Contestability: economic theory or Trojan horse?
Contestability has been widely promoted in recent times by the Harper Competition Review, multinational consultancies, commissions of audit and conservative governments on both sides of politics.
It is an economic theory whose real importance is not in its stated primary purpose, which is to improve organisational performance, but in the conditions requisite for its operation, that being open and unregulated economies. Open economies means open, free markets which are achieved by removing barriers to entry – barriers like regulation and trade and foreign investment controls.
In a nutshell, contestability theory argues that even a monopoly can be competitive if there are no barriers to entry or exit to the market in which the monopoly is operating. Entry into the market is then absolutely free and exit is costless, that is a business is not encumbered by sunk costs, which cannot be recovered or exit fees like taxes if a foreign investor sells their Australia business. Ease of entry and exit thus attracts potential competitors who pose a threat to any incumbent. Contestability theory claims that to keep them out the incumbent must behave competitively, i.e. maintain low prices, often called the entry limit price. Even in the case of unregulated monopolies, supernormal profits will not be taken as this would encourage new entrants. An incumbent’s vulnerability to ’hit-and- run entry’ by profit takers is the crucial feature of a contestable market.
Contestability was conceived by teams of US economists led by William Baumol from Princeton and New York universities and Elizabeth Bailey from Bell Laboratories, the research arm of telecommunications giant, AT&T in the 1970s. The theory was used to justify, on economic grounds, AT&T’s monopoly structure, which at the time was coming under sustained legal pressure from the US Federal Government in the case United States v AT&T (1977-1982). The book Contestable Markets and the Theory of Industry Structure by William Baumol, John Panzar and Robert Willig, was published just prior to the case ending in 1982. It lays out in the language of economic mathematics an attempt to resolve the problem of the lack of competition in monopoly and oligopoly industry structures. Specifically the theory proffers a way to justify deregulating industries which have non-competitive structures. This justification was timely as the private sector started to take over an increasing number of government assets and services, many of which form ‘natural’ monopolies (like water and electricity) as well as oligopolies in the early 1980s.
Baumol hedged the theory by stating that, “perfectly contestable markets do not populate the world of reality”.[1] Even in oligopoly, which is considered the optimal contestable structure, the conditions for such a market to exist are unlikely to occur. The chief conditions being the absence of sunk costs (like pipelines, bus depots , airline check in and port access, client relationships and marketing) and knowledge and technology parity between incumbents and new entrants. Baumol claimed that a contestable market could be engineered. However, 35 years after the publication of his Contestable Markets and the Theory of Industry Structure, this author has found no case studies of actual markets cited in any of the international literature. Irrespective of the absence of evidence, key economic agencies like the National Commission of Audit (NCA) claims contestability works to,” … drive lower costs, improve quality and give people what they want.”[2]
Contestable market theory has spawned a contestability brand complete with slogans like, ‘meet the market, beat the market’,[3] as a way of driving the message across the public sector, that contestability established in cooperation with the private sector can achieve greater efficiencies. This message has been fostered through association with concepts like stewardship. An instructive example is adoption of contestability rhetoric by the consultancy arm of infrastructure-mining engineering giant Worley Parsons, Advisian. They established a program management office (PMO) within NSW Roads and Maritime Services (RMS) in 2012, tasked with implementing a ‘contestability reform program’ for road maintenance. As a supplier embedded into government there is no longer an ‘arm’s length relationship’. Advisian contends that: “suppliers will join with governments in acting as stewards of the public interest”, as a way of deflecting concerns over such changes.[4]
The effectiveness of ideas in protecting the public interest is however, uncertain. Paul Davies from Professional Engineers Australia, reported in the SMH in 2014 that: “RMS has lost 20% of its engineering workforce through recent restructuring. These are the professionals who know how to build, maintain and deliver roads for NSW… A Senate inquiry into the shortage of engineering skills (2012) showed that these problems resulted in 26% of projects over $1 billion running more than $200 million over budget”. [5]
Contestability is also centre stage in efforts to drive greater efficiencies in community services which is uniquely dependent on a workforce with a large contingent of volunteers. Deloitte’s report Contestability in Human Services (2015) refers to contestability as a ‘value creation process’ exemplified by the social impact investment market. The social impact investment bond market is projected to reap $32 billion within a decade. One of the test programs was the Uniting Care’s Burnside New Parent and Infant Network, whose objective was to save the NSW government money, by returning children in foster care to their parents. The sale of Newpin Social Bonds to institutional investors on the basis of a 7-10% return each year for seven years, amounted to a capital raising of $7 million for the program. The return on the bonds was calculated on the ‘restoration rate’, that is the percentage of children in the program who were returned to their parents. In 2014, 60% of children in the program were returned, earning investors a 7.5% coupon. If 70% of children had been repatriated, investors would have made 15%. [6]
The NSW Government’s Social Impact Investment Policy (2015), backs financialisation of the sector by guaranteeing investors a 5% return whatever the outcome.[7] Deloitte refers to a ‘contestability process’, but the connection between trading products like Social Benefit Bonds (invented by Goldman Sachs) and decisions pertaining to social program design and delivery are yet to be measured in this infant market.
