Friday, June 6, 2008

I jigged economics in high school, but I think I've figured it out...

I had a one-sided (almost) conversation with an economist today. I couldn't draw him - I think he realised I was trying to pump him.... I think:

So many people say that debt is bad, but for infrastructure isn’t it best to borrow, particularly when the infrastructure will take a long time to pay for because it’s expensive, for example, Dams, roads, etc. (We need more dams!!)
Local governments now prefer to be extracting the money from their ratepayers almost immediately for the provision of infrastructure. They no longer want to borrow because of the stigma attached to being in debt.

Also, with for example, the state buy back of the water infrastructure, the people really already own the infrastructure (piplines, pump stations, etc), and the council is bitching that they aren’t going to be getting enough from the state government for the asset – I just don’t get it.

The councils also reckon they’ll have to put up their rates (gee, that’d be a change from the norm, wouldn’t it!?!?!), because they’ll be getting less money because people won’t be paying water rates any more… ??

Maybe I’m confused, but I’m sure you can sort me out, economically speaking….

Surpluses? Well, to me, the object of the government isn’t to make a profit. If there’s surpluses, huge surpluses (not sure what’s classed as a huge surplus, though), doesn’t that mean that the infrastructure and services which are supposed to be furnished by the government/s are not being properly provided?

The economist said he basically agreed with me... or said he did. And then mentioned the coming "Glorious revolution". (Jokingly). I said "I was under the assumption that Kev07 was the glorious revolution."

...And one more thing, if the price of petrol or sugar go up, everything goes up. I've kinda noticed that over the years.

If anyone wants to enlighten me I'm open to knowledge!


ntk said...

The theory is that you can use the operating surplus to partially fund the capital budget. The normal way of doing things is to balance the operating budget over the business cycle, meaning that all capital works are debt-funded over the business cycle (operating surplus years will lead to partial equity funding of capital works, operating deficit years will lead to the partial debt financing of operating expenditures). But on average over the business cycle, the operating budget should be perfectly balanced, implying that the capital budget is all-debt (save for public-private partnerships).

That's the theory. Problems:

1) With the private investment share of GDP at a post-war (all time?) high, it's not immediately obvious that there is a desperate need for increases in public investment. It leads to pork barrelling and other wasteful investments. The "infrastructure" thing was only ever a talking point for the ALP (as if they can talk about running down infrastructure).

Therefore, given the lack of debt to pay down, surpluses should be returned as tax cuts. They'll find their way into private investment.

2) Governments (of one particular political stripe; do hazard a guess) are good at paying themselves big dividends from public utilities. This dividend income is recurring and thus winds up as operating revenue. Here in WA, the state gubmint pays itself about $400m a year in dividends from the water corporation. Public utilities are the worst possible companies to shake down like this, because they're relatively capital-intensive. Leaving their dividends as retained profits would give these companies the ability to partially fund capital works from those profits, thus lowering their interest expense. So, when you see the state government's operating surplus, remember to mentally deduct the "special dividends" they pay themselves each year. Keating shaking down Telecom every year was the most egregious example.

When you hear how much the gubmint says it's spending on electricity or water infrastructure, remember that they're just giving back the dividend income and tax-equivalent payments they took.

This, incidentally, is another reason why these state-owned companies should be sold - so the government can't use them as a piggy bank.

If there’s surpluses ... doesn’t that mean that the infrastructure and services which are supposed to be furnished by the government/s are not being properly provided?

It means that taxes are too high!

kae said...

thanks ntk

I love it when the government tells us how lucky we are that OUR money is being spent on stuff WE need...
like infrastructure that the state governments have not been providing for increasing population, etc.

Let's talk about dams... and such.

Wouldn't Wolfdene be full after the recent rain in Qld?

stackja1945 said...

Once 'guvment' sold bonds to mums and dads. Allowed tax deductions on family expenses. Then the smarties got into the act. Margin loans etc, etc. Ah, progress.

Stevo said...


Thanks for your analysis. I'm asking for capital in my latest project. But how the capital cycle works, I'm still clueless. You didn't mention tax. I'm sure that has something to do with it. Even after reading above. Too many VBs. If you can summarise your comment in a few sentences for me, that would be helpful.


Skeeter said...

