Economic impacts on the contracting industry

Phil O’Reilly, CEO Business NZ, address to Contractors Federation

4 August 2005

Thank you for the invitation to talk to you today on the subject of economic impacts on the contracting industry. I’d like to touch on the issues of lack of investment in infrastructure, the impact of the economy generally, and resource management and energy issues.

A problem that you and I share is that of under-investment in infrastructure. It’s a problem for the contracting industry that would hope to build the infrastructure. And it’s a problem for the business sector that I represent, because business and a healthy economy require good infrastructure.

To give you an idea of its importance – this is Business NZ’s Seven Pillars of Growth – the seven policy areas that we think New Zealand has to get right, in order to improve our health and wealth. Infrastructure is the first pillar: “Business NZ’s vision for NZ’s infrastructure is a first world nation with world-class, well-maintained infrastructure assets.”

We have indicators that go with it, to show how we’re doing at realising the vision.

Here’s one for roading infrastructure: Expenditure on roading as a percentage of GDP – we would like an increase in the medium term, then for it to remain reasonably constant at a level similar to other developed nations

And here’s one for energy infrastructure: Percentage of growth in GDP per energy input – this indicates the level of efficiency in energy infrastructure – we would like to see the percentage rising over time.

Infrastructure is absolutely crucial for a properly functioning economy. And the right attitude to infrastructure is important too. I’ve just returned to New Zealand after a few years living and working in Australia and I have to say the difference in attitude between Australia and New Zealand is quite marked.

Last year, when the rail line between Adelaide and Darwin was completed, there was an amazing celebration of the achievement. A specially painted train did the inaugural journey and people turned out at every stop along the way to cheer it on, the Prime Minister was there, the media were there, kids got the day off school to see it pass through their region – it was a great celebration.

I wonder if we would celebrate a big project in quite the same way.

Here’s another example. The State of New South Wales has a new Premier – Morris Iemma - to replace the retiring Bob Carr. In yesterday’s newspaper, here’s the first thing Iemma said – he was going to abolish property vendor tax, and he was going to promote infrastructure development. “I want New South Wales to be the state where investment is rewarded,” he said.

He said he was committed to infrastructure spending so that New South Wales remained the economic powerhouse of Australia. He said he would establish a specialist unit to coordinate infrastructure projects, including rail, water and hospital construction – “It will set milestones, benchmarks and targets. Where the targets are not being met, the unit will have the power to pull all those responsible together to ensure the project is delivered.”

What a fantastic attitude!

The Council for Infrastructure Development has calculated that the amount of investment required for our infrastructure needs equates to around 5 per cent of GDP per year – somewhere around six billion dollars. It points out that any fiscally responsible government can only inject around 2 per cent of GDP per year – so the need for the private sector to work collaboratively with the government is clear.

But in many cases the private sector is either discouraged or blocked from investing in New Zealand’s infrastructure.

Roading, for example. We could be speeding up the pace of getting new roads, using private sector investment, and allowing them to operate tolling for them to recoup their investment. Tolling is a perfectly legitimate undertaking. It’s the logical way of funding long-lived assets because it means future users pay as they use them, rather than free- riding on previous generations’ investment.

There’s widespread acceptance of the practice. Yesterday’s announcement that the Government would allow a toll-funded bridge for Tauranga came as a result of polling the residents of Tauranga, 70% of whom wanted a toll bridge now, rather than a free bridge later. Congratulations to the Government for this decision – until now, the Government has been very wary of such initiatives.

The BOOT system, for example, where a private operator builds a road, operates it for a while, using tolls to recoup costs and make some profit, and then transfers the road back to state ownership – that’s a great public-private partnership model.

But the Land Transport Management Act that the Green Party had such a hand in makes it very difficult for BOOT projects to be approved. The Act imposes quite onerous consultation requirements and strict limitations on the length of time the tolling can operate. It requires Ministerial approval for all toll operations, making the process susceptible to political decision-making. And for a toll operation to be approved, there has to be an alternative, untolled route. This is a bit of a catch-22 – because the whole reason for using tolling in the first place is because there isn’t a road there!

These are all areas that Business NZ advocated on when the legislation was being drafted, and we will continue to put forward our views on this issue with a view to getting the legislation changed.

Another problem with total government ownership and control of roading and other assets is that upgrades and improvements tend to happen in a less than optimal fashion. Governments tend to view infrastructure assets as cost centres, and approve capital investment in a way that’s often too little too late.

Government over-control affects maintenance too – because the government tendency is towards funding cycles that are too short, with separate funding streams for building and maintenance. That means frugal capital stretched too thinly, with higher maintenance needs downstream.

You are the experts here – and I’d like to hear your views on this – but wouldn’t we do better with integrated funding?

By bundling capital and maintenance into a single contract, using a single contractor, and fixing both the capital and maintenance costs into a known future cash flow – surely the contractor could then balance the capital and maintenance needs to get the best outcome.

