Water markets in the Murray-Darling Basin

The best bit of Per Capita’s ‘market design’ conference proved to be the case studies of public markets in Australia, rather than any gems about market design per se. One of those related to water markets operating in the largest surface water system in Australia, the Murray-Darling Basin. Straddling five jurisdictions, the basin carries water from the Murray and Darling rivers over an area equivalent to the combined size of France, Germany and the UK. Water shortages here are not a new problem by any means but have got much more extreme in recent years with:

• Reduced rainfall: rainfall in the last five years has been around 10% of the historical average;
  


• Changed rainfall patterns: with rain falling in different seasons the traditional autumn rainfall over the Murray-Darling Basin has disproportionably fallen;
  


• Over allocation of water rights: which were based on assumptions of higher trend rainfall and lower levels of land utilisation; and
  


• Higher temperatures: with three of the last five years having broken temperature records there has been increased evaporation.
  

How does the market work?

• A new inter-governmental organisation called the Murray Darling Basin Commission has been established to oversee water use: this brings together six governments (the Commonwealth plus Queensland, New South Wales, Victoria, South Australia and the Australian Capital Territory). Beneath this is a highly complex governance arrangement – each can send three Ministers to the MDBC’s Ministerial Council and a further two as MDBC Commissioners.
  
  
• State-level caps on diversions: which prevent upstream States unfairly diverting water, or building dams to reduce flow. (These first came into existence in the mid 1990s.)
  
  
• Inter-state water trades: the six governments are able to trade water rights using fixed exchange rates determined by the MDBC (or by individual states if transparently reported to the Commission).
  

Where’s it all at?

The market is still in very early development and the region remains in a semi-crisis state. Nonetheless it already appears to be triggering some of the innovation and efficiency adjustments you’d expect. For example, there’s been a recent shift in economic composition in the basin, with an increased value of wine production (a falling quantity effect being more than offset by rising quality). There’s also been a shift in use of water as a factor of production with dairy farmers trading their water rights and importing animal feed rather than growing within the basin region.

Where could the market go next?

As the market evolves it could employ a few further features:

• Leasebacks: where one entity buys the rights and then leases back some of the allocation to the user. This would be a good way to spread risk and reduce transactional economies of scale.


• Covenants: this would permanently transfer the environmental rights. Indeed this is happening in part through a Federal buyback scheme worth $10bn.


• Future and options exchange: this would allow for trade of water (and future water rights) in the same way in which that oil exchanges work. So instead of an ‘exchange rate’ you’d get spot prices. For this to work you’d need a fair degree of depth in the market – both buyers and sellers.

I don’t know enough about environmental economics to fully appraise the emerging market here, nor know if there are better examples elsewhere, but it strikes me as a potential good case study for water rights issues occurring in much more extreme environmental and governance circumstances such as the Nile Delta region.

Learning the wrong lessons from crisis

One of Australia’s leading progressive think tanks, Per Capita, are holding their annual conference in Brisbane this week. It’s on ‘market design’ – in other words when, where and how to use markets to help deliver government services. It comes at a really unfortunate time though as politicians of all colours scramble to find fault with ‘markets’. Take for example Sarkozy’s recent “laissez-faire capitalism is over” speech, or the line No. 10 pushed that Brown long ago warned us that markets fail.

It would help to distinguish between at least three broad types of markets: financial markets which trade risk; goods and service markets which trade products between businesses and to households; and public service markets which provide government funded services but are not necessarily managed by government agencies (and could for example be run for profit).

Even such a simple definition shows how silly the politics has already got. When Sarkozy talks of the end of capitalism he’s beginning to slide into the goods and services territory – and to industry protection and state support policy. Even more bizarrely, the recently-dug-up speech which Brown gave at the SMF in 2003 is very much focused on the use and limits of markets in public services and is not a general theory of markets. (Amusingly it also talks a lot about the problem of state failure replacing market failure, a risk probably rising in significance daily.)

