side-by-side, but one presents the investor with more (or different kinds of) flexibility than the other? How are those two options to be compared on a like-for-like basis? Unless the flexibility is valued quantitatively, there is every chance that the two investment opportunities will not be compared on a level playing field, and the wrong (i.e., value-destroying) investment may inadvertently be selected.
Figure 1 presents a simple example, which shows that when faced with uncertainty, flexibility to respond to new information can increase the value of an investment.
Consider two investment options available to an investor.
Under Option 1, the investor can invest at Time 0 at a cost of $10 million. The investment will provide a guaranteed cash flow of $1.25 million at Time 1. However, the cash flows at Time 2 (and thereafter) are uncertain: with equal probability they will either rise to $2 million, or fall to $0.5 million. This uncertainty resolves only at Time 1. Under Option 1, this occurs after the investment decision has been. If the investor takes Option 1, the expected NPV of the investment (at a constant discount rate of 10%) would be $2.5 million.
Note that the expected NPV represents the average outcome, given that there is a 50/50 chance of cash flows from Time 2 onwards increasing or falling significantly. If the investor is unlucky and cash flows drop, then the actual NPV of the investment would be -$6.59 million. The investment would have turned out to be a very bad one.
Under Option 2, the investor could—in recognition of uncertainty about the future—wait until Time 1 and choose to invest only if the cash flow at each point in time increases to $2 million. This would mean giving up a guaranteed cash flow of $1.25 million at Time 1. However, in exchange, the investor can avoid an outcome where the cash flow drops significantly and forever to $0.5 million, producing a loss-making investment. If the investor takes Option 2, the expected NPV of the investment would be $4.55 million—significantly higher than under Option 1, where the investment would occur immediately regardless of future uncertainty. By selecting Option 2, the worst the investor can do is avoid losses by not investing if the cash flows decline.
The difference in the NPVs under Options 1 and 2, $2.05 million, represents the economic value of flexibility (the ‘option value’) to change the investment strategy in response to new information.
Real options analysis (ROA) is a technique that allows the systematic quantification of the economic value of flexible decision-making. Unlike standard NPV analysis or CBA, ROA recognises that investors can alter the way a project is rolled out as circumstances change and calculates the value of the project under different possible investment strategies rather than a single, fixed strategy.
Examples of flexibility in decision-making that ROA can account for include the options to:
ROA has two main advantages over standard NPV analysis and CBA:
A key insight from the ROA literature is that the value of flexibility can be particularly large if:
This means ROA can be particularly useful when valuing infrastructure investments—such as: roads, rail lines, ports, airports, water networks, desalination plants, water recycling plants, telecommunications networks, mining and exploration assets, gas pipelines, electricity grids and power stations.
This is because infrastructure investments tend to be long-lived (so economic conditions can change materially over the life of such assets), and typically involve billions in sunk costs.
With a forecast peak funding requirement of $51 billion, the National Broadband Network (NBN) represents the largest infrastructure project ever undertaken in Australia.
Given the size of the project, it is astonishing that the Rudd Labor government, which pledged to deliver the NBN, refused to conduct a CBA to assess its merits. Indeed, the Federal Communications Minister at the time argued that the benefits of the NBN to Australia were self-evident, and that conducting a CBA would be a “waste of time, waste of effort, waste of money.”
The most contentious aspect of Labor’s NBN plan was a commitment to deliver fibre to the premises to 93% of the population with broadband speeds of up to 100 megabits per second. The ambitious choice to build fibre to the premises was intended to deliver a network with sufficient capacity to last for generations, but also involved the highest construction costs.
The decision to roll out fibre to the premises was particularly controversial because it was unclear in 2009, when the plan was first announced, that there would be sufficient future demand to justify the broadband speeds and build costs associated with a fibre to the premises network. Whether fibre to the premises would be truly worthwhile depended on what sort of applications would emerge, and how consumers would choose to use broadband services, in future. However, the government of the day pressed on with its plans for a “Rolls-Royce” NBN as though such speeds would definitely be required, regardless of the uncertainty over future demand. No account was taken of the option to delay or to build gradually.
When Labor lost the 2013 general election, the incoming Coalition government commissioned a CBA of the project. That study assessed the net benefits to taxpayers of three options for rolling out the NBN. It concluded that, against the base case scenario of halting the project immediately:
The study suggested that Labor had picked the worst of all rollout options.