Former Serco analyst, Gary Sturgess has influenced government’s approach to contestability. Contestability in Public Services, (2015) develops contestability concepts first elucidated in Diversity and Contestability in the Public Service Economy (2012) he published under the imprimatur of the NSW Business Chamber. The aim of contestability is to lift productivity through benchmarking, procurement, outsourcing, market-testing, and commissioning. The big barrier to entry in government is ‘domain knowledge’ which Sturgess suggests could be overcome by the ‘entry of international providers’, (like Serco).
However, in a Kafkaesque twist, it is the public sector itself which is being targeted as the main barrier to entry. Public agencies and enterprises are barriers to corporations wishing to take over the business of government. The Queensland Commission of Audit, noted that, “the existence of government providers in these areas [road maintenance] may have created a barrier to entry, which discouraged a market for private providers.”[8]
The case of the health care services plan for the Northern Beaches of Sydney highlights such distortion with use of contestability rhetoric to justify privatisation without appropriate regulatory oversight. The plan will shut down two public hospitals, leaving 270,000 people with three private hospitals and only one emergency department between them by 2018. Mike Baird promotes this as the future model for health in NSW.[9] The public-private sector mix with appropriate regulation of competitive health sector activity relative to community needs which appropriate consideration of contestability should support, is replaced by for-profit oligopoly. The competition and service differentiation implicit in the public-private system is lost, where politicians and senior bureaucrats cannibalise their own public hospitals to realign as a private sector oligopolistic structure, serving the appetites of global private investors rather than NSW communities and patient needs.
Baumol expressed his antagonism to the public sector in a 1997 lecture at the University of Tasmania, decrying the “… propensity of even well-intentioned public servants to sabotage the market mechanism.”[10] He sets contestability theory, a theory which justifies reduced competition, as an ‘extension’ of the perfectly competitive market, which while not real, is the pivot on which such free market rhetoric turns. Baumol’s faith based economics claims that, “…the invisible hand holds sway. In a perfectly contestable world it seems to rule almost everywhere.”[11] Such omnipotence of thought is likewise embedded in the assertion by Sturgess that, “contestability in public service delivery is contestability in management”.[12] This is the ‘everywhere’ of contestability’s contemporary rationale. The idea is promulgated that human and other assets are attached to management that wins competitive tenders and ‘alternative management teams’ are replaced, so that, “in a failing public service, it is senior management that will be replaced”. [13]
Deloitte’s Ian Harper, Chair of the Competition Policy Review, couples Sturgess’s assertion with his stated principle that, “government should not be a substitute for the private sector where … contestability can be realised”,[14] in an attempt to justify substitution. The public sector is presented as being objectionable on contestability grounds, because of the enormous sunk costs the public sector represents. It takes a lot of investment to develop a workforce with expertise to manage complex systems and who understand concepts like the public interest, the social contract and fiduciary duty to the Commonwealth and Crown.
Commonwealth entities are now subject to the Contestability Framework run through the Contestability Programme of the Department of Finance. The aim is to find, “alternative structures, processes or provider arrangements”[15] for government entities. This Framework, introduced by the 2014-15 Federal Budget will function until the ‘desired outcome’ of privatisation is reached.
In December 1981, Baumol described contestability theory as an ‘uprising’ against the established order,[16] erupting at the very beginning of an era labeled economic rationalist, neoliberal and corporatist. The uprising is perceptively real to those who have the money and power to harness its rhetorical power. For those not yet aware of its intent, it falsely evokes the notion of competition and obfuscates its meanings. These are the tactics of stealth - quiet, insidious, duplicitous - lies at every junction white-anting Australia’s social democracy.