This ‘contagion’ effect is unfortunate: the financial crisis has some very specific and technical causes and shouldn’t lead us to hasty conclusions about the operation of goods and service markets (and junking long established competition policy) nor about public service markets (and putting unnecessary brakes on bringing the benefits of markets into public services when and where they can add value). In so far as there are general lessons about markets to be found from the financial crisis it’s the importance of good information for them to work effectively and of careful ‘agent-design’ (e.g. that the bank knows who the ‘right’ people to lend to are, and there’s no third party ready to benefit from misselling). But we knew all this already and the three broad market types I described each have specific features and come with very detailed theory as well as evidence and practice in how they work.

Perhaps it’s a good example of how societies – and politicians – respond to crises:

• We have to find historical precedence: so the current economic crisis is rivalled only by the Great Depression of the 1930s. (Actually it’s a poor comparison: we remember the Great Depression for the one in three who became unemployed and the almost half pushed below the poverty line, a human consequence that the current problems will have nothing to compare to, and not the fall in stock values.)
  
  
• We must all somehow be affected: perhaps this is some sort of solidarity effect, or maybe that people are perversely jealous of the attention a crisis gets. But it’s amusing that almost everyone is trying to claim relevance to the credit crisis at the moment. I’ve lost count of the number of times I’ve recently heard policy makers say things like “in the current turbulent times [environment/ social/ education/ insert random policy area] is now more important than ever”. Why don’t we just let the macroeconomists have their moment in the limelight and acknowledge that constitutional reform or what’s in the school curriculum isn’t the most pressing issue right now?
  
  
• Something must be done: we have to find the general lessons and apply them in all forms and in all places. So we get an equal and opposite reaction with for example politicians getting lukewarm on markets in public services. This is also a particularly common response following disasters whether natural or man-made with disproportionate reactions like with health and safety measures that represent extremely poor levels of cost-effectiveness.
  
  
• Obfuscation and denial of the root cause: a sensible reaction would be to say something’s gone wrong with (parts of) financial markets therefore we need to (1) stop this from worsening (2) limit the consequences elsewhere (3) reduce the chance of this happening again. We’re close to doing (1) now and attention is beginning to shift to doing (2) and (3) through fiscal measures and regulatory and banking reform. This will expend enough political time and effort without trying to fix all other areas of life with some element of market in. Arguably, even talking about the failure of ‘financial markets’ is far too loose a description – it is only some elements we now have problems with that will require fixing (e.g. subprime mortgages, derivative swaps) and the rest is effect on rather than cause of.
  

Anyhow I’ll be listening closely at the conference to whether (and for how long) each speaker drones on in generalities about the financial crisis and attempts to make convoluted links to other areas. I suspect the politicians will be the worst offenders...

Income inequality

Interesting paper on income inequality out this week from the boffins at OECD. Particularly worth playing with the data in the graphical package Gapminder.

The main findings include:

• Income inequality rising since the 1980s in all countries along with increased social spending to offset it. This suggests if governments start to ‘let loose’, or fail to target poverty-reducing spending, income inequality will accelerate further.
  
  
• Income inequality rising since 2000 in countries like the US and Germany but falling in the UK and Australia. I tested this out on the historical data plotting poverty against social spending since the 1980s. Each bubble represents a year; I’ve added the green lines to highlight the change in most recent years. Of the four, the US has the highest rates of poverty, then Australia, Germany and the UK. Germany and the UK have traded places with a radical drop in poverty in the UK in recent years and coinciding rise in Germany. The UK’s cut appears to have cost an additional 3 percentage points of GDP on social spending; Germany’s rise has been while social spending has been pretty constant (presumably feedback from the structural and higher unemployment they’ve suffered in recent years).
  
  


• Getting more people in work is – unsurprisingly – found to be one of the major ways to reduce poverty, although capital inequality is now more significant in the past. This must be particularly so for those house buying, share-owning Anglo-Saxon economies.
  
