Consideration of the Telstra (Dilution of Public Ownership) Bill 1996
CONTENTS

MINORITY REPORT

CHAPTER 2

THE ECONOMIC CASE FOR PART PRIVATISATION OF TELSTRA

2.1 A logical next step as competition increases

We believe that the part privatisation of Telstra is a logical continuation of a series of reforms over the last 20 years. The first occurred in 1975 when the Australian Telecommunications Commission was created out of the old Post-Master General's Department to give a more commercial focus to the organisation. A second step was taken in 1989, with the creation of AUSTEL and the introduction of competition in value-added services. Then in 1991, a third set of reforms saw Telecom made into a company under Australia's Corporations Law, the introduction of a transitional competitive duopoly involving Telecom and Optus (and, in mobile telephony, three way competition between Telecom, Optus and Vodafone), and the prospect of full and open competition from 1 July 1997.

At each stage of these reforms there have been critics, and strident claims have been made about adverse effects on universal service delivery, service quality and efficiency. However, the outcome has been a strengthening of universal services, improved service delivery and a more efficient and profitable Telstra. Contrary to the expectations of the critics, increased pressures on Telstra to produce services in competitive markets and to provide better financial returns to the Government in the last decade has helped forge Telstra into a stronger and more competitive company.

We note with interest that the last two of these important reforms occurred under a Labor Government. We think that they were right to take the steps they took then. It is a great pity that Labor now appears to have lost the energy and courage to introduce needed reforms into the telecommunications market - reforms which are supported by a logic which is compelling, and a logic which must be just as clear to Labor in Opposition as it was to Labor in Government.

2.1.1 Telstra operates in an increasingly competitive environment

The evidence shows that there is a world wide trend to competition in telecommunications, and that Governments everywhere are seeking to ensure their carriers are fit for the challenge. Telstra in its submission to the Inquiry said:

Significant structural changes are occurring within the global communications industry as technologies converge and new global players enter the communications market. The environment in which Telstra operates is becoming increasingly competitive and more dynamic as historical barriers to competition are being eroded by technology and by Government's drive towards greater competitiveness and efficiency. [1]

The evidence from Telstra and other witnesses also shows that Telstra's ability to continue to survive and prosper in this market environment as a wholly government owned company is questionable. For example, the Business Council of Australia said:

If Telstra is to continue to operate and prosper in such a rapidly changing environment, it will have to respond quickly to changes in the market place and to technology. Privatisation, even when this is limited to a one third minority stake as envisaged by the Commonwealth Government, can play a significant role in developing a more responsive and competitive enterprise. [2]

A similar view was expressed by the WA State Government:

So, for Telstra to remain healthy in more heated competition, now is the time to undertake a partial privatisation. [3]

Australians should not be misled into thinking that Telstra's size and strength in the Australian market could guarantee it success in a converging and increasingly competitive world market. Telstra's own submission stated:

By comparison with the 50 largest world telecommunications companies, Telstra is currently a middle sized company (ranks 22 on 1994/95 revenue). However, if Telstra is unable to improve its efficiency and compete effectively in this changing market, then the company's positioning and Australian industry's leverage in regional markets will diminish. [4]

In the Australian communications market, there are several ways in which competition is becoming manifest. National telecommunications carriers (often referred to in the industry as “telcos”), including completely or partially privatised national telecommunications companies, have formed powerful international alliances for providing global services to large multinationals operating in Australia, as well as Australian-based firms. This is making national borders ever less relevant to regulation. Non-traditional telcos, including global information technology and media companies, are also moving into the telephony market. Some of these non traditional telcos, such as Internet providers, are offering core telephony services. The growth of service providers and resellers operating in the market since 1991 provides an important basis for the emergence of yet another tier of carriers once the current duopoly ends.

We believe that the portents for Telstra in this increasingly competitive market if it remains 100% publicly owned are not encouraging. With the telecommunications market being opened to full competition as of July 1, 1997, Telstra's environment will become ever more complex and demanding. Already, Telstra has lost substantial market share, notably in the highly profitable long distance service, and the development of competition in the market for local access and calling will strike at the core of Telstra's revenue streams.

To survive and prosper in this environment, Telstra will need a high degree of commercial flexibility - but it is by no means apparent how this can be reconciled with the kind of control by the Government which has characterised full public ownership. At the same time, it will need from its investors, and should legitimately be able to secure, advice and guidance about complex, competitive decisions - yet these involve issues increasingly far removed from the expertise of the Government and its advisers. Finally, it will need more flexible access to capital, but this is hardly a realistic option at a time of severe fiscal constraint, affecting governments of all political persuasions.

2.1.2 The world wide regulatory trend in telecommunications: competition, appropriate regulation, & privatisation.

Telecommunications world-wide is undergoing dramatic change. The evidence we received was abundantly clear on this point. Markets long structured as monopolies are being opened to full competition; government-owned carriers are being privatised; barriers to international trade and investment are being reviewed and reduced.

Combined, these changes create enormous benefits for consumers, through sharp falls in service prices and in improvements in the range and quality of service.

At the same time, we believe that these changes place great pressures on existing suppliers - and especially on the former monopolists such as Telstra now being exposed to the gales of competition. The inefficiencies which could be tolerated in a monopoly environment are no longer sustainable; mistaken investment decisions can no longer simply be passed on to consumers; and the bureaucratic culture inherited from the public service is entirely inappropriate to meeting the demands of a fast-changing market-place.

Like its counterparts overseas, Telstra must now face the challenge of adapting to this new environment. If it fails to do so, Australian consumers will inevitably suffer, as prices remain higher and service quality lower than they should be. We will also bear a loss as tax-payers, as the value of the national investment in Telstra is eroded. And Telstra's employees will lose out, as failure to win in the competitive stakes forces ever deeper cuts in employment and in the quality of working life.

The inquiry has heard that there is a global trend to liberalise telecommunications markets. Liberalisation generally involves three facets: competition, appropriate regulation and privatisation. The aim of such a policy is to deliver substantial efficiency gains on the part of telecommunications carriers, which feed through into benefits for consumers.

A good summary of the worldwide trend was contained in Telstra's submission:

...regulatory trends around the world are towards more open telecommunications market structures. Telecommunications markets in the United States, United Kingdom and New Zealand have been important test-houses for market liberalisation. Governments in these countries have been among the first to remove regulatory barriers as technological obstacles to competition have been eroded.

All major telecommunications markets have moved towards open competition. The European Union has determined that each government and telecommunications authority of its member states must open telephony markets to competition in 1998 (Portugal, Greece and Ireland are subject to later dates for liberalisation). The United States Congress has passed legislation to remove all constraints on competition in local telephony and other markets. Governments in Latin America and the Asia Pacific region have moved to allow varying degrees of competition.

Privatisation is also not an isolated phenomenon, but has been associated with telecommunications market liberalisation. In Europe, the national carriers of Belgium, the Czech Republic, Denmark, France, Germany, Greece, Hungary, Latvia, the Netherlands, Ireland, Italy, Portugal, Spain, Sweden, Turkey and the United Kingdom have been, or are proposed to be, privatised or partially privatised. The major Latin American telecommunications companies in Argentina, Chile and Peru have been privatised. Within the Asia-Pacific region, the governments of Singapore, Malaysia, Japan, Korea and New Zealand have privatised or partially privatised State-owned carriers..... [5]

Many witnesses who appeared before the inquiry pointed out that competition is the most important aspect in achieving efficiency gains in the telecommunications market. The Western Australian Chamber of Commerce and Industry (WACCI) said:

Both economic theory and empirical evidence suggest that the key to efficient markets is effective competition.

Analysis by the Organisation for Economic Co-Operation and Development (OECD) and the Bureau of Industry Economics indicates that the degree of competition in telecommunications markets is a key determinant of the market's efficiency. Any reforms undertaken by the new government must be made in a manner which promotes competition....

...both within Australian markets and between countries, there appears to be a clear link between the degree of competition and the extent to which prices are falling. Competition is probably the single most important determinant of market efficiency [6].