Under-investment has also been a major reason for the inadequacy of our electricity infrastructure.

Over the last twenty years there’s been a series of decisions – by both National and Labour Governments - that have blocked the investment needed for future power supply.

Starting in 1984, when the incoming Labour Government opened the books, it found generating capacity that would be inadequate by 2005, and a fiscal deficit that meant the taxpayer couldn’t possibly fund around 14 billion dollars worth of new generation plant. The Government didn’t have the creditworthiness to cope, so it began to separate the assets off for sale.

In the separation, the Electricity Corporation got all the good hydro stations at an undervalued price. That was the first disincentive for private investment in hydro generation.

Then when National was in power, in 1996 ECNZ was split into ECNZ and Contact Energy. Again ECNZ got the best bits and Contact got the rest. The idea was that any new entrant wouldn’t have to compete with the might of the ECNZ generators, but only with the marginal price of Contact. But no new entrant materialised – so no new investment.

Then Contact was privatised and ECNZ further split – but that was bungled too because the bits of ECNZ got locked together on a regional basis, leading to three big SOEs that

are still regional monopolies. Again, not a situation that would entice private investment in the sector.

There were several points along this 20-year history where good decisions could have been made to promote private investment in electricity assets – but unfortunately they didn’t happen, and that’s had a severe impact on business.

The chickens came home to roost in the big winter drought of 2001 that led to extremely high spot prices for businesses. It wasn’t a problem for residential users locked into contracts with the SOEs; it wasn’t a problem for the SOEs that were making bumper profits; and it wasn’t a problem for the Government that was getting record dividends from the SOEs. But it was a real problem for many small businesses that couldn’t afford either the hedging or the spot prices of electricity and in some cases had to shut down production lines, losing orders and profitability as a result.

A sector where the Government is getting record dividends from its SOEs off the back of an extended business crisis – that’s a sector that clearly needs more private investment.

Now, when we talk about under-investment, we’re open to the charge that past and present governments have, in fact, approved billions of dollars for infrastructure. That’s quite true. The Government has made some substantial allocations recently that are well appreciated.

But the unfortunate thing is that a lot of it doesn’t get spent. A couple of years ago Transfund had around 250 million dollars sitting unallocated. This year, Land Transport NZ is projecting a surplus of more than 150 million dollars.

A lot of the blame for that has to be sheeted home to the land Transport Management Act and the Resource Management Act – two pieces of legislation that require over-the- top consultation and put obstacles in the way of sensible, much-needed development.

The RMA in particular, has increased the time taken to gain consents, even for straightforward, non-controversial roading projects, to seven years or more. You and I know what the issues are:

- consultation requirements
- trivial or ideological appeals
- inconsistencies between local authorities in the way they handle consents.

There are also problems with some of the fundamental definitions and wording of the RMA. Its definition of ‘environment’ contains all sorts of woolly references to aesthetics and cultural and spiritual matters that are hard to reach concrete decisions over. The fact that it’s focused on ‘sustainable management’ rather than ‘sustainable development’ means that development is downgraded, making it harder to get development projects through.

Probably of most concern to you is the fact that minor adverse effects are able to outweigh substantial economic benefits in projects of national significance – making it harder to get large national developments approved.

These are all issues that Business NZ has consistently advocated on – and will continue to do so.

If you were listening to Parliament yesterday, you would have despaired of an early resolution to these problems however. Here we were on the last sitting day before the election, rushing through an RMA amendment that most MPs clearly didn’t understand, with no select committee scrutiny, and a 36-page supplementary order paper they’d just received, with no time to read it – not the best example of law-making. The MMP system, with multiple parties’ conflicting views of resource management, is probably hampering investment decisions more than any other legislation.

Touching very briefly on some of the other economic impacts on the contracting industry, I guess you’d have to say that energy costs are looking problematic. Being a signatory to the Kyoto Protocol means carbon taxes from 2007 – and that will mean large increases in costs for fuel-intensive industries.

The Kyoto Protocol will affect infrastructure development because we won’t know what our energy costs will be out into the future. That will put us at a disadvantage when competing with other countries for investment – competing with Australia, for example, where energy costs will be known with reasonable certainty.

And finally, the economy itself – the fundamental impact on everyone’s business. Our economy is affected by a myriad of policy decisions on tax levels, on employment- related law, on investment in education and skills, and others. Where we are coming from at Business NZ is trying to influence the government, the bureaucracy and other decision-makers, to achieve an environment for doing business that allows our businesses to be internationally competitive. That’s really important, because our wealth must fundamentally come from exporting, since we have too small a population to, on its own, drive a growing economy.

That environment affects the smallest business right through to the large ones that are reflected in your membership – and we want to get it right. It’s good to know that we are in agreement on the major issue of investment in infrastructure, and you can rest assured that we will advocate on that issue as strongly as we can.

ENDS

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