Like the Trojan Horse of Troy, contestability has conveyed into the Australian state the corps armoured with cause to assail the barriers, turning Baumol’s uprising into the revolution he understood it to be, in the name of corporate hegemony. END
© Caroline Colton
[1] Baumol, William J. “Contestable Markets: An Uprising in the Theory of Industry Structure.”
The American Economic Review, Vol. 72, No. 1, (Mar., 1982), pp. 1-15
http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.470.8509&rep=rep1&type=pdf
[2] National Commission of Audit. Towards Responsible Government: The Report of the National Commission of Audit Phase One. Canberra, NCA, 2014. http://www.ncoa.gov.au/report/docs/phase_one_report.pdf
[3] Sturgess, Gary L. Contestability in Public Services: An Alternative to Outsourcing. Melbourne, Australian and New Zealand School of Government, April 2015.
https://www.anzsog.edu.au/media/upload/publication/150_Sturgess-Contestability-in-Public-Services.pdf
[4] Cashen, Ian. “Ensuring contestability succeeds through stewardship”. Advisian web site: Viewed 27 June 2015. http://www.advisian.com/perspectives/ensuring-contestability-succeeds-through-stewardship-2.aspx
[5] Davies, Paul. “Best value is elusive without engineers: Taxpayers are expected to carry the cost of cutbacks in experienced staff”, Sydney Morning Herald, 22-23 March 2014. Viewed: 27 June 2015. http://www.smh.com.au/comment/best-value-is-elusive-without-engineers-20140321-3588q.html
[6] Eyers, James. “NSW social impact bond returns 7.5 per cent.” Sydney Morning Herald, 31 August 2014, Viewed: 2 June 2015. http://www.smh.com.au/business/nsw-social-impact-bond-returns-75-per-cent-20140831-10ajsa.html
[7] NSW Government. Social Impact Investment Policy: Leading the way in delivering better outcomes for the people of NSW. Sydney, February 2015. http://www.dpc.nsw.gov.au/__data/assets/pdf_file/0011/168338/Social_Impact_Investment_Policy_WEB.pdf
[8] Queensland Commission of Audit. Final Report. Vol 1, pp. 1-10, February 2013. http://www.commissionofaudit.qld.gov.au/reports/coa-final-report-volume-1.pdf
[9] Baird, Mike. “Transforming NSW: Operator chosen to build and run new Northern Beaches Hospital.” Media Release: 29 October 2014. https://www.nsw.gov.au/media-releases-premier/transforming-nsw-operator-chosen-build-and-run-new-northern-beaches-hospital
[10] Baumol, William J. “Privatisation, Competitive Entry and Rational Rules for Residual Regulation. Annual Giblin Lecture, University of Tasmania, 1997 (Occassional Paper No. 2, Sept 1997). (Not on Net)
[11] Baumol, William J. “Contestable Markets: An Uprising in the Theory of Industry Structure.”
The American Economic Review, Vol. 72, No. 1, (Mar., 1982), pp. 1-15.
http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.470.8509&rep=rep1&type=pdf
[12] Sturgess, Gary L. Contestability in Public Services: An Alternative to Outsourcing. Melbourne, Australian and New Zealand School of Government, April 2015.
https://www.anzsog.edu.au/media/upload/publication/150_Sturgess-Contestability-in-Public-Services.pdf
[13] Sturgess, Gary L. Contestability in Public Services: An Alternative to Outsourcing. Melbourne, Australian and New Zealand School of Government, April 2015.
https://www.anzsog.edu.au/media/upload/publication/150_Sturgess-Contestability-in-Public-Services.pdf
[14] Competition Policy Review. Competition Policy Review: Final Report. Canberra, March 2015. (Harper Review). http://competitionpolicyreview.gov.au/final-report/
[15] Department of Finance. “What is the Contestability Programme?” DOF web page. Viewed: 24 June 2015. http://www.finance.gov.au/resource-management/governance/contestability/overview/
[16] Baumol, William J. “Contestable Markets: An Uprising in the Theory of Industry Structure.”
The American Economic Review, Vol. 72, No. 1, (Mar., 1982), pp. 1-15
http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.470.8509&rep=rep1&type=pdf