A similar view was put by the Business Council of Australia:

After 1997 the telecommunications industry will be further deregulated and the march of technology will continue to impose new realities in the communications market place. The Business Council believes that a competitive environment will enable the development of more efficient service providers and better, more innovative and competitively priced products and services to their customers. [7]

Interestingly, it was not just business groups which acknowledged the benefits of competition. The Australian Consumers Association said in its submission:

...ACA believes effective competition rather than privatisation per se, is the key to delivering improved efficiencies... [8]

Senator Schacht and other Opposition Senators participating in the Inquiry at times attempted to suggest that while competition has brought benefits to the telecommunications industry and consumers, privatisation is a separate and different matter. We think this argument does not take account of the interaction between competition, privatisation and market liberalisation. The Government's policy will allow for powerful interactions between these forces, resulting in a greater benefit than would come from any of them occurring alone. It is true that the principal benefit comes from competitive forces operating on companies as they make their decisions; but the key point is that wholly or partly privatised companies respond much better to those competitive forces. This point was made by Mr Ian Martin, telecommunications analyst with investment bank BZW:

Certainly the greater benefits come from competition...There is a joint benefit. You get far more out of competition if you have also got private sector influence. [9]

We therefore believe that the weight of evidence suggests that as the telecommunications market becomes more competitive, and less regulated, the part privatisation of Telstra is an appropriate and sensible policy for the Government to introduce.

2.2 Part privatisation will improve Telstra's performance

We are satisfied, based on the abundant evidence we have received, that part privatisation of Telstra will improve the company's performance, for several reasons:

• it will make Telstra more efficient
• it will give Telstra greater freedom of action
• it will give Telstra greater clarity of purpose.

2.2.1 Part privatisation will make Telstra more efficient

2.2.1.1 Telstra is relatively inefficient

We have been provided with extensive evidence which leaves us with a very clear conclusion: Telstra is still relatively inefficient compared to other carriers around the world. Submissions to the Inquiry indicate that Telstra is currently 25-40 percent behind worlds' best practice on common measures of operational performance:

Telstra has scope to improve its performance. Although commercialisation and the introduction of competition have brought a more commercial focus to Telstra management in recent years, comparisons of Telstra's performance relative to other international telecommunications carriers indicates that it is still operating below optimal efficiency, for example against the widely used operating benchmark "access lines per employee", Telstra's ratio of 135 compares with a ratio of 200 for both BT and Telecommunications Corporation New Zealand (TCNZ). [10]

A number of research bodies have investigated Telstra's performance, and reached the view that there is considerable scope for improvement. The BIE, for example, in Research Report 65, International Performance Indicators Telecommunications 1995, pointed to growth in Total Factor Productivity (TFP) for Telstra between 1980 and 1994, with strongest growth since 1991-92. The Report found improvements in TFP and the return on assets encouraging but expressed concern about the distance between telecommunications operating performance and international best practice. It concluded that by international standards, productivity in telecommunications in Australia remained low up to and including 1992-93. [11]

Table 1 below was prepared by investment bank BZW. It suggests that on a number of key measures, Telstra needs to make substantial improvements in several areas if it is to attain world's best practice.

 

Table 1 - Telstra's comparative performance

Company	Enterprise value per access line (US$)	Enterprise value/sales (US$)	Enterprise value/EBITDA (US$)	Access Lines per employee
Telstra	2,654	2.3	5.1x	135
RBOC Avg	2,120	2.7	6.6x	250
BT	1,426	1.8	5.0x	200
HK Telecom	6,734	6.1	14.3x	200
Singapore Tel	27,746	14.9	25.2x	125
KPN	2,662	1.9	5.2x	235
Telecom Italia	866	1.5	3.0x	270
TCNZ	5,495	4.8	8.9x	200

Source: BZW, March 1996.

The Department of Communications and the Arts also drew the Inquiry's attention to work done by the Bureau of Industry Economics in comparing access lines per employee in selected countries. Table 2 below is based on this work (note that it draws on slightly earlier data than that contained in table 1).

 

Table 2 - Access lines per employee in selected OECD countries

	Lines per employee
Australia	124
Canada	187
Denmark	186
Finland	194
Germany	158
Italy	271
Japan	235
Netherlands	234
Switzerland	206
United Kingdom	160
United States	223

Source: BIE International Performance Indicators Telecommunications 1995, p.121

Clearly, no single measure can fully capture the dimensions of Telstra's productivity gap. But as the Department of Communications and the Arts noted, there is wide acceptance of Telstra's relatively poor performance against a range of overseas benchmarks.

The BIE's broad conclusion has been recently supported by Xavier and Graham who prepared an international benchmarking report for AUSTEL. They conclude that `Telstra's efficiency performance remains mediocre when compared against the world's benchmark carriers. While ... Telstra's exact positioning [is] open to protracted disagreement, there will be less disagreement that a performance gap exists. Indeed, Telstra itself does not dispute such a gap'. [12]

The Department of Communications and the Arts informed the inquiry that the Bureau of Transport and Communications Economics (BTCE) has recently estimated Telstra's lines per employee for 1993-94 and 1994-95, compared with the period 1979-80 to 1992-93. A graph drawn from the BTCE work is at Figure 1 below. It shows that the lines per employee ratio improved from the late 1980s to 1993-94, but it also suggests that overall the rate of improvement is declining, and that the rate of this decline would be greater if not for the strong growth in the number of mobile subscribers. Since mobile subscribers are typically excluded from the international data set out above, it is the “fixed lines/employee” ratio which is relevant - and which points to a serious and persistent problem.

Source: BTCE estimates

Evidence about Telstra's inefficiency was also provided by Mr Brian Perkins of the Service Providers' Action Network:

As a broad comparison, SPAN member, AAP Telecommunications (AAPT), currently generates around $770,000 per employee per annum compared with Telstra at around $160,000...Telstra's efficiency is significantly less than AAPT's. [13]

The combined weight of this evidence leaves us no choice but to conclude that there is significant scope for improving Telstra's performance.

This was acknowledged by Mr Paul Rizzo, Group Managing Director, Telstra:

...for 1994-95 we assess that we are approximately 25% below the floor on world's best practice compared to the peer group in this particular methodology. As the peer group continues to improve - we are not in a static world - we could be up to 40% below best practice within the life of our next three year corporate plan. [14]

It is particularly interesting that there is acceptance across a wide range of ideologies and interests that Telstra is inefficient. For example, the point has been acknowledged by the Australian Consumers' Association:

ACA argues that Telstra is only a mid range performer in terms of efficiency... [15]

Indeed, even the Telstra unions accept that Telstra is behind world's best practice. The following exchange between Senator O'Chee and Mr McLean of the CEPU demonstrates the point:

Senator O'Chee: Do you accept the fact that it [Telstra] is behind world's best practice?

Mr McLean: It can be improved. I do not think there is any argument about that. [16]

Some witnesses argued that Telstra's poor performance relative to international best practice can be accounted for by the different operating conditions in Australia, such as Australia's large relatively lowly populated land mass. However, we are satisfied that the evidence shows that these conditions do not account for Telstra's relative inefficiency. The evidence on this point was summarised by the Department of Communications and the Arts:

The contribution of a geographically-dispersed population to the productivity gap between Australia and other carriers has been examined (Henry Ergas and BIE) and the conclusion drawn that only a small amount of this gap can be attributed to geographical factors. While Australia does have sparsely-settled areas to service, the additional cost of these is small relative to total cost (BTCE). Also, Telstra has the advantage of highly-urbanised areas connected by the so-called `golden boomerang' communications corridor. Comparisons with carriers operating in sparsely populated areas - such as US West (BZW) and the Canadian carriers (BIE) - indicate that Telstra's productivity is substantially lower. [17]

Of course, the Opposition Parties know full well Telstra is relatively inefficient. They do not want to admit it, though, because this fact is one of the foundation stones for the Government's policy of part privatising Telstra. So the Majority Report contains this delightful piece of equivocation:

The Committee concluded that the evidence submitted to it on Telstra's performance allowed for a wide range of interpretations. [18]

This is the kind of thing you would expect to hear if you returned home to find someone rifling through your bedside table: “It might look like a burglar, but the evidence allows for a wide range of interpretations.” Just as you would be sceptical in this situation, so we are unpersuaded by this remark in the Majority Report. We believe that the evidence overwhelmingly shows that Telstra is relatively inefficient by world standards.