  
• Growth and poverty is a more mixed story. The US and Australia have been growing but with rising inequality in recent years (albeit Australia from a much lower base). The UK has been growing but with sharply falling rates of inequality (albeit still higher than Australia).

Focusing solely on the Australian and UK trends for a second this does go some way to explaining in general terms where the two currently differ in political trends. The UK has cut poverty and inequality but the rising social spending this has cost is probably coming to an end and seems to have - for the present at least - maxed out taxpayers' willingness to spend. Meanwhile, Australia has had a long period of rapid growth, though the public now appear more willing to countenance higher spending on social security and public services to improve equity and fairness. I guess we'll find out what the US electorate think very soon...

Australia's $10.6bn rescue package

Kevin Rudd this evening addressed the nation to give details of his $10.6bn ‘rescue package’. It is basically a massive fiscal stimulus package:

• $4.8 billion for an immediate down payment on long term pension reform;
  
• $3.9 billion in support payments for low and middle income families;
  
• $1.5 billion investment to help first home buyers buy a home;
  
• $187 million to create 56,000 new training places in 2008-09 (comment: small beer relative to the other items); and
  
• Acceleration of the implementation of the government's three nation building funds (education, health, infrastructure).
  

Benefits will start coming on line from early December with single pensioners receiving a lump sum payment of $1,400, pensioner couples receiving $2,100, and people receiving the carers allowance $1,000 for each eligible person in their care.

The rescue package comes on top of the guarantee over the weekend for 100% of bank deposits and is sourced from the c.$20bn surplus in the recent budget.

A good way to blow $10bn?

If a surplus ever was going to be drawn down now is probably the right time. What’s currently a credit crisis is soon going to become a nasty and lingering business recession here and elsewhere so an early inoculation against the downturn may be a good idea. IMF forecasts for Australia are for an economic slowing, although notably not the zero per cent growth facing many other OECD countries. Australia's well regulated banks also are generally in good shape so the landing is going to softer here than at home and this package may help ensure that's even softer and for worse off groups. $10bn is also not a huge amount of money in the scheme of things (c.1% of GDP) so it could be seen as a sort of insurance policy in uncertain times.

On the other hand there should be a few questions asked:

• Is it the right time to try and target a fiscal package? We’re in the eye of the storm of a credit crunch at the moment. Sure, the ‘real’ effects will land in due course in a business recession but what would be the cost of waiting another week or so to have a better idea of where markets are heading? The key to fiscal packages is ensuring they land at the right time and we'd have a better idea of when that might be in even a few days' time. Of course the timing is more about the politics but they'd be other ways to manage this (e.g. signal the size of the package but announce the timing in the next few weeks).
  
  
• Has there been sufficient time to fully think through? Perhaps they’ve been thinking about this for a long while and there's been some rigorous analysis. But I suspect not: and spending $10bn warrants serious examination to get it right.
  
  
• Is it appropriate targeted? The package is partially targeted but not completely – for example to all pensioners. If Australia’s income distribution is anything like the UK’s this is not a good way to tackle the potential poverty effects that Rudd says it is designed to – pensioners have the highest levels of income variance of any group.
  
  
• Some bad spending items in there. $1.5bn for first time buyers is more good money after bad.

Meanwhile, over in Blighty, Gordon seems to be getting some good headlines e.g. 'Gordon Brown has saved the world's financial system, says economics Nobel Prize winner' from today's Daily Mail as both Europeans and Americans copy elements of the British plan.

Subprime explained...

Bit off topic for the blog but in lieu of a regular article here's a highly amusing primer to the subprime market I saw today.

Affluenza

I met with the authors of the Australian book ‘Affluenza’ recently.

What’s the book about?

The argument is a familiar one. The Western world is in the midst of a consumption boom – we’ve never had it so good with seemingly unlimited availability of new goods and services to meet our wants and desires. We measure and define our progress on GNP indicators of economic growth. Yet, there’s little evidence we’ve become happier for it (see chart below). Indeed rates of depression and stress continue to rise. And meanwhile we run down the world’s resources at an alarming and unsustainable pace.

