Anatomy of an Economic Decision

touch-decisions

Clear thinking is a prerequisite for good economics.  This leads to improved decision making, and that creates better outcomes.

The next time someone claims to be making an economic decision or proposes an economic course of action; dissect their claim or assertion.  You do not need to be an economist to do that.  There are five simple signs for good economic decision making:

  1. Decision to be made is articulated
  2. Available choices are considered
  3. Measurable objectives are described
  4. Input variables are identified
  5. Relationship between variables is determined

Without these famous five, the risk is the economic decision may be dead on arrival.

Inland Freight

canola

Recently I have been thinking about inland freight and logistics to see how this affects Australia’s seaports. Volumes may be constrained by production factors – you can only grow what you can grow when the environment allows you to grow it – but where these volumes go can be determined by these inland costs.

Policy can have consequences as NSW’s freight and logistics strategy shows. Improvements in freight handling and inland cargo aggregation can reduce costs. Some of these improvements reduce the cost of multi modal handling, as well as reduce the cost of line haul by mode – whether that is by rail or road.

For an economist like me it is a relative comparison game. Relatively lower costs will shift the movement of commodities from one mode to another, as well as shift the direction of commodities. Subject, of course, to existing commercial agreements.

However this is not the only story. The other story is around the development of vertically and horizontally integrated businesses that develop their own end-to-end freight and logistics systems. This means they are able to profit maximize by using less profitable parts of their networks to feed the more profitable parts. These firms are also taking equity stakes in their clients.

This is different to geographically and modally constrained freight and logistics operators – they have to maximize efficiency of throughput at a single point or along the linear operation of a particular mode. They certainly do not own parts of their client’s operations. Also, singular operations cannot transfer price because the other parts of the network or system are owned by other parties, and often singular operations cannot aggregate the volumes of goods required to develop leverage over prices.

This article also provides a gratuitous opportunity to show some of the canola fields near my home town in the South West Slopes region of NSW. I took this picture last week on a visit there. Primary production remains an important part of the freight task, albeit a volatile one that is hostage to world demand, weather and yields.

A Civil Society

kuwaitidiwaniya

While working recently in Kuwait, I was privileged to be invited to a diwaniya (https://en.wikipedia.org/wiki/Dewaniya) along with colleagues from my project team.  This type of forum is fairly unique to Kuwait and it a key element of their civil society.

For around an hour we discussed industry policy with a number of leading lights from Kuwait’s business community.  I learned a lot from them.  The discussion took our project team beyond the numbers and statistics we were considering to just how the reforms might actually be implemented.  The exchanges were robust but expressed in good humour and with great politeness.

I think these kinds of gatherings are extremely important in shaping consensus.  Kuwait has hundreds of diwaniyas and candidates for public office often seek to turn up at as many as possible around election time.  In my view, it removes a lot of the adversarial nature that characterises public discourse in Western countries.  Where hard decisions are needed to effect significant change, a consensus based approach may deliver better outcomes than a crash or crash though approach.

Australia used to do evidence-based, consensus-driven public policy quite well.  It was grounded in clearly explaining the need for change.  I fear now that the people putting themselves forward for public office are increasingly driven more by populism and a startling touch of irrationality.

The Rent Economy

Kuwait.jpg

I am currently on assignment Kuwait, one of the oil drenched Gulf states. The economic incentives at play here are unlike anything I have ever seen. At university years ago we spent a couple of hours in undergraduate economics talking about rent seeking – looking for an economic gain without a reciprocal return to society through wealth creation.

Laid out before me is a whole economy resting on this premise and driven by the distribution of oil rents. Kuwait has been pumping around 3 million barrels of oil a day and is targeting 4 million  with some urgency now oil prices have collapsed. Currently this earns them an oil rent (after costs of production and depending on the price) around US$60 million a day. When oil prices were over US$100 a barrel they were getting US$300 million a day. Kuwait has one of the highest dependencies on oil – some 93% of its revenues come from oil rents.