2.2.1.2 Experience shows that privatisation tends to bring increased efficiencies

Experience of privatisation elsewhere in the world shows that privatisation leads companies to improve their performance. For example, the Department of Finance cited a study of 41 firms fully or partially privatised between 1981 and 1989 in fifteen (primarily industrial) countries, which showed those firms achieved substantial efficiency gains. Once privatised, the firms:

1. increased returns on sales, assets, and equity;
2. improved internal efficiency through better utilisation of physical and human resources;
3. improved their capital structure - becoming less leveraged;
4. increased capital expenditures; and
5. marginally increased their work forces as a result of higher investment and faster growth. [19]

Referring to the same study, Telstra said:

In a separate empirical comparison of the pre and post privatisation financial and operating performance of the fully and partially privatised companies, Megginson et al found that the mean and median profitability, real sales, operating efficiency and capital investment spending increased (in statistical and economic terms) after privatisation. Sales per employee increased from an average 95.6% of the year 0 value during the 3 year pre privatisation period to 106.2% of the year 0 in the post privatisation period. Net income per employee increased even more, by a mean 25.1%. According to this study, efficiency improvements were the norm for most of the sample companies. [20]

Summarising the outcome of the major economic studies on the effects of privatisation Telstra submitted:

The authoritative empirical studies summarised here support the conclusion that private ownership is likely to result in higher levels of company profitability and performance. These studies and the weight of numbers of other studies, support this conclusion. We have not identified a body of studies which indicate that public ownership is likely to result in superior commercial performance. [21]

Telstra also cited research on a related point: the relative economic performance of firms in public and private ownership.

Vining and Boardman (1992), in their major study Ownership Versus Competition: Efficiency in Public Enterprises, provide an overview of empirical research on the efficiency of private and public firms. Their review...shows that most studies of the comparative performance of private and public companies conclude that private companies are more efficient than public companies. [22]

We expect that the benefits of privatisation experienced by other countries will be achieved in Australia. After all, the experience from other industries in the Australian context has been similar. For example, the Department of Finance pointed out that the operating efficiency of the Commonwealth Bank of Australia (CBA) has improved significantly since the Initial Public Offering (IPO) of shares in 1991. The CBA's cost / income ratio has fallen from 67.7% in 1991-92 to 60.9% for the half year ended 31 December 1995. CBA staff numbers (measured as full-time equivalents) have fallen from 45,790 in 1991-92 to 35,822 in 1994-95. [23]

The likely efficiency gains which Telstra might achieve were summarised thus:

If Telstra was to realise efficiency gains of 30% (based on operating expenses per access line) bringing the company closer to world's best practice, it is estimated that this would realise savings in the order of $1.6 billion. Privatisation, with accountability to private investors, would accelerate the necessity to achieve such efficiency improvements. Ultimately, shareholders and consumers benefit from such efficiency improvements. [24]

2.2.1.3 The Commonwealth will share in efficiency gains as two thirds shareholder

We believe it is significant that the Government is proposing to retain two thirds ownership of Telstra. The constant references, during the course of the Inquiry, by the Opposition Senators and some witnesses to total privatisation were misleading and untrue. The same untruth is repeated throughout the Majority Report. Many witnesses who made such claims were asked by Government Senators who they believed would take the decision to permit 100% privatisation, given that the Government does not have a majority in the Senate. They were quite unable to provide a satisfactory answer to this question.

Unlike some full privatisations overseas where a significant proportion of the efficiency gains went to the new private sector owners, the Commonwealth, as the major shareholder of Telstra, will share in the efficiency gains produced from privatisation. On this point, the Department of Finance submitted:

While the Government will forego future dividend payments in proportion to the shareholding it sells, Telstra's current and expected dividend payments are significantly less than the expected interest savings associated with the likely reduction in Commonwealth debt (equivalent to the estimated value of the Company). If the potential for increased profitability is realised following the stimulus of private investment, this would further increase the value of the Commonwealth's residual two thirds equity in later years, and may be expected to increase dividend payments on a pro-rata basis. [25]

We note that paragraph 4.44 of the Majority Report makes the extraordinary claim that the only beneficiaries of a partial privatisation of Telstra would be a few private individuals, and not the people of Australia. This claim reveals a fundamental misunderstanding of the rationale for the Government's policy: to increase Telstra's efficiency so as to bring consumer benefits.

In addition to consumer benefits, of course, there will be significant benefits to the Government as majority shareholder, due to the increased profitability which Telstra would achieve as a result of its exposure to the private sector. An extensive study conducted by Parker and Martin (1996) on the profit levels of 11 privatised firms in the United Kingdom confirmed that 'privatisation does seem to have been associated with higher profitability.' [26] As the partial privatisation increases Telstra's efficiency and hence its ability to prosper in a competitive environment, the government, and the people of Australia, as the majority shareholders, will more than likely stand to gain from the enhanced value of their investment in Telstra. Conversely, should Telstra remain in full public ownership, with the handicaps which that will impose on its ability to respond to competition, the value of that investment will inevitably shrink.

2.2.1.4 Exposure to capital markets discipline and scrutiny

That partial privatisation will improve Telstra's performance is not a matter of theory. Rather, the evidence presented to the Inquiry points to a range of ways through which these effects will occur.

We are persuaded by the evidence that we heard that privatisation will drive Telstra to be more efficient because its managers' performance will be subject to the disciplines and scrutiny of the capital market. When Telstra's shares are listed, the prices at which they trade will provide a benchmark for assessing management performance and determining the value of investments and marketing initiatives. In listed companies, shareholders dissatisfied with corporate performance are able to sell shares in the enterprise, driving down share prices and exposing management performance. The threat of sell-down, and the continuous assessment of performance, disciplines management to operate efficiently and meet market expectations. The market's changing valuation of Telstra will also provide an important indicator to the Commonwealth, assisting in its own scrutiny of Telstra's performance.

Part-privatisation will not only impose greater disciplines on Telstra management by exposing them to the disciplines of the capital market; it will also provide additional public accountability as Telstra is subjected to the scrutiny of the capital market. This point was made by the Business Council of Australia:

The exposure of a company's commercial performance and structure to the capital market, both in terms of price trends and scrutiny by market analysts, will provide a sharper focus for management and prove to be a strong driver to improve products and efficiency. [27]

Similar views were expressed by other witnesses, including investment bank BZW, the Department of Finance and the WA Chamber of Commerce and Industry.

We therefore believe that the listing of Telstra, following its part privatisation, will increase the scrutiny on and accountability of Telstra management. We further believe that this increased scrutiny and accountability will force greater efficiency and create room for sustainable benefits to consumers.

2.2.1.5 Alignment of staff, company and shareholder objectives through employee incentives

A number of submissions to the Inquiry explained that through the provision of special incentives for employee share ownership, the Government is helping to ensure that a partially privatised Telstra will improve its performance. Schemes which encourage share ownership among employees allow the closer alignment of objectives within a company. As owners, employees will have an even more direct incentive to improve company performance.

Of course, the Opposition Senators argue that employees of Telstra already have an ownership interest along with all other Australians, as the company is publicly owned. This is mere sophistry, and does not engage with the key issue: that there is plenty of evidence that companies whose employees own shares in the company in their own right do better than companies where this is not the case. This occurs because employees who own shares have a direct financial incentive to see the company performing optimally. This, in turn, leads to superior company performance, as the Telstra submission pointed out:

Surveys by the Remuneration Corporation 1992/95 show that for Australian listed companies over a recorded half decade, those companies with an employee share plan delivered 88% higher total realisable returns to shareholders. Comparable studies in Canada by the Canadian Stock Exchange reveal 123% higher profit growth for companies with employee share plans. [28]

 

2.2.2 Part privatisation will give Telstra greater commercial freedom

A second set of reasons why partial privatisation will lead to improvements in Telstra's performance comes from the fact that Telstra will enjoy greater commercial freedom post partial privatisation, subject to monitoring by financial markets. In many important facets of its operations, Telstra is subject to restrictions as a result of being in public ownership which leads to sub-optimal performance. For example, it is clear from the evidence that under full public ownership Telstra faces special difficulties in raising capital.

