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Naval shipbuilding in Australia: the case for a regulatory overhaul

Posted By and on December 14, 2016 @ 06:00

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The government’s decision to pursue multi-decade domestic ship and submarine building programs sits oddly with decades of economic reform. Successive governments have striven to maintain competition in the Australian economy, and for good reason. Competitive markets drive efficiency, promote innovation and contain costs.

But what’s left of the local car industry attests to the unintended consequences of such policies. And of course that helps explain how these local mega projects—well over $50 billion and extending to beyond the mid-century—came to be. Even if they won’t replace jobs lost in the manufacturing sector, they’ll be large, symbolic and make for great photo ops.

But they are also going to provide the firms involved with effective monopolies. In practice, it will be so hard to change horses in midstream that the incumbents will have an assured position for years to come. Monopoly supply arrangements arise frequently in the defence sector, usually because there’s only one supplier of a unique piece of equipment. The cost, time and expertise required to develop alternatives is a high barrier to effective competition. The risk is that these new shipbuilding programs will become as inefficient as the government-owned shipyards of the 1970s and 80s.

In other areas where it’s infeasible to maintain competition—for example, in the provision of some utilities—the government regulates the industry to protect the consumer. For example, the US Government tightly regulates its defence industry to encourage innovation and efficiency and, just as importantly, to ensure that contractors don’t extract excessive rents, notwithstanding Mr Trump’s recent concerns about aviation projects. When we buy from the US we piggyback on America’s massive investment in research and development, and on its self-interested oversight of its defence firms.

We think that the government needs to be thinking much more about regulation of the monolithic enterprises it’s creating. The Department of Defence cannot effectively do the job itself; its agenda is not the same as the taxpayer’s.  We need a new arrangement.

A case study is illustrative. Until recently, submarine maintenance was largely a monopoly arrangement—albeit one involving a government-owned supplier ASC. Up until a couple of years ago, the results were increasing costs and diminishing vessel availability. It wasn’t until the government (acting in its triple role of owner, regulator and customer) commissioned the 2012 Coles Review that performance and efficiency started to turn around. The result has been dramatic, and Australia’s submarine availability is now approaching industry best practice (though costs remain an unanswered question). The key point is that it took intervention to shake Defence and ASC into action.

We don’t want to have to wait for things to fail again. There were many institutional and technical reasons behind the poor performance of the Collins fleet, but the core problem was that successive governments failed to take action. Given the sorry record of Collins sustainment, there’s a strong case for facing up to the challenge of regulating new monopoly suppliers right from the start.

That involves much more than ensuring that profit margins are kept in check, because it’s entirely possible for a firm to be inefficient and still make modest profits. And in the absence of countervailing pressures, a monopoly will tend to be less efficient than a firm subject to market competition. We’ve been making that argument for years, and we were heartened yesterday to see Senator Xenophon telling the AFR that he’s similarly seized with the idea.

Like the good Senator, we’re unpersuaded by the government’s response that the attention of the Australian National Audit Office is sufficient. We love the ANAO’s work in the defence space but, by definition, their audits are retrospective. Instead, we need to get these things right up front, and to have the ability to continually monitor progress.

Nor are we convinced that our own organisation is the right fit, as flattering as it was to be mentioned (along with the Productivity Commission) as part of the putative oversight mechanism. We’re happy to help to define the job of the eventual regulator, and we have some ideas. But the sums and timescales involved suggest to us a need for an enduring stand-alone office, perhaps on a statutory basis, that can push against the tide of political or bureaucratic enthusiasm when required.

This piece also appears in today’s Australian Financial Review and is reprinted here with their kind permission.



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