It’s trendy to think this is something new that humankind has hit on. It’s not – it goes back at least as far as the Epicurean school in 4th century BC ancient Greece. Of course, the lines of argument have evolved and changed since but the fundamental question about the relationship between material wealth and human happiness remains.

Is anything different now?

Yes, at least to some extent. First, prosperity has been growing at historically unprecedented rates since the industrial period and particularly since the Second World War. Essentially the first 6,000 years of human history were punctuated by marginal gains in wealth followed by major slumps and setbacks. So the last fifty years gives us a good opportunity to assess things.

Second, the science about what makes us happy and the evidence linking wealth and happiness has got much better. For example, lots of interesting findings are coming out of the field of neuroscience alone. Third, the sustainability trends have started to get really quite irreversible, particularly of course on climate change.

Time for a grand alternative?

This is where books and theories like ‘Affluenza’ rapidly deteriorate, as they amateurly try to create a grand-alternative narrative. It’s too easy to fall into the unthinking tradition of left-liberals from Hampstead. The consumer-orientated, economic-centric model of society won because its arguments are simple, powerful and complete. So it’s not a midnight session ‘solving the world’ over a bottle of Bordeaux, or a Hippie-like tendency to say ‘why don’t all businesses start being nice’, that’s going to make any difference. More to the point there isn’t any sufficiently robust alternative that can be systematically used for policy development. Indeed, that’s self evident in the terms of the debate – an offensive on materialism rather than promotion of a coherent set of rival solutions.

Give up and resign ourselves to a never-ending spiral of rising wealth but growing misery and depletion of the environment?

Personally, I think there’s much to be said for taking an admittedly less sexy but more focused approach to the debate. What might this involve?

First, some subtle shifts that have potential to add up to something more substantive:

• Let’s try to develop and mainstream some alternative measures of progress. The UK DEFRA’s attempt to look at wellbeing is to be welcomed even if it’s little known within Whitehall let alone beyond at the moment. Linked to this we also need some more systematic policy-testing of what the science and evidence on happiness is telling us. (We need to get over our social fear of randomised policy trials for a start).
  
  
• Reintegrate economic thought with other social sciences. The post-war debates between the likes of Milton Friedman and Ludwig von Mises against the Keynesian and Galbraithian schools were not just about what the right economic models were, but also how to think about economics. The legacy of which was the sad divorce of economics from other social sciences in which its roots lay (particularly politics, philosophy, psychology, sociology and geography). I think reintegrating the practice of economics with the developments of these other social sciences could start leading us some different policy conclusions – like the importance of making short-term transitionary adjustments to effects like globalisation or the value of labour market policies to reduce the harshness of tradeoffs that people have to make between work and leisure and family.
  


• Invest in community and public assets. A clear trend in the evidence is that we systematically over-invest in the individual things we think will make us happy (DVDs, clothes, cars, homes) but under-invest in some of the community and social assets that also contribute to our happiness. So it might sound old-fashioned but actually having high quality parks, civic institutions, public spaces and cultural activities is important to happiness and something government needs to initiate to overcome the free-riding problem.
  


• Teach young people some broader social and emotional skills. There’s long been an obsession with teaching the skills that most contribute to productivity. The focus on science, maths and literacy and numeracy is broadly the logical result of that. As too are political calls to meet the challenges of globalisation through developing ‘hard’ skills. All of course right in part but we shouldn’t under-value the importance of personal and social education – providing young people with the skills in order to make better choices later in life that will impact on their happiness and life satisfaction.

Second, a focus on reducing unhappiness, misery and want:

• Attack on the scourge of mental health. This was Lord Layard’s focus in his book on ‘happiness’ and there’s actually some positive developments here like the UK Government’s commitment to fund cognitive behavior therapy (e.g. see Scotland's recent initiative). I think this is only a start to tackling not just the high rates of mental illness we find today (one in six people will suffer from depression at some point in their lives) but also the attached social stigma.
  