Currently, Telstra's capital requirements are met through internal fund raising, largely from retained earnings. As a government business enterprise, Telstra is subject to Loan Council constraints, similar to other Federal and State owned enterprises. This places an upper constraint on Telstra's annual borrowing capacity. The company does not have access to capital injections, as is the case for other companies and borrowings.

As the global environment becomes more competitive, the continuation of such constraints may not be commercially sustainable in the future, particularly where profitability and cashflows come under pressure from new market entrants. [29]

Although Telstra is not currently capital constrained, ultimately it must have greater access to capital if it is to continue to grow. Part-privatisation will assist in this, as the WACCI pointed out:

Telstra must be free to raise capital according to its commercial requirements. Telecommunications is a highly capital intensive industry and its investment requirements are massive. Privatisation will free Telstra from explicit (Loans Council) and implicit (political) pressures which might otherwise restrict its capacity to raise capital, and will reassure investors that capital raisings are being undertaken on commercial grounds.

In the current tight fiscal climate, the willingness and capacity of the Government to fund substantial investment by Telstra is, at best, open to question. [30]

Another area where a part privatised Telstra would enjoy greater freedom of action is in its capacity to enter into joint ventures. Indeed, the very inclusion in the terms of reference of this Inquiry of paragraph (g), “whether joint ventures by Telstra are `de facto' privatisation and whether they confer unfair competitive advantages on Telstra's partners”, is a good example of how public ownership currently imposes restrictions on Telstra's capacity to enter into joint ventures.

Telstra pointed out in its evidence before the Inquiry that joint ventures are an important commercial tool which are routinely used by businesses in private ownership. Telstra sees sound strategic reasons for using joint ventures in a range of circumstances, but currently its capacity to do this is limited.

From a commercial perspective Telstra sees sound strategic reasons for entering into partnering arrangements. It is one of a range of business tools that can be employed to provide more flexibility for a company entering into new markets, capturing efficiencies through outsourcing and protecting the company's revenue base. Partnering with local companies can also be a regulatory requirement for entry into overseas markets.

...From a commercial view, Telstra considers that partnering in Australia and internationally is important to the company's future success. Telstra's strategy should be seen in the context of a global market, where alliances and joint ventures are becoming a normal way of competing in the market. FOXTEL and the ISSC partnerships are two prime examples where Telstra is using alliances to make the transition to an information and communications services company, while also protecting the value of the core business. [31]

We are satisfied that it is highly desirable that Telstra should be able to enter into joint ventures. As to our view on paragraph (g) of the terms of reference, “whether joint ventures by Telstra are “de facto' privatisation and whether they confer unfair competitive advantages on Telstra's partners”, we are satisfied that joint ventures do not represent de facto privatisation. Moreover, we have heard no evidence to suggest that the normal laws regulating anti-competitive conduct are in any way inadequate to prevent Telstra's joint venture partners receiving any unfair advantage.

Finding: There is no basis for the concern that the entry by Telstra into joint ventures constitutes de facto privatisation or confers unfair competitive advantages on Telstra's partners.

 

2.2.3 Part privatisation will give Telstra greater clarity of purpose

A third driver of improvements to Telstra's performance which we have identified from evidence heard by the Inquiry is that partial privatisation will bring a greater clarity of purpose to Telstra. Full public ownership means that Telstra management, of necessity, must have greater regard to the possible political consequences of business decisions than a private counterpart. Telstra's own submission indicates that it perceives that political considerations are having an important bearing on its decision-making:

Complying with the range of government objectives and company law reporting obligations can impose conflicting objectives on management. For example, objectives to maximise shareholder returns may be incompatible with achieving other "political" objectives to provide services to satisfy a particular constituency. [32]

A similar point was made by Mr Alan Horsley of the Australian Telecommunications Users Group:

...the private sector ethos of commitment and achievement is likely to bring benefit to the quality and robustness of the Telstra network. I think, from our perspective, the quality of services provided by Telstra is second to none. Our concern is that often you cannot get them, that the development does not occur quickly enough, that the way in which the services are presented ought to be more customer focused...

We think that the drive that is offered by the private sector ethos, the concept of some private sector people on the board of Telstra, is a good thing. We also see that the discipline of removing ministerial reference and interference is an eminently sensible thing to do in that it will provide a much more focused opportunity for Telstra. [33]

This point was also endorsed by the former Labor mayor of Townsville, Mr Mike Reynolds:

I have no doubt that with a privatised or partly privatised organisation we would have less political interference in that particular way...In terms of a privatised or semi-privatised board of Telstra, naturally we see a lessening of that government influence. [34]

Witnesses commented that they saw the proposed ownership structure as achieving a desirable outcome for Telstra:

In regard to ownership issues the ATIA fully supports the approach foreshadowed by the Government that Telstra remain majority Australian owned and controlled. This approach will provide the policy thrust to ensure Telstra is more responsive to market signals whilst ensuring that this most important strategic industry remains in Australian hands. [35]

2.3 Part privatisation will bring benefits for consumers

Improvements in Telstra's efficiency are just a means to an end. Unless the benefits from those improvements in efficiency are passed on to consumers, we do not believe there is a case for privatisation. We were therefore pleased that the Inquiry received ample and convincing evidence, based on overseas experience, that part privatisation of Telstra will benefit consumers through performance improvements being shared with consumers. In our view, this evidence demonstrates compellingly that the Majority Report is wrong in arguing that part privatisation will make the people of Australia the financial losers. [36] In fact, the lesson of overseas telco privatisations is that as Telstra becomes a more efficient operator in a competitive environment, it will pass on price reductions to the Australian people which will lead them to enjoy, in aggregate, significant financial gains.

The Inquiry learned that consumers received substantial benefits as a consequence of privatisation in the UK telecommunications industry. Telecommunications consumers in the aggregate gained in every year since the announcement of the sale of BT. Although there was some deterioration in the quality of service in the early years after privatisation - partly because of increased demand - subsequent improvements reversed the deterioration and yielded an overall improvement. [37]

The submission from the Department of Communications and the Arts went into considerable detail about the benefits for consumers arising from privatisation of BT in Britain and TCNZ in New Zealand:

A World Bank study “Welfare Consequences of Selling Public Enterprises” published in 1994 stated that the benefits to the British consumer of the sale of British Telecom (BT) amounted to 4,150 million pounds.

The study further concluded that the substantial additional revenues which BT generated from sales each year, both before and after government divestiture, differed in their source in that prior to divestiture the revenue boost came primarily from raising prices; whereas after divestiture it came from increasing real output.

Since BT's privatisation in 1984, OFTEL figures show that the overall weighted average of BT's prices subject to control under its licence has declined by over 40 per cent in real terms. Business connections, for example, decreased by 36 per cent, while reductions in peak rate national calls were between 56 per cent and 78 per cent depending on the category. At the same time, BT's quality of service has improved significantly when measured against most indicators.

The costs of telecommunications have also fallen sharply for the smaller residential customers: those who make relatively few STD calls. In the three years since July 1993, the total bill of the typical “low user” residential customer - one who makes less than five pounds of calls per quarter - has fallen by over 20 per cent.

The privatisation of Telecom New Zealand (TCNZ) and the deregulation of telecommunications in New Zealand has resulted in similar benefits. On average, charges for residential toll calls decreased in nominal terms by 14 per cent per annum over the seven years to 1995. TCNZ's overall price per minute for national long distance calls reduced by 55 per cent in real terms between 1988 and 1994; and TCNZ increased its total factor productivity by 9.5 to 10 per cent annually over the same period. [38]

The Department of Communications and the Arts provided the Inquiry with the data in table 3 below, which are drawn from an OECD comparative study on telecommunications prices. The OECD methodology for the comparison of national business user prices involves a basket of fixed charges and usage charges, including fixed phone lines, local and trunk call charges set at certain ratios (20% fixed - including installation and rent, and 80% usage). The table demonstrates that Telstra's performance ranking has been static, remaining at 14, whilst both BT and New Zealand have improved their respective rankings.

Table 3 - Price movements and OECD price rank for Australia, New Zealand and the UK, 1992 and 1994

Country	1992(rank)	1994 (rank)
Australia (Telstra)	1156.20 (14)	1012.19 (14)
UK(BT)	925.77 (10)	763.48 (7)
New Zealand	934.47 (11)	778.79 (8)

 

Similar evidence on this point was provided by Telstra:

The overseas evidence suggests that market liberalisation, along with exposure to market disciplines, has created the mix of commercial incentives for telcos to achieve efficiency gains and deliver lower price services for consumers. Moreover, there is evidence that the quality of service delivered by the newly privatised firm does not decline...