Some indicative figures provide context. The population of Kuwait is about 3 1/2 million people.  Around one third of residents are Kuwaiti citizens, the vast majority of the remainder are guest workers. Guest workers remit around A$25 billion a year to their home countries. This is equivalent to 55% of the Kuwait national budget. Nine in ten Kuwaiti citizens are employed by the government. The country rests on a cash reserve of around US$600 billion.

All businesses, with a few limited exceptions, are required to be 51% owned by Kuwaitis. So there are a range of business partnerships that are not strictly commercial but compliance-based. At any stage, the dominant partner can take control of the business.

This creates some very peculiar incentives. Lack of permanency for guest workers provides little incentive to save, spend or invest in Kuwait. So Kuwait misses out on retaining a significant proportion of their remittances.

With significant reserves in the ground – over 75 years – there is little incentive to move away from this rent-seeking model and the inherent imbalances it introduces. However in the long term that transition will be necessary.

It will be fascinating to see how this plays out over time.

 

Introducing Cost Benefit Analysis

How do you find out what an economic cost benefit analysis should contain?

Reference materials run to hundreds of pages, with detailed explanations depending on the nature and purpose of the investigation and the field under consideration.

I thought a simple introduction would help explain what is involved and prepared Intro to CBA for my clients.

NSW Northern Beaches Hospital Deal

One of the largest public health projects in NSW has been slowly releasing more and more information about the total cost of the project. Like some other public private partnership arrangements this project is a combination of capital investment and operating service payments.

The Northern Beaches Hospital project was belatedly revealed to the public to cost $2.14 billion cost, up from “over $1 billion” in December 2014. See: http://www.brisbanetimes.com.au/nsw/revealed-the-real-2-billion-cost-of-privatised-northern-beaches-hospital-20150501-1mxgqd.html

A lot of information was shrouded in commercial secrecy and the Health Minister has indicated she did not get involved in the financing.

So let’s have a look at what the good taxpayers of NSW may be getting.

From public information, the hospital development itself will cost $600 million. The NSW government plans to chip in some $400 million in adjacent transport improvements. A big assumption is that this is actually delivered on schedule and budget.

That basically handles the capital investment side of the equation and may leave $1.14 billion for the hospital services NSW is purchasing up to 2038 from the consortium.

Let’s say the hospital is operational in 2018, so there is a 20 year service period. According to some reports, 488 public beds will be provided.

This means the average daily cost per bed – occupied or not – is around $320 over this period.

Across the NSW health system the average cost per occupied bed was around $1,400 per night in 2012-13, based on information given to the NSW Auditor General.

See: http://www.audit.nsw.gov.au/ArticleDocuments/358/10_Managing_Length_of_Stay_Hospital_Readmission_Appendix_Three.pdf.aspx?Embed=Y

So this looks like it might actually be a good deal even at low occupancy rates. But since we do not know the basis of the service payments we simply cannot be sure.  The consortium get to make some extra cash on the side by selling private services through the site.

At about this point I can hear a lot of health economists scream.

So let’s recognise there is a lot of detailed, good work being done by the Independent Hospital Pricing Authority (see: http://www.ihpa.gov.au/internet/ihpa/publishing.nsf) that is putting evidence-based price signals into the hospital funding system, allowing funding arrangements to move from block grants to activity-based funding payments.

Over time this should help improve the efficiency of our hospital systems.

ROI on degrees

As we head towards $100,000 university degrees, the investment decision becomes increasingly critical.  No longer is an undergraduate degree simply three or four years in a person’s life.  Large debts are going to be attached.  So will the expected increase in lifetime earnings offset this?

It is hard to say because there are a lot of factors at play.  However doing an economics degree still looks like a good return on investment for school leavers:

http://thenewdaily.com.au/money/2015/04/15/uni-degrees-best-roi/