• Prioritise health activity on long-term conditions and other ‘life-course’ ill health events. Proportionally too much health activity is on the visible, event based, and invasively-solved ill health. But, like mental health, there are 17 million people in the UK suffering from long-term conditions that materially impact on their quality of life. Getting really serious about this (and not just a few words about care planning) could have a dramatic impact on their wellbeing.
  


• Don’t surrender the fight on poverty and disadvantage. I think one of the as yet under-recognised achievements of New Labour was the shifting of the terms of debate on poverty. Admittedly, progress has been mixed (e.g. on child poverty), and in some cases has got worse (e.g. on relative inequality). But the Thatcherite legacy of implicit social acceptance of poverty in society is now in retreat. Even Cameron’s Conservatives now too have social and community policies where they would once have been unthinkable to them. The progressive left needs to continue to push the fight and not surrender this territory.

I’d meant to keep this one short but it’s already become too long and I haven’t started to do the topic justice. So I’ll stop for now and return to at another point…

An argument for consumption taxes

Australia’s Treasury has recently kicked off a fundamental review of the tax and transfer system, with publication of a discussion paper and creation of a review panel.

It’s got a pretty immense scope. On the tax side, Australia’s three big taxes are - like most OECD countries - income tax, corporation tax and consumption tax (in that order). Together these make up about 85% of total revenue, with a further 122 taxes making up the rest.

For my part I’ve long thought the left needs to get over its fear of consumption taxes and shift this up the revenue hierarchy. Why?

Here’s a quick list of 10 for starters…

1. Easy to administer: unlike many other taxes a consumption tax doesn’t need such a level of bureaucracy and administration to run.
   


2. Hard for the rich to avoid: let’s face it – it’s pretty easy to avoid many taxes if you’re wealthy enough to pay for a decent accountant or smart enough to know how to shift money into different forms or between different countries. Consumption – paid at source – is almost impossible to avoid.
   


3. Consumption is a better tracker of long-term income: while incomes used to be relatively stable over the life course, today many people’s incomes will fluctuate considerably (e.g. as people take career breaks or move between different sectors). Taxing consumption is actually a lot fairer way to pay your share over the long term.
   


4. Earned income less correlated with wealth than consumption: again, while in the past earned income formed a sizable proportion of total wealth, today unearned income (like from share investment) rising and difficult to tax. So income tax becoming relatively unfairly burdenous on middle and low-middle income earners. Consumption more closely linked to total income.
   


5. Income and corporation taxes are not the tax bases that they once were: Income tax is less useful these days as unearned income rises in proportion of wealth. In any case income taxes always a drag on productivity through their labour supply effect. And there’s strong downward pressure on corporation taxes in a global economy. Meanwhile the revenue side needs to come from somewhere.
   


6. Link between consumption and happiness weak: the line from classical economists has always been that people know best how to spend their money. I’d broadly agree but at the margins the evidence looking clearer that that marginal DVD really doesn’t matter that much to us anymore.
   


7. We need to save more anyway: Anglo-Saxon economies have long been over-consuming and under-saving. Indeed I’d argue that’s one of the causal factors driving the current downturn. A marginal shift to consumption taxes will raise the savings rate.
   


8. Possible to exempt goods for social objectives: the left always been afraid of effect of consumption taxes on the poor. But easy to exempt for things like babies clothes (which we do already).
   


9. And vice versa on ‘sins’: good evidence that price (as part of a wider package of behaviour drivers) can reduce unhealthy smoking and drinking.
   


10. There are other economic benefits to consumption taxes like their neutrality on differential investments (unlike corporation and income taxes).

Fuel Watch

Compared to Europe, Australia has relatively low taxes on petrol. Hence, prices at the pump are much more responsive to changes in global demand (or for that matter supply). So the last week has been an interesting case in what results when a reactive government meets with vocal concern from a nation of drivers. The result, it turns out, is to ‘price watch’.