The Wolfdene dam was scheduled for completion in 2005 and I think it highly likely that it would be full right now — that is, of course, if the Goss government had not killed it.
The Wolfdene's catchment is close to the Hinze Dam catchment, and experiences similar rainfalls. The Hinze Dam has been overflowing, or in the high 90s% capacity all this year.

Local governments now prefer to be extracting the money from their ratepayers almost immediately for the provision of infrastructure.

It's even worse than that, Kae. Local governments are now extracting the infrastructure money from the developers of new residential land, not the ratepayers. The buyers of the land are actually making a prepayment for infrastructure capital works before they become ratepayers. They then pay rates on capital assets that they have already paid for.

kae said...

No wonder land is so expensive with all the imaginary infrastructure charges paid for... BEFORE they're provided.

(just tried to post and it didn't work, wonder if this'll work?...)

Skeeter said...

The developers pay a "contribution to infrastructure" cheque to Council before the plans on a new subdivision are sealed. The dollar amount of that "contribution" is based on the number of dwellings that can be built on the new blocks. That money is for "future" infrastructure costs in the local government area but is only a small portion of the total infrastructure costs paid by the developers.
The major part of the infrastructure costs added to the price of the new blocks are for completed works such as roads, footpaths, water mains, fire hydrants, storm water control, underground power and telephone, parks (complete with sports fields and playgrounds for the kiddies), tree-planting and landscaping.
All of those works must be completed and paid for by the developers before council will seal their plans. They can't sell the land before the plans are sealed.

missred said...

i failed economics in college.. after the law of supply and demand, which i understood, the rest was and still is, totally incomprehensible

Caz said...

Skeeter - nice try at suggesting that developers are being ripped off, or losing money - I'm betting every dollar, plus a healthy margin is passed straight to the little home buyer. Also nice try to suggest that infrastructure is a one off expense requiring no maintenance, or that rates contribute solely to infrastructure - community services, such as health, childcare, libraries, recreational facilities, hey, even rubbish bins and collection, are paid for with - rates!

The surplus is a measure of the amount by which we have collectively paid too much tax. Why it's something to boast about, I have no idea. "We have taken your money and given you nothing!" That, apparently, is a measure of an economically responsible government. Bah humbug.

Skeeter said...

Caz, perhaps you made the above comment tongue-in cheek. In case you were being serious, I offer the following response:

I did not suggest that developers were being ripped off, or losing money.
Obviously you would win your bet (if you could find somewhere to place it) because every dollar plus a healthy margin is passed straight to the home buyer.
That is exactly the process that confirms my claim that the buyers are paying for the infrastructure before they become ratepayers.
Show me where I have suggested in my comments that infrastructure is a one-off expense requiring no maintenance.
Then show me where I have suggested that rates would not be be needed for the other things like services.
Perhaps what sent you down that track was in my first comment, where I wrote:
[The buyers of the land] then pay rates on capital assets that they have already paid for.
Some of the rates they will be paying will be applied to funding infrastructure in other places. Some of it will be going to maintenance, and services.
A very large part of it will be going into the pay packets of a bureaucracy staffed largely by university graduates.
However, the essence of my claim that the new buyers were paying rates on infrastructure that they had already paid for was this:
All the infrastructure that the new landowner has paid for in her purchase price now belongs to the council, and it became part of the council's infrastructure asset. It is that asset on which they collect rates from the ratepayers.
Perhaps an example might help.
A recent development cost paid by developers in my area was $110,000 to extend the town water-main by 500 metres to our street.
Now, the new land owners will pay water rates to the council. The base water rates are to pay for infrastructure and maintenance of the water distribution network. That's what I meant by the ratepayer paying rates on infrastructure that she had already paid for.

While you are reading my comments again, I hope you can agree that I was merely pointing out how new infrastructure is currently being financed by local governments.
This is in contrast to the traditional method, which was for the councils to borrow for infrastructure and then use ratepayer income to service the loans. In effect, under the old system, the ratepayers were paying off their share of infrastructure costs over the years of their land ownership.
The method used these days is to have the new infrastructure paid for up front by the developers.
Obviously, if they want to stay in business, the developers will pass on to the buyers, all their costs plus a profit.
Ergo, it is then the buyer of the land who is paying for the infrastructure up front.
Existing ratepayers will probably be in favour of this new system because it will help reduce rate increases.
New ratepayers are probably against it (once they realise it is happening), because they are pay a much greater share of the infrastructure costs than existing ratepayers.