....Competition, along with privatisation is expected to maximise these consumer benefits. In the case of New Zealand, Ergas has argued that "the trifecta of full liberalisation, privatisation and light-handed regulation" has delivered positive consumer outcomes. New Zealand telecommunications charges are now estimated to be around 20% less than charges in Australia. Ergas also compared the quality of service between TCNZ and Telstra and found no significant difference. [39]

Telstra also cite a recent study of the New Zealand experience which finds very positive results for consumers following the TCNZ privatisation.

Boles de Boer and Evans (1996) report that New Zealand deregulation and privatisation resulted in price reductions leading to an increase in consumer welfare valued at NZ$575 million per year. The discounted value of this sum exceeds the sale price of TCNZ (NZ$ 4.25 billion). The authors state that the bulk of the gains have accrued to consumers. [40]

It is interesting that the likelihood of price benefits for consumers following the privatisation of Telstra appears to be accepted by many participants in the present debate. For example, Ms Ros Eason, Senior Industrial Research Officer with the CEPU, said:

Telecom New Zealand's prices have declined. All the telecommunications companies' prices have declined since privatisation - that is not at issue. [41]

As well as studies dealing with the experience of telco privatisation in Britain and New Zealand, there is a considerable literature dealing with the more general question of the consequences of privatisation for consumers and other stakeholders. In a supplementary submission to the Inquiry which reviewed this literature, Telstra noted:

The two most authoritative studies dealing directly with the effects of privatisation are The Financial and Operating Performance of Newly Privatized Firms: An International Empirical Analysis (Megginson, Nash and van Randenborgh, 1994) and International Welfare Consequences of Selling Public Enterprises (Galal, Jones, Tandon and Vogelsang 1994). Although these are not perfect, these studies are thorough, empirical and not contradicted by other evidence. [42]

Telstra's submission reports that the Galal, Jones et al study:

• is based on detailed case studies of 12 privatisations in the UK, Chile, Malaysia and Mexico, including three telecommunications companies
• compares actual outcomes from privatisation to “counterfactual” scenarios, ie assumptions about what would have happened had privatisation not occurred
• finds that privatisation improved economic welfare in all 12 cases studied
• found that the distribution of privatisation benefits varies from case to case - for example, the benefits of privatising the Chilean telephone company flowed largely to consumers
• found that consumer welfare increased in five cases and was unchanged in three cases. [43]

Telstra expanded on the Chilean outcome as follows:

In the case of Chile, the majority of benefits arising from privatisation of the national phone company accrued to consumers (90%), as a result of increased network investment made possible by funds freed up by the divestiture. [44]

The Majority Report devotes considerable effort to criticising the empirical evidence which was put to the Inquiry, including the studies we have cited above, as to the efficiency and other benefits of privatisation. [45] The main theme of the criticism was that no empirical study exists which exactly duplicates the circumstances of Telstra's privatisation. This is quite true; there is only one Telstra, there is only one Australia, and there is only one 1996. But it is equally true that the overwhelming weight of evidence from privatisations around the world, across a range of countries and industries, suggests that privatised companies perform more efficiently and this leads to benefits which are shared between a range of stakeholders including, importantly, consumers. No amount of rhetorical extravagance about General Pinochet's regime will allow the Opposition Parties to evade this fact.

The evidence we have cited raises the question as to how it is that privatisation brings benefits of the kinds described above. The evidence provided to the Inquiry suggests that benefits arise because private sector companies, focussing on improving returns and reducing costs, are likely to be more innovative than their public sector counterparts. A part-privatised Telstra will have every incentive to maintain and improve its relationship with existing customers. It will want to satisfy their needs for new and improved services or risk losing them to competitors. For example, one of Telstra's key commercial advantages is the ubiquity and nearly universal use of its basic telephone network. It will want to retain that advantage as the services available are enhanced. It has clear incentives to try to be the low-cost provider of enhanced services to rural and remote customers, thereby ensuring the fullest use of its network facilities.

A good statement of the effects of part privatisation on Telstra's motivation to provide superior customer service was made by Mr Graeme Ward, Group Director, Regulatory and External Affairs, Telstra, when he appeared before the Inquiry:

In an increasingly competitive environment - and we are going to move from one period of competition between 1991 and 1997 and beyond 1997 into a very open competitive regime - competition is all about competing for customers and customer business and our focus is very much on fighting for customers, retaining our customer coverage and winning new customers....What we are on about is winning the customers' loyalty and we can really only do that by service, the duality of service at competitive prices - the value equation. [46]

The Government of Western Australia, in its oral submission made by Mr Phillip Skelton, indicated that it supported part privatisation of Telstra on the grounds of the likely benefits for consumers:

...consumers will benefit if Telstra, as one of the competing carriers, is robust, effective, customer responsive and internationally competitive. Telstra has gone a long way towards improving its performance over the last few years in the face of the competition that it has actually had....Nevertheless, we see that it has now reached a barrier where some further significant change has to take place before it can remain healthy and competitive and deliver its good results in the future more open and competitive environment.

Consequently, the Government of Western Australia supports the concept of the partial privatisation of Telstra. We see a number of benefits flowing immediately to Telstra as a result of that action. That, in turn, would flow through as benefits to consumers. [47]

The National Farmers' Federation supports part privatisation of Telstra on the grounds of improved service.

Look at the New Zealand experience where they privatised New Zealand Telecom. We have spoken to New Zealand Federated Farmers and asked them if they found the service better or worse since New Zealand Telecom has been privatised. They have certainly said there is a better service delivery. The sort of examples that are quoted are that the waiting time for new lines is down from six weeks to three days. Certainly the farmers of New Zealand feel that service delivery is a lot better. [48]

Electronic Commerce Australia, the peak body for the electronic commerce community, also believes privatisation will lead to improvements in service.

ECA members support the sale of Telstra in the belief that Telstra will be able to compete in the same market place with the same conditions as any other service provider. Users of electronic commerce require from their suppliers improved services, lower costs, improved quality and on time delivery. A fully privately owned Telstra will, we believe, create the market conditions for this to evolve. [49]

The Majority Report argues that the expected consumer benefits may be compromised because Telstra is a monopoly. [50] We believe this argument overlooks the fact that in many key markets, including mobile, long distance and international, Telstra has lost substantial market share to Optus and Vodafone. The increased competition to be introduced under the post-1997 regime will only add to the competitive pressure on Telstra. Additionally, the argument used in the Majority Report appears to assume that as a part privatised company Telstra is in some way less likely to exploit any monopoly power it enjoys than it would be as a public company. The absurdity of this proposition is evident to anyone who recalls the indifferent customer service and high prices which prevailed in the days when Telecom was the sole telephone company in Australia.

We are therefore satisfied, based on a very thorough review of the evidence, that the partial privatisation of Telstra will deliver substantial consumer benefits.

2.4 The case for withdrawing Government funds from Telstra

As many submissions demonstrated, there are considerable benefits to introducing private ownership in Telstra. But - as a separate issue - there is also a strong case for reducing Government ownership of Telstra. As the Department of Finance argued, at one time there was a good case for putting Government money into what was then a fledgling industry; but that time has long since passed:

The need for Government investment in the telecommunications industry is reducing and public resources may better be redirected to other uses. While in previous generations it may have been necessary for Government to invest to develop the national telecommunications industry, it is now clear that three forces are reducing the case for public intervention in private capital decisions:

1. the commercial capital markets now have the depth, sophistication and readiness, not only to provide the further capital needed for development, but also to replace the Government's own sunk capital; the industry is now sustainable in the private equity market;
2. pressure for scarce public sector resources to be deployed to national goals that are inappropriate for private sector investment (such as public sector debt reduction and environmental safeguards and restitution) means that public capital, where possible, should be withdrawn from investments which can now be appropriately funded by private capital and placed more appropriately in these higher priority areas - privatisation achieves this; and
3. the telecommunications industry is in an era of fast growth, diversification and technological change; this increases the risk associated with continuing to hold a substantial investment in the industry. While governments do have a substantial capacity to spread risks, taxpayers have a clear reluctance to accept high levels of risk. The need for taxpayers to assume a higher level of risk is much reduced compared to a decade or so ago because the capital markets now allow investors to choose the level of risk that they are prepared to accept - with commensurate expected returns. This allows individuals - either directly or through institutions and fund managers - to exercise greater individual choice than if they were all required to assume a specific risk because of public ownership of assets that may be riskier than they would freely select. Adequate private risk capital is available in an efficient market, with investors participating in the market doing so with full knowledge of the risk-return trade-off involved. [51]

2.4.1 Release funds for other purposes

One set of reasons for withdrawing public money from Telstra is that resources are limited and must be allocated where they are most needed. Public ownership of Telstra represents a very substantial public capital investment in the provision of telecommunications infrastructure and services. Public ownership of Telstra is no longer a necessity to ensure that all Australians have access to adequate telecommunications services. It makes good sense, therefore, for Government to consider whether some of the capital tied up in Telstra might be better employed.