Based on the experience of Western Australia, Rudd has decided to nationally rollout out a scheme called Fuel Watch. While not the only international example of such a scheme, its main feature is an obligation placed on fuel retailers to notify their ‘tomorrow prices’ by 2pm each day, which are then posted onto a consumer forum. The idea – conceptually a good one – is that when empowered with information consumers will be more likely to shop around for petrol and put downward pressure on providers.

But of course there are also some problems. First, the whole process of daily posting prices is a fairly bureaucratic affair and it’s unclear what the size of these ‘transaction costs’ might be and the extent to which they offset any gains. Second, the Australian pump market is highly dominated by a small number of major retailers so it’s unlikely marginal changes in consumer power will exert significant pressure on prices. Third, any observed price change is almost certain to be inconsequential relative to the (larger) price effect from the global economy. And fourth, to an outsider at least, it feels like a slightly inappropriate role for government to be mandating retailers to tell them the prices they’ll sell at – how is one supposed to draw the line at what consumer prices the government should or shouldn’t be regulating? (indeed it was announced yesterday that the government will also be ‘watching’ the prices of child care providers following reforms to how they are funded). Surely a rigorous compeition policy apporach is preferable to government market-monitoring?

Anyhow this has kicked off a slightly odd national debate not about the principle so much, but more the econometric evidence of whether it actually works. Unfortunately for the government in turns out not to be so effective. Although pump prices have fallen in Western Australia since the introduction of the scheme in January 2001, this also coincided with the move of a major Australian supermarket retailer, Coles, into the region. It turns out it was this move, rather than the price watch scheme, that explains the majority of the (small) relative fall in prices compared to the rest of the country.

Even more unfortunately for the government, leaked memos suggest their own officials advised them of the neutral, or even negative, effect the scheme would have. Disappointingly, the agency which undertook the econometric research for them has refused to release details of the model they actually used, or indeed even the confidence intervals for the results they produce. The political fallout has been a loss of five percentage points in approval ratings for Rudd. But with two out of three Australian’s still in favour of the Labor leader, I’m sure it’s a position Gordon Brown wouldn’t mind being in now.

The ‘big government’ budget

The Rudd Government had its first budget a few weeks ago. It was heavy on the progressive rhetoric and included a few interesting policies on education, infrastructure and housing: http://budget.australia.gov.au/

What struck me more than the announcements themselves though was the quite hostile reaction to what represented only a very marginally increased role for government. Overall, the budget increased planned Government expenditure by around one-tenth of one percent as a proportion of the total economy between now and 2010/11. Yet it was widely lambasted as a socialist budget paving the way for an era of big and bloated government. Of course, you might say that any increase in the size of government is necessarily a bad thing. But contrast the scale of reaction here to that of the UK where the Labour administration increased the relative size of government by over five percentage points in the early part of the decade (or in other words, fifty time Australia’s planned increase) without massive outcry.

Tax:GDP in the UK (1981-2011)











Tax:GDP in Australia (1981-2011)










Indeed, looking back over the two countries’ recent economic history one can observe two things. First, the size of government is much reduced in Australia relative to the UK, at about one-quarter of the overall economy compared to two-fifths in the UK. Second, the role for government in both has been relatively ‘sticky’ over a long period of time, fluctuating by only a few percentage points around their long-term average.

What could explain both the difference and stickiness? The first, and perhaps most common explanation, is that Australia’s much smaller government is a function of their electorate’s preference for greater reliance on free markets to deliver services and a reduced concern for the equity of social outcomes. I’m sure this is part of the answer, but I’m left thinking it can’t be a complete explanation – after all are Brits really so much more in love with big government that they’ll pay over half as much again as your average Ozzie? I doubt it. So, the second, and I think more interesting explanation is that public debate often revolves around starting-points or reference-points, rather than any more rigorous or fundamental assessment.

So the observed 'stickiness' is then a product of the countervailing forces of the left and right neutralizing each other about the principle of whether governments should or shouldn’t have a big role, and not the actually more bottom up assessment of what the appropriate role for government is at any given time, irrespective of whether that represents 25%, 28%, 33% or any other proportion of the economy.