If you want to attack developers because you believe they are evil and making excess profits, neither I, nor my comments, should be your target.

Caz said...

The olden days are long gone Skeeter, hence why councils got jack of taking out loans and paying interest.

Home buyers also got jack of waiting 15 years for paved footpaths and street lights.

Developers wouldn't bother to develop without significant profit, alas, they don't do it for the love of it. I wasn't attacking developers, although the quality of work and the whole McMansion thing is often less than ideal.

I very much doubt that established rate payers consider their rates to be somehow constrained thanks to an influx of newbie rate payers. Their rates all use the same formula. In other words, rate payers complain endlessly about rates, no matter who they are or where they live or how much their house is appreciating. It wouldn't matter how infrastructure was funded, it will be ever thus.

Oh, as for the graduates being paid heaps in local councils: "snort". Good grief.

Federal gov't pays best, in general, but still pitiful for the average middle level worker. State gov'ts pay even less, but there are exceptions (few). Councils pay a pittance, have no career path, employ as few people as possible, and the majority of self respecting graduates wouldn't touch a council job, unless out of desperation - and these are not desperate times.

Current local infrastructure planning and funding arrangements aren't any worse than other levels of gov't, the latter is actually worse, with the whole PPP business model, and there's no back peddling on that distorted construct either. All of us indirectly pay far more than an amount for annual rates for soaking up the continual financial leakages and mismanagement of PPPs.

Skeeter said...

The olden days may be long gone Caz, but in my experience very few people realise that so much of the infrastructure is now being paid for up front in the price of the land. Did you know that fact before this thread started?
Another thing they don't realise is just how much those council-imposed costs add to the price of a house block and how high is the proportion of the final price to the consumer.

Your comment on the quality of the developers' work seems to be a non sequitur in this discussion, but it invites a response from me. The quality of the work done by the developers' private contractors is subject to frequent inspection by council officers. Some items had to be done three times in our street because the inspectors considered them to be below standard. The contractors doing the work had a different view, of course, but they were always overridden by the council inspectors. Inspectors sometimes required work to be done that was far in excess of the standards set out in the DA conditions. (Eg, six fire hydrants required by a council inspector, where the DA conditions spelt out only one hydrant on that stretch of a new water main. In this case, the contractor took it to a higher authority, and the inspector was overridden. All of that fuss added about a day and a half to the job for the contractor.)

As you suggest, the established ratepayers would be very unlikely to be aware that their rates were in any way constrained by the new system. However, there is little doubt that the annual rate increases would be much greater if the old infrastructure funding system prevailed. (Then they would really have something to complain about.)
Where else would the councils get the extra money to service new infrastructure loans? It would have to come from increased rates.

I didn't claim that the graduates were being paid heaps. I was claiming that the bureaucracy is large, and it absorbs a large part of rates.
Our council bureaucracy employs many new graduates in their first jobs out of uni. They have never run a business and have minimal experience in the complex costing of the development industry. They are all avid environmentalists and green reigns supreme in their thinking, with no regard for costs.
(Another example: One such bureaucrat has imposed a condition of planting 4800 trees on 4800 square metres of private land that was to be gifted to council for public open space. All at the developer's expense, of course.)
They are the ones the developers have to deal with when making development applications.
There can be up to 8 bureaucrats compiling the conditions for a simple DA on a 10-acre lot being reconfigured into 4 lots.
As soon as the sprog bureaucrats learn enough about the industry, they leave the council to become planning consultants in the lucrative private sector.
And guess who pays their humongous fees in their new jobs.

I'm not arguing that local government infrastructure planning and funding arrangements are any worse than other governments. I'm just letting the readers know what they are paying for these days when they buy a house block.

On the matter of developers' profits. All three developments in our street achieved their DAs mid 2007. A year later, not one of the new blocks in the street has been released for sale yet because the present market price for such blocks would not cover costs, let alone profit.

Caz said...

Yes, I did. It's not very new. I simply know from reading papers, not because I have any personal involvement.

How could people not know this, not know the mechanics of their own governance?

Ah, our gov'ts holding onto land, bloody disgraceful, holding-up land, ditto, etc, etc. Australia is growing by up to one million people every three years. Our housing stock is growing at a fraction of that pace. Disgraceful.