In our view, there is no doubt that there is a pressing need for that capital to be applied to reduction of public debt. Following Labor's years in government, the interest bill on public debt is a major Budget item in its own right.

The pressing need for spending on the environment is another reason why it makes sense to withdraw funds from Telstra. The Government has identified a program of investment to repair and replenish our natural capital for this and future generations of Australians. There has been no questioning of the priority which should be accorded to this investment - the only issue is the means by which it can be funded.

2.4.2 Reduce the Government's exposure to an increasingly risky industry

We believe that another set of reasons for reducing public ownership in Telstra relate to the increasing risk of the telecommunications industry, and the desirability of the Government reducing its exposure to this risk.

Telstra highlighted the increasingly risky environment it operates in:

Rapidly changing technology as is occurring in the telecommunications industry brings with it greater risk, along with the possibility of greater reward. The product range is expanding and diversifying and the product development cycle is shorter. Lower barriers to entry enable more competitors, generating high returns to those who can act quickly to marshal the necessary resources. [52]

The implication of this is that Government should carefully examine whether it is appropriate to have so much public money tied up in this industry. The point was well made by the WA Chamber of Commerce and Industry:

....the changing nature of the market implies that taxpayer funds invested in the telecommunications industry are less secure than they once were. Shareholders who risk their wealth by investing in private businesses do so voluntarily. It is not appropriate for the Government to risk taxpayers' funds in this way in an industry which can be demonstrated to operate at least as efficiently in private hands as in the public sector, unless there are strong over-riding arguments implying a public benefit from public ownership. For telecommunications this does not appear to be the case. [53]

The decisions which Telstra has to make - about network investment; about provision of new services; about entering new markets - are all commercial decisions. They are decisions which should be fully subject to commercial assessment. Even on the issue of universal service obligations, the decisions Telstra must make are fundamentally commercial: namely, to determine the most economical means to provide the standard of service which the Government has mandated. Decisions of this kind are not the proper province of Government, because they are not public policy decisions.

2.5 Part privatisation will reduce the Government's conflict of interest

While the Government has made clear that it will be giving priority to achieving a pro-competitive framework and maximising benefits to consumers over obtaining the maximum sale price from Telstra, there is a clear perception that full public ownership creates conflicts of interest with the Government's negotiating role. A number of submissions argued that part-privatisation will reduce the scope for such conflicts, as it forces the Government to make regulatory arrangements transparent and deal with Telstra at arms-length:

Privatisation would also reduce the Government's conflict of interest in the way in which the industry operates. The Government has responsibility for providing a national legal and regulatory framework designed to ensure economic efficiency by encouraging competition and preventing abuse of monopoly power. But as sole owner of Telstra and sole recipient of its revenues it also has a substantial interest in maximising profits and returns, and retention of regulation and anti-competitive behaviour are likely to be profitable to the government. [54]

It is interesting that Professor Quiggin has pointed to the existence of this same conflict of interest:

Senator Margetts: Professor Quiggin, you have indicated that there seems to be a potential for a major conflict of interest in relation to part-privatisation...

Professor Quiggin: The issue is basically that these decisions are going to affect the sale price to the extent that the government can give guarantees that the decisions after privatisation will be in a manner favourable to the owners of the asset...Any guarantees of that sort will increase the sale price, but they may well lead to bad public policy. [55]

While both the Government and its opponents perceive the existence of the same conflict of interest - between the Commonwealth as regulator and as owner of shares in Telstra - only the Government is suggesting a solution. The opponents seem quite happy to leave Telstra 100% publicly owned, with the conflict starkly exposed.

2.6 Part privatisation will bring national economic benefits

The Inquiry received considerable substantive evidence concerning the potential benefits to the wider economy. Based on that evidence, we are of the view that part privatisation of Telstra will bring substantial national economic benefits in two important ways:

• GDP consequences
• benefits to national savings and repayment of public sector debt.

2.6.1 A boost to GDP

Telstra's submission provided a detailed exposition of benefits in terms of GDP growth, consumer surplus, more efficient use of the community's resources, improved international competitiveness and reducing the relative cost disadvantages experienced by businesses and residents in rural and remote regions of Australia.

According to Industry Commission analysis, adoption of Hilmer-type competition reforms in the telecommunications sector was estimated to achieve significant improvements in GDP of the order of $2.7 billion. Follow-up analysis by the Centre for Regional Economic Analysis showed that all industries and every state of Australia would benefit from these reforms. This results because virtually every business in Australia is connected to a telephone network and therefore uses a component of communications as an input in the production process.

...It is also important from an international competitiveness viewpoint that Australia has an efficient and minimum cost telecommunications infrastructure. Improving productivity within Telstra and the industry assists exporters (and potential exporters) to compete in international markets and domestic-focussed firms to compete with imports. Higher exports and import substitution both operate to increase measured domestic GDP. Furthermore, this could lessen (although difficult to quantify) the current account deficit, historically a major cyclical constraint to economic growth in Australia. [56]

Several submissions reinforced this point by drawing attention to the benefits for other industries - particularly those exposed to international competition - of achieving efficiencies in the delivery of telecommunications services. For example the submission by the National Farmers' Federation stated:

As business operators at the end of the chain, the farming community have had to bear the cost of, in many respects, inefficiencies in services provided in that way in the past. As the telecommunications industry moves into the next century, we have to have them moving at that pace and we definitely need Telstra to be able to keep pace with the competitors that are now snapping at their heels. [57]

The case for widespread economic benefits deriving from a combination of part-privatisation of Telstra and enhanced competition in the telecommunications market was further supported by work commissioned by the Department of Communications and the Arts.

The Inquiry heard that the Department of Communications and the Arts had commissioned some modelling of the potential economic gains arising from improving Telstra's labour and capital efficiency. [58] This built on work done previously by EPAC and the Industry Commission and suggests that there are some significant potential gains to the wider Australian economy simply through improving Telstra's technical efficiency (ie. without taking account of likely changes to service offerings).

The work was summarised as follows:

For labour, efficiency gains of 15%, 30% and 45% were modelled for the communications sector as a whole. These correspond to improving Telstra's ratio of access lines per employee to about 160, 190 and 220 respectively (adjusted for Telstra's market share). For capital, efficiency gains of 0%, 10% and 20% were modelled. Notably, the middle case scenario (a 30% gain in labour efficiency and 10% gain in capital efficiency spread over four years) indicates the following:

• private consumption (an indicator of living standards) would increase by $1.7 billion (a permanent 0.6 per cent gain)
• an 11.7% fall in the long run price of communications services
• an associated gain in economy-wide GDP peaking at 0.5% ($2.4 billion) in 2002/3 moderating to 0.35% ($1.7 billion) in the long run.
• a decline in employment in the communications sector of 17.5%, which was offset by increases in employment in other sectors and a long run economy-wide gain of $3 per employee per week in 1995-96 prices.

Allowing for the limits of modelling of this type, there are clearly significant benefits to the economy, businesses and consumers from increased efficiencies in Telstra and the communications sector generally. [59]

Clearly there are very real benefits for the community and the economy as whole from improving Telstra's efficiency. Because of Telstra's importance in the telecommunications sector and the significance of telecommunications to other sectors, the benefits of efficiency gains in Telstra will permeate virtually every area of economic and community activity.