This implies that public policy is often locked into particular, and perhaps random, equilibrium paths than require massive (and rare) political forces to shift. That would represent a positive result for people who believe in conservatism of social change, but bound to lead to disappointment from those who believe in a progressive role of government that has to adapt and shift as the world around changes. Unfortunately, I think the Rudd Government may prove a case in point. Really, it’s hard to see how they can deliver on the ambitious scale of change they have set themselves without winning the public case for a more active and increased role for government. Something I'll try to write more about another time...

The blame game

An interesting feature of Australia is its constitutional and political federalism. The Commonwealth Government, based in Canberra, receives the lion’s share of tax receipts, coordinating the spending of this as well as financial allocations to States. Meanwhile, State governments, such as Queensland’s, lever some resource through local sales tax, though an insufficient amount to fully deliver on the responsibilities to which they are locally accountable, not least of which is health care. This, of course, results in an elaborate and fragile structure of negotiations between state and federal agencies about exactly how public services will be funded and delivered.

The key, and evident, problems with this are:

• Perverse incentives in arrangements to shift costs onto the other side, particularly in health and social security;


• A lack of delivery clarity among businesses and the community about who actually has responsibility for what;


• Weak accountability between Commonwealth and State governments with opportunities for one to blame the other whenever things go wrong; and


• Distortions, duplications, and double-running costs in the administering of public policy.

An unfortunate manifestation of this is something called Specific Purpose Payments (SPPs) whereby the Commonwealth bypasses the States with ring-fenced conditionality in the pursuit of particular policy objectives. Effectively, States are required to fulfill specific conditions in order to receive these SPPs. Since the 1960s these have represented a major source of State funding, to the extent that they now total around two-fifths of all payments from the Australian Government to States.

What to be done?
The incoming Rudd Government identified the situation as a priority for reform, and it’s a central issue coming up in the range of policy overhauls underway. Clearly, reform needs to be guided by some set of subsidiarity principles about which government functions to, and which not to, aggregate up. These principles should include:

• Where there are spillovers or economies of scale in more centrally delivering something;
  Where there are significant concerns about the equity of outcomes within or between regions;


• Where there are coordinating or complementarity efficiencies in policy – such as education and training policy;


• Where there is a compelling need for uniformity in the given service, or where diversity of rules would create inefficiency; and


• Where the funding, delivery or monitoring of the service is aligned at a similar level.

For example, there is a strong a priori case for aggregating functions like defence, international development, trade, and most aspects of law to a national, or even supranational level (e.g. to the EU in the case of the UK). On the other hand there’s probably little sense in aggregating services like the delivery of community services for the elderly to a higher level merely for the sake of doing so. Indeed, one of positive features of current arrangements is that State governments are much closer and more locally responsive to the needs of their citizens than the equivalent in the UK.

So… where next?
It seems there may be a number of potential options for reform, several of which are within the boundaries of achievability. These include:

• A process of horse trading whereby the different governments swap areas of shared responsibility so only one government retains responsibility for a given service;


• A clearer split between funder and provider to separate responsibilities between Commonwealth and State, so that Commonwealth government either becomes the sole funder of a service, or a purchaser of discrete components from the State;


• A new performance management role for the Commonwealth, where it monitors States performance on functions of national priority with the right to intervene as a measure of last resort; or


• A competitive bid process, whereby States bid for Commonwealth funding for the delivery of certain functions, with performance criteria negotiated as part of the partnership.

Practically, some mix of these different approaches could suit different service areas – for example the alignment of responsibility for provision of roads is likely to be more amenable to the horse trading model than the performance management approach (and equally vice versa for health). And, indeed, the relative attractiveness of these different approaches to constitutional reform depends on the extent to which the Rudd Government is prepared to expend hard earned political capital in the pursuit of any gains from a more enlarged and empowered federal administration.