A commendable aspect of the CBA—which made it stand out compared to most other government CBAs—was that it made some effort to account for optionality. The CBA recognised that a key uncertainty was the extent of future growth in demand for high-speed broadband. The study concluded that whilst a multi-technology mix rollout would offer slower speeds than a fibre to the premises rollout, it would allow the NBN to be upgraded at a later date, if demand turned out to be higher than anticipated.
The authors of the CBA modelled the net benefits of having the ability to upgrade later if required, under a multi-technology mix rollout, instead of building full fibre to the premises capability upfront. Figure 2 presents the value of the multi-technology mix rollout over and above the fibre to the premises rollout if:
This analysis demonstrated two important things:
Based on these results, the CBA concluded that:
Overall the [multi-technology mix ] MTM scenario has significantly greater option value than the [fibre to the premises] FTTP scenario. The MTM scenario leaves more options for the future open because it avoids high up‐front costs while still allowing the capture of benefits if, and when, they emerge. It is, in that sense, far more ‘future proof’ in economic terms: should future demand grow more slowly than expected, it avoids the high sunk costs of having deployed FTTP. On the other hand, should future demand grow more rapidly than expected, the rapid deployment of the MTM scenario allows more of that growth to be secured early on, with scope to then upgrade to ensure the network can support very high speeds once demand reaches those levels.
John Maynard Keynes is often credited with saying “When the facts change, I change my mind. What do you do, sir?” In fact, the actual source of this quote was not Keynes, but Paul Samuelson, another famous economist.
Regardless of who actually said the words, the sentiment behind them makes intuitive sense to most of us. We do not go through life following a perfect linear path, regardless of what life throws at us. We adapt our plans as circumstances change because doing so makes us better off.
Commercial and government investment decisions are much the same. Yet, standard NPV analysis and CBAs used to appraise such investments typically ignore the value that can be gained from changing the investment strategy in response to new information. This can result in the value of investments—particularly those that are long-lived, exposed to significant future uncertainty and involving large sunk costs—being mis-estimated. This, in turn, can lead to suboptimal investments being selected, at significant cost to shareholders or taxpayers.
ROA addresses this problem by quantifying explicitly the value of flexibility, and allowing identification of optimal investment strategies, thereby improving decision-making.
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The Competition Commission of India (CCI) recently unconditionally cleared Facebook's acquisition of a 9.99% stake in Jio Platforms through its subsidiary Jaadhu Holdings LLC. In addition to this investment, the acquisition involved a strategic tie-up whereby JioMart would use WhatsApp as one of the communication channels for its retail business.
The CCI examined many theories of harm. In relation to horizontal concerns, the CCI examined overlaps in consumer communications apps and online advertising. In relation to vertical concerns, the CCI explored leveraging issues in the e-commerce space and electronic payment mechanisms, and analysed whether the parties would have an incentive to deviate from net neutrality. The CCI also considered whether there would be any adverse effects resulting from data sharing between the Parties. The CCI concluded that the combination was not likely to have any appreciable adverse effect on competition in India on any of the above theories.
A team from Frontier Economics (Europe) and Frontier Economics (Asia-Pacific) advised Facebook on the economic aspects of the competition clearance. The team was led by Director David Parker, with Martin Duckworth, Carlotta Bonsignori, Eleanor Monaghan and Monica Gambarin from Frontier Economics (Europe) and Warwick Davis from Frontier Economics (Asia-Pacific).
The Competition and Consumer Commission of Singapore (“CCCS”) has issued its findings and recommendations for its market study on e-commerce platforms. The market study focused on gaining an in-depth understanding of e-commerce platforms that compete (or potentially compete) across multiple market segments offering distinct products and/or services.
The study also analysed potential competition and consumer issues which may arise from the proliferation of such e-commerce platforms.
Frontier Economics (Asia Pacific) was appointed to undertake a consultancy study for the CCCS. This study formed a key input for the CCCS’s findings and conclusions. Our work consisted of a consumer survey, focused interviews and an economic analysis of the emerging literature on digital platforms and its application to e-commerce activities.
While no specific competition problems were identified in the course of the market study, further analysis of theories of competitive harm relating to competition in multiple markets was undertaken. The CCCS consequently elected to update some of its key guidance documents, including competition guidelines relating to market definition, mergers and abuse of a dominant position.
With respect to consumer protections, our analysis highlighted that many e-commerce platforms had developed consumer trust, as this was a critical part of platform success. However, the Frontier Economics consumer survey did highlight concerns with unfair consumer practices in online markets, and the CCCS has proposed further information dissemination and commitments from key e-commerce platforms to better inform sellers on their platforms.