Finding: Part privatisation will induce Telstra to become more efficient, which will in turn improve the quality and reduce the cost of telecommunications services, leading to significant improvements in Australian economic activity.

 

2.6.2 A boost to national savings and debt repayment

An additional national economic benefit comes from the use of the proceeds of part privatisation to repay public sector debt. This is clearly a secondary consideration to the benefits to the community and the economy associated with efficiency gains in Telstra and the telecommunications sector, but it is nevertheless important, and of course it is relevant to paragraph (e) of the terms of reference, “the impact on public sector savings of the partial sale of Telstra.”

The Department of Finance explained the economic benefits that will follow:

The proceeds of the partial sale will provide the Government with an opportunity to reduce the amount of Government debt which it needs to service (with ongoing savings in debt service costs), and/or to fund high priority tasks - such as the Natural Heritage Trust. Importantly, lower debt levels - and correspondingly lower interest costs - reduce the vulnerability of the Commonwealth to movements in interest rates. It also improves the Government's capacity to pursue counter-cyclical economic policy by varying levels of debt-funded expenditure at relevant points in the economic cycle. [60]

The WA Chamber of Commerce and Industry addressed the same issue, drawing attention to the constraints that high levels of public sector debt place on the Government's ability to respond to real community needs and the regressive and inequitable distribution effects of public debt.

Revenues from asset sales should be used only to reduce liabilities or enhance the value of other public assets. Failure to do so by previous governments has been a major cause of the run-down of net public assets and accumulation of liabilities in Australia over recent years...

The level of Commonwealth Government debt has escalated dramatically in recent years thanks to persistent deficits. According to the 1995-96 Budget papers, between June 1990 and June 1996 the level of debt was estimated to more than treble from around $30 billion to nearly $100 billion. The interest bill alone on debt in the general government sector was expected to be more than $10 billion in 1995-96, rather more than defence spending and only a little less than the education budget. Had the Government not borrowed so much over the early 1990s, the general government sector would be nearly in surplus and the fiscal task facing the new government would be one of prudent management rather than major repairs to restore a structural deficit. [61]

During the course of the Inquiry, there was a good deal of controversy about this issue of the effect of part-privatisation of Telstra on public sector savings and on the Commonwealth Budget. It is therefore important to get the position absolutely correctly understood, and for that reason we closely questioned Mr Hutchinson of the Department of Finance when he appeared before us for the second time. He made it clear that the part privatisation will have a positive effect on the cash side of the budget:

If we look at the situation over the last fully reported financial year, 1994-95, the average interest rate paid on the Commonwealth's stock of debt was around 9.4%. The dividend declared by Telstra was $944 million. Of the sale proceeds of Telstra, $7 billion was to be applied to the reduction of debt. So the dividend loss involved would be one-third of the $944 million - that is, $315 million. The interest cost on the debt repaid would have been $660 million, so the balancing items in a cash sense are a $660 million reduction in interest payments and $315 million in debt, a net saving to the cash side of the budget of $345 million. [62]

He also pointed out that the sale of Telstra at its value in the Commonwealth's notional balance sheet would make no difference to the notional capital side of the budget. [63]

Finding: part privatisation of Telstra will provide an increase in public sector savings by allowing the redemption of $7 billion of public debt and removing a yearly interest bill of around $660 million (ie $7 billion at 9.4% a year) while retaining two thirds of Telstra dividends which last year totalled just under $1 billion (out of a total Telstra contribution to Government by way of taxes, interest and dividends of $2.5 billion).

 

2.7 Part privatisation will benefit the supplier industry

The Inquiry was charged with considering the effect on the supplier industry under paragraph (n) of the terms of reference:

(n) the extent to which the Bill and the post-1997 arrangements will foster the development of Australian telecommunications services and equipment industry, research and development, and the development of new services.

We concluded, based on the evidence presented to the Inquiry, that:

• Telstra will continue to purchase equipment locally after part privatisation
• the present industry plan arrangements will continue
• based on the experience in New Zealand after privatisation of Telecom New Zealand, the prospects for the local telecommunications supply industry are encouraging.

 

Finding: The Telstra (Dilution of Public Ownership) Bill 1996 and the post-1997 arrangements will stimulate the development of the Australian telecommunications service and equipment industries.

 

2.7.1 Telstra will continue to purchase locally

We are satisfied from the evidence we have received on this point that Telstra's role in industry development and fostering Australian suppliers has little to do with its public ownership. Both Optus and Vodafone are committed to industry plans by licence conditions. Under the industry plans the carriers have been pursuing strategic alliances with efficient and competitive Australian-based suppliers because it is in their interests to do so. We have heard nothing to suggest that this will change.

The point is made most tellingly by the Australian Telecommunications Industry Association, which is the “peak industry association representing local and international companies involved in the design, development and production of telecommunications and associated products and systems.” [64] The Association commented as follows:

In brief the Association believes that on the basis of a continuation of the present successful approach of recognising a close nexus between communications and industry policy, the partial privatisation of Telstra will not affect the Australian telecommunications industry. [65]

Telstra made clear to the Inquiry that it will continue to purchase equipment from local suppliers, not out of any sense of patriotic duty but because it is in Telstra's commercial interest to do so:

...For competitive purposes, Telstra has sought arrangements with equipment suppliers and manufacturers. Telstra's partnership with Australian telecommunications industry, formalised in the 5-year Industry Development Plan, is important in meeting the company's strategic objectives to move into new information and communications services. Similarly, the links with Telstra may enable some supplier firms to expand overseas and probably fosters greater innovation on their part.

Telstra does not regard its industry development role as solely about developing local suppliers. Instead, local sourcing has a number of practical and cost advantages for Telstra in terms of shorter supply leadtimes are possible, reduced transport and handling costs because of proximity to suppliers, and more timely and cost-effective after sales service can be offered. These advantages cannot be ignored by any company seeking efficiencies and productivity gains. Therefore, Telstra expects that it will continue to seek out and encourage local companies who can serve Telstra demand for telecommunications equipment and components...

Telstra's commitment to the supply industry is demonstrated by some key highlights of Telstra's Industry Plan (1994/95):

Telstra increased its spend on products and services in 1994/95 by $794 million to $4 252 million;

Telstra traded with more than 10 000 suppliers

- over 50 companies received orders of $10 million or more (a 25% increase);

- over 1000 companies received orders of $400 000 or more;

Expenditure on Australian content increased by an average of 7 to 8% per annum over the past 3 years;

Over 65% of all purchases were sourced locally;

Australian based suppliers received orders of $224 million for Telstra's off-shore;

$218 million was spent on research and development;

• Telstra's support for local telecommunications manufacturing industry employs 13 000 Australians directly and a further 20 000 indirectly.

Telstra is proud of its investment record within the industry and given the mutually advantageous nature of the arrangements, there is little likelihood that the commercial incentives for local sourcing would be diminished. [66]

A similar view was put by a representative of AAP Telecommunications:

Again, I speak as a practitioner. If we can buy from Australian sources, it is absolutely our preferred approach. The greatest nightmare is to buy from overseas sources and find that they do not have anybody available locally... [67]

This position was supported by independent comments by investment bankers BZW:

There is no reason to think privatisation will have a significant effect on the development of the Australian telecommunications services and equipment industry.

Telstra as a publicly owned company should be no more or less benevolent than Telstra as a privately owned company to Australian equipment manufacturers, but rather treat them on their merits. Industry support arrangements including minimum local content rules should be the same in both cases...

Possibly, improved efficiencies within Telstra may flow on to a more efficient Australian telecommunications services and equipment industry, increasing its prospects for competing with overseas companies.

BZW actively researches and advises investors on the merits of two listed Australian equipment companies, AWA and ERG, which develop and manufacture telecommunications services and equipment for the Australian and overseas markets. Neither company would, in our view, be impacted by a partial privatisation of Telstra. [68]

The Majority Report asserts that part privatisation will reduce Telstra's local purchases. [69] In the light of this substantial body of evidence to the contrary, that assertion looks very hollow. We are satisfied that Telstra's purchases from local companies will not be affected by part privatisation.