The full report is available at: https://www.cccs.gov.sg/resources/publications/market-studies
The GCR Live Interactive 2020 conference was held in Singapore and virtually on 4-5 September, 2020.
Philip Williams participated in a panel discussion, "When antitrust, consumer protection and data protection laws collide” and these notes were presented as part of the session.
The National Transport Commission has released the consultation regulation impact statement for reforms to the Heavy Vehicle National Law.
The Heavy Vehicle National Law regulates the use of heavy vehicles on roads. Its purpose is to ensure that heavy vehicles and their drivers are safe and that they operate on suitable routes to minimise public safety risks.
The reforms being considered aim to improve heavy vehicles’ access to roads, vehicle roadworthiness and safety and the management of driver fatigue. Refinements to the supporting assurance regime and regulatory tools are being considered along with reforms to enable greater use of technology and data for compliance purposes.
The National Transport Commission is now seeking formal submissions on the Consultation regulatory impact statement. They aim to finalise the policy options for ministers’ decision in the first half of 2021.
Frontier Economics assisted the National Transport Commission to draft the consultation regulatory impact statement and assess the impact of the policy reform options being considered.
Frontier Economics advises clients in the transport sector on a range of economic issues.
Two separate mergers that Frontier Economics advised on have been cleared by the Australian Competition and Consumer Commission (ACCC).
The ACCC will not oppose Australian Finance Group Ltd’s (ASX:AFG) proposed acquisition of Connective Group Pty Ltd (Connective). AFG and Connective are both mortgage aggregators, which act as intermediaries between mortgage brokers and lenders, such as banks.
The ACCC found that the AFG and Connective compete closely with one another and that the proposed acquisition will create the largest mortgage aggregator in Australia. However, the ACCC cleared the proposed acquisition because they found that other established aggregators, including Finsure and the aggregators owned by the National Australia Bank, are likely to continue to provide strong competition. Frontier Economics assisted lawyers for AFG in drafting their submissions to the ACCC.
The ACCC will not oppose Lumibird’s proposed acquisition of the Lasers and Ultrasound Business of Ellex (ASX:ELX). Lumibird and Ellex supply ophthalmic lasers and ultrasound equipment for the diagnosis of eye conditions in Australia and globally. Both companies export products throughout the world and Ellex is the clear market leader in Australia. However, the ACCC found that Lumibird’s acquisition of Ellex would only slightly increase the market share of the combined business and cleared the acquisition. Frontier Economics advised lawyers for Ellex.
Frontier Economics regularly advises clients on competition matters.
The Australian Competition and Consumer Commission has opened up consultation on its draft bargaining code between digital platforms and news media.
The bargaining code arises from the digital platforms inquiry, completed in 2019, and looks to address issues of power between the two groups in negotiating payments for content. In particular, the digital platforms considered are Google and Facebook, while the news media covers all media organisations providing news to Australian services.
The concepts paper sets out 59 questions it is seeking input on, with submissions required by 5 June (a brief 14 working days consultation window). The consultation questions pose range from the definition of news to be covered under the code, to issues around bargaining, use of user data, and the way the digital platforms algorithms operate.
The ACCC anticipates it will release a draft mandatory code for public consultation in late July 2020. With digital platforms attracting attention from regulators around the world, it is likely that Australia’s response will be of interest as one of the first regulators to take action in this particular area.
Frontier Economics regularly advises clients on issues in telecommunications, media and digital platforms.
Economists are usually sceptical of governments getting into the business of owning and running commercial firms. Governments face complex and competing objectives, and this rarely leads to good outcomes. The experience of Air New Zealand in the 2000s, however, suggests that bad outcomes are not a given. If the Queensland Government acquires a stake in Virgin Australia, could it learn from the nationalisation of Air New Zealand? And could those insights have any broader relevance to Australia in the wake of the COVID-19 pandemic?
On 21 April 2020, Virgin Australia—Australia’s second-largest airline—announced that it was entering voluntary administration. It was dubbed “Australia’s first big casualty of the coronavirus pandemic.”[1] Whilst it was true that the economic and travel shutdowns caused by the COVID-19 crisis had a devastating impact on its revenue streams, in reality Virgin Australia had been in trouble for some time. The company had posted large losses of $90 million or more in every year since 2013, and by 2020 was groaning under the burden of over $5 billion in debt.