2.7.2 Industry plan arrangements will continue

We are advised that there will be no change to the current arrangement for industry plans. Under that arrangement, Telstra and other licensed telecommunications carriers are required by licence conditions to produce industry development plans that outline the basis of commercially based relationships with suppliers. This requirement is aimed at the promotion of long term strategic relationships between carriers and suppliers. Those plans have been responsible for encouraging the carriers to source approximately 70 per cent of their telecommunications equipment and software requirements locally (averaging over $2.8 billion per annum from 1991-92 to 1996-97). They have also been a factor behind assisting the telecommunications equipment manufacturing industry to increase exports from $218 million to almost $900 million per annum (approximately a 400 per cent increase) over the first four years of the current industry development policies and in turn, significantly improving the sector's export/import ratio. [70]

The Department of Communications and the Arts provided the Inquiry with the following assurance about the continuation of industry development arrangements:

The essential aim of sector-specific industry policy measures after 1997 would be to provide a regulatory environment that actively encourages the carriers, including those involved with broadband cable networks, to continue to seek to maximise their involvement with the domestic telecommunications supply industry on a commercial and competitive basis and to form long-term strategic alliances that benefit all parties...

The scale and positive impact of existing carrier procurement policies on the sustained growth and development of an internationally competitive domestic telecommunications industry, and the wider economy in general, argue for the continuation of sector specific policies. In this way, a significantly larger proportion of carrier expenditure might remain in the economy. Carriers' current annual purchases of local equipment and services are approximately $4.5 billion. Expenditure levels are expected to remain high in the next few years as carriers rollout their cable networks (Foxtel and Optus Vision). Most importantly, the local carrier market provides the base and market momentum from which the local industry undertakes innovation, investment and, most critically, exports. [71]

2.7.3 Lessons from New Zealand

There were comments made by some witnesses and members of the Committee about the experience of the New Zealand telecommunications supply industry following privatisation of TCNZ. These comments are picked up in the Majority Report. [72] Many of these comments were ill-informed or based on a partial assessment covering only the first year or two following privatisation of TCNZ.

The facts are contained in the submission from the Department of Communications and the Arts:

The experience of the New Zealand telecommunications electronics industry post-privatisation of TCNZ provides some valuable insights on the possible effect of privatisation for Australia's telecommunications supply industry.

Prior to 1984 the New Zealand electronics industry was dominated by “screwdriver” assembly operations - there were no exports. After liberalisation of the New Zealand market the “screwdriver” companies disappeared, but a few specialist electronics firms in niches such as electric fences, mobile radios and medical electronics continued.

The industry has now regrouped and internationally competitive and export oriented firms now operate in key niche markets, including specialist telecommunications equipment. In 1990 exports of telecommunications equipment totalled $NZ 43m. In the year to 30 June 1996 telecommunications equipment exports are expected to total approximately $NZ 200m. Growth in this market is now 30% pa. While growth is slowing in response to appreciation of the NZ dollar exports are forecast to reach $NZ 400m by the year 2000. [73]

 

Footnotes

[1] Telstra, Submission No. 189, Vol 7, p. 1294

[2] Business Council of Australia, Submission No. 355, Vol 14, p 2768

[3] Official Hansard Report, 4 July, p. 245

[4] Telstra, Submission No. 189, Vol 7, p. 1298

[5] Telstra, Submission No. 189, Vol 7, p. 1298

[6] Western Australian Chamber of Commerce and Industry, Submission No. 334, p. 2422

[7] Business Council of Australia, Submission No. 355, Vol 14, p 2768

[8] Australian Consumers Association, Submission No. 340, Vol 13, p 2516

[9] Official Hansard Report, 3 July 1996, p. 145

[10] Department of Finance, Submission No. 188, Vol 7, p. 1271

[11] Department of Communications and the Arts, Submission No. 131, Vol. 4, p. 694

[12] Department of Communications and the Arts, Submission No. 131, Vol. 4, p. 695

[13] Service Providers Action Network, Submission No. 313, Vol. 12, p. 2234

[14] Official Hansard Report, 3 July 1996, p. 108

[15] Australian Consumers Association, Submission No. 340, Vol. 13, p. 2517.

[16] Official Hansard Report, 11 July 1996, p. 419

[17] Department of Communications and the Arts, Submission No. 131, Vol. 4, p.695

[18] Majority Report, para 3.26

[19] Department of Finance, Submission No. 188, Vol 7, p. 1268

[20] Telstra, Submission No. 189, Vol 7, p. 1300

[21] Telstra, Submission No. 366, Vol 15, p. 2907

[22] Telstra, Submission No. 366, Vol 15, p. 2922

[23] Department of Finance, Submission No. 188, Vol 7, p. 1269

[24] Telstra, Submission No. 189, Vol 7, p. 1308

[25] Department of Finance, Submission No. 188, Vol 7, pp 1273-4

[26] Parker and Martin, “The Impact of UK Privatisation on Employment, Profits and the Distribution of Business Income”, Public Money and Management, Vol 16(1), January 1996, p 38

[27] Business Council of Australia, Submission No. 355, Vol 14, p 2768

[28] Telstra, Submission No. 189, Vol 7, p. 1304

[29] Telstra, Submission No. 189, Vol 7, p. 1301

[30] Western Australian Chamber of Commerce and Industry, Submission No. 334, p 2423

[31] Telstra, Submission No. 189, Vol 7, p. 1305

[32] Telstra, Submission No. 189, Vol 7, p. 1303

[33] Official Hansard Report, 12 July 1996, p. 447

[34] Official Hansard Report, 10 July, p. 328

[35] Australian Telecommunications Industry Association, Submission No. 194, Vol. 7, p. 1373.

[36] Majority Report, para 4.45

[37] Department of Finance, Submission No. 188, Vol 7, p. 1268

[38] Department of Communications and the Arts, Submission No. 131, Vol. 4, p.699

[39] Telstra, Submission No. 189, Vol 7, p. 1309

[40] Telstra, Submission No. 366, Vol 15, p. 2907

[41] Official Hansard Report, 3 July 1996, p. 218

[42] Telstra, Submission No. 366, Vol 15, p. 2097

[43] Telstra, Submission No. 366, Vol 15, pp 2907-2917

[44] Telstra, Submission No. 189, Vol 7, p. 1309

[45] Majority Report, para 1.11

[46] Official Hansard Report, 3 July 1996, p. 113

[47] Official Hansard Report, 4 July 1996, p. 241

[48] Official Hansard Report, 26 July 1996, p. 800

[49] Electronic Commerce Australia, Submission No. 365, Vol. 15, p 2892

[50] Majority Report, para 4.38

[51] Department of Finance, Submission No. 188, Vol 7, pp 1271-2

[52] Telstra, Submission No. 189, Vol 7, p. 1299

[53] Western Australian Chamber of Commerce and Industry, Submission No. 334, p 2425

[54] Western Australian Chamber of Commerce and Industry, Submission No. 334, p. 2424

[55] Official Hansard Report, 10 July 1996, p. 364

[56] Telstra, Submission No. 189, Vol 7, p. 1313

[57] Official Hansard Report, 26 July 1996, p. 796

[58] Econtech Report at Attachment B, Department of Communications and the Arts, Submission No. 131, Vol. 4, pp 734-5

[59] Department of Communications and the Arts, Submission No. 131, Vol. 4, p. 697

[60] Department of Finance, Submission No. 188, Vol 7, p. 1273

[61] Western Australian Chamber of Commerce and Industry, Submission No. 334, Vol. 12, p 2430

[62] Official Hansard Report, 26 July 1996, p. 746

[63] Official Hansard Report, 26 July 1996, p. 746

[64] Australian Telecommunications Industry Association, Submission No. 194, Vol. 7, p. 1372.

[65] Australian Telecommunications Industry Association, Submission No. 194, Vol. 7, p. 1372.

[66] Telstra, Submission No. 189, Vol 7, p. 1311

[67] Official Hansard Report, 12 July, p 481

[68] BZW Australia, Submission No. 295, Vol. 9, p. 1857

[69] Majority Report, para 4.97

[70] Department of Communications and the Arts, Submission No. 131, Vol. 4, p.723

[71] Department of Communications and the Arts, Submission No. 131, Vol. 4, p.724

[72] Majority Report, para 4.102

[73] Department of Communications and the Arts, Submission No. 131, Vol. 4, p.725