In late March 2020, Virgin Australia had approached the Federal Government for a $1.4 billion loan but was rebuffed. Its major shareholders—many of whom were themselves airlines facing financial strain as a result of the global pandemic—also refused to inject new capital into the business. By early April, as it became clear that the airline was nearing collapse, many urged the Federal Government to take an ownership stake in the company to rescue the failing airline. The main arguments for doing so were firstly to maintain a viable competitor to Australia’s largest carrier, Qantas, and secondly to save thousands of jobs.
Whilst the Federal Government showed no interest in nationalising Virgin Australia, on 13 May 2020 the Queensland Government announced its intention to bid for a direct stake in the company via the Queensland Investment Corporation (QIC). Whilst the Queensland Government has indicated that its ownership of Virgin Australia would be at arm’s length through QIC, it has also made clear that its interest in the airline is motivated in part by wider policy considerations. For instance, the Queensland Treasurer has stated that:[2]
My number one focus as Treasurer is to retain and create jobs for Queenslanders, particularly as we move beyond the COVID-19 crisis.
We have been very clear. Two sustainable, national airlines are critical to Australia's economy. We have an opportunity to retain not only head office and crew staff in Queensland, but also to grow jobs in the repairs, maintenance and overhaul sector and support both direct and indirect jobs in our tourism sector.
Partial or total government ownership of airlines around the world is not rare. Some of those carriers are very successful commercially—Emirates and Singapore Airlines, to name just two. Others, however, have lamentable track records of safety and financial performance. For example, Air India, which is currently 50% publicly-owned, has accumulated losses over the past decade topping an eye-watering AU$14 billion (Rs696 billion).[3] When the Indian Government tried to sell its stake in the airline in 2018, not a single bid was received.[4]
A benefit of public investment is that the government can take into account broader social costs and benefits. In the short-term, there might be some (net) benefits if investment can (i) deliver short-term financial stability (ii) preserve competition or (iii) maintain transport links that would otherwise be severed if a major airline were to fail. Transport links are essential to economic activity and losses of links can be very detrimental to communities.[5]
A key issue here is the counterfactual (the state of the world without the government investment). It might be possible to create a positive net impact on economic activity, particularly if the counterfactual is no service at all. In the short-term, this might require capital injections and financial stability, which only the government may be able or willing to provide in a time of crisis.
The benefit of government investment can also be its greatest weakness. By introducing objectives other than purely commercial objectives, it can destroy rather than create economic value—by allowing inefficiency to creep in. This means that taxpayers, who did not have a direct say in whether their money should be invested in the enterprise, may not get the best return on that investment.
Such problems may be manageable in the short run. However, the longer the government remains an investor, the greater the risk that such conflicting (and vested) interests may arise.
So, if the Queensland Government is serious about taking an ownership in Virgin Australia, how can it ensure that its investment delivers the potential benefits outlined above, rather than the disadvantages?
One standout success story of government investment and ownership of an airline is Air New Zealand. In 2001, like Virgin Australia, New Zealand’s national carrier was on the brink of collapse. It had expanded aggressively throughout the 1990s into Asia and Australia, culminating in the full acquisition of Australia’s second-largest airline at the time, Ansett Airlines, in 2000.
Ansett was a larger company than Air New Zealand and required significant equity injections to upgrade the safety of its fleet. Ansett also faced growing competition from Qantas and Virgin Australia (which was known as Virgin Blue at the time). Unable to control ballooning costs, Ansett folded in September 2001. Air New Zealand posted a loss of NZ$1.425 billion for the year to June 2001, including an asset write-down of NZ$1.32 billion relating to Ansett. This led to Air New Zealand’s credit rating being downgraded to ‘junk’ status,[6] and its share price fell by over 80% between late August and late September 2001.
In October 2001, the New Zealand Government took an 82% ownership stake in the company at a cost of NZ$885 million. Over the next decade, Air New Zealand set about reorganising and improving its business model. The company returned to profitability in 2003, and posted a net profit after tax of NZ$290 million in 2019. Between October 2001 and December 2019, the total returns delivered by Air New Zealand stocks increased by nearly 12%, outperforming the New Zealand stock market (see Figure 1). In November 2013, the Government sold a 20% stake in the company, gaining NZ$365 million, leaving it with a 53% share.[7]
Figure 1: Air New Zealand and NZX50 total returns
By almost any measure, the New Zealand Government’s intervention to bail out Air New Zealand has, with hindsight, turned out to be a success. The injection of much-needed capital stabilised the business. Moreover, knowledge that an investor with very deep pockets was now standing behind the airline gave other investors, including lenders, greater confidence in the company.
However, the real secret to Air New Zealand’s recovery was a change in the way the business was managed and governed.
A new Board and management team was appointed, following the public acquisition of Air New Zealand. The new CEO, Ralph Norris, accepted the role on a number of conditions. The first of those was that the Government should stay out of operational decisions. Norris has stated that:[8]
We can't divorce business from the community. But that doesn't mean we should be any more obligated than any other commercial organisation in the country.....My job is to get on and run the business commercially - not as an arm of social policy. I wouldn't have taken the role if I'd seen Air NZ as an arm of Government. I'm here to steer this company around and I believe the relationship between management and the board will be good one.
This freedom from government interference allowed Air New Zealand’s management team to overhaul the company’s business model. The company adopted a low-cost airline model for domestic and trans-Tasman flights, relaunched a more focussed long-haul business and invested heavily in improving customer service.
The new management also reduced staff numbers significantly, and negotiated lower pay for remaining staff, in order to bring costs under control and return the company to profitability.[9] It seems unlikely that such restructuring would have been possible if the Government allowed itself to intervene in operational decisions.
The Government was explicit when it took an ownership stake in Air New Zealand that it did not intend to remain a long-term investor in the business. For example, the Finance Minister at the time, Dr Michael Cullen, stated in parliament that:[10]
…any investment by the New Zealand government in Air New Zealand will ensure that there is effective control for a period in time but it will be subject to a clear message that the government does not see itself the long term shareholder in the company.
This meant that the Government was motivated to ensure that Air New Zealand would return to profitability quickly, and deliver as high a commercial return to taxpayers’ investment as possible. This clear objective made it possible for the Government to step back and allow the business to be run commercially. This appears to have been a successful approach even though the Government has ended up being a longer-term shareholder.
Another ingredient in Air New Zealand’s winning formula was that it remained a publicly-listed company. One of the most important benefits of being a publicly-listed firm is the availability of a stock price that embodies the market’s sentiment about the value of the business. If the market considers that the firm is performing well, the price will increase. However, if the market thinks that the firm is performing badly, the price will fall.
In Air New Zealand’s case, the availability of a share price would have given the Government a clear idea of what it could sell its shares for. But it also provided an important market discipline: Government intervening in the operations of the business in ways that may destroy value would be clearly visible.
Moreover, many of the owners of Air New Zealand’s listed shares were mum and dad investors, who also happened to be voters. Any meddling by the Government that destroyed value to those investors would not have been viewed favourably, come the next election. This was perhaps another factor that helped restrain any temptation by the Government to intervene in a non-commercial way.
The COVID-19 pandemic has created unprecedented economic challenges for businesses in Australia and elsewhere. Now more than ever, governments may feel pressure to intervene by taking stakes in struggling firms that are viewed as somehow essential to the public interest. The airlines industry—and the story of Air New Zealand in particular—shows that government intervention of this kind need not destroy economic value.
The benefit that government investment or ownership brings, apart from major capital injections, is the ability to restore confidence to other investors that standing with them is a large, well-resourced investor who also has some skin in the game. This can be invaluable in restoring stability during a crisis.
The big risk with government investment is that this new, large investor will be motivated by considerations other than maximising returns—such as winning the next election—and that this investor will use its clout within the business to pursue non-commercial objectives that ends up destroying value.
The Air New Zealand case shows that if a government:
then public investment can produce outcomes that benefit taxpayers as well as other investors. While there are no guarantees of success, the Queensland Government may well be serious…and don’t call them Shirley!
[1] BBC, Virgin Australia slumps into administration, 21 April 2020.
[2] Financial Review, 'Project Maroon': Queensland breaks cover in Virgin race, 13 May 2020.
[3] Business Today, Air India net loss at all-time high of Rs 8,550 crore in FY19, says aviation minister, 5 December 2019.
[4] The Hindu, Now, govt goes for 100% stake sale of Air India, 28 January 2020.
[5] See, for example, Frontier Economics, Airlines: Helping Australia’s economy soar, 9 September 2019.
[6] CNN, Air NZ hits back over Ansett collapse, 17 September 2001.
[7] Sydney Morning Herald, NZ government sells 20% of Air New Zealand for $324 million, 20 November 2013.
[8] Management New Zealand, Unfinished business: Why Ralph Norris is flying Air NZ, 4 April 2002.
[9] It was estimated at the time that 800 of Air New Zealand’s 9,300 staff would need to be made redundant in the first round of restructuring. New Zealand Herald, Job losses likely to hit 800 in Air NZ cutbacks, 9 October 2001.
[10] Response to parliamentary questions by Dr Michael Cullen, 3 October 2001.
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