Ten Messages about Structural Reform

Improvements in public transport systems and logistics in Indonesia are important to improve investment environment in the economy.

Professor Christopher Findlay, University of Adelaide

Maria Monica Wihardja writes on East Asian Forum on 23/9/11 (available here) about Indonesia’s challenges in implementing its commitments on structural reform.   She calls for a clear understanding of the priorities and argues that what matters is both bureaucratic and regulatory reform.

The design of a structural reform program was the topic of a research project for the Policy Support Unit (PSU) of APEC released earlier this year.  The full report is available here. Ten key lessons from past efforts and structural reforms are identified in the report: these are all relevant to Indonesia for the work on the reform agenda which Dr Wihardja calls for.   As she says, getting this agenda right is difficult and requires a lot of work.  But it is possible.  The 10 key lessons provide a significant amount of guidance.

The following is based on an extract from the summary chapter in the report of the APEC project.

1.    Competition is more important than ownership

Generally the result of the review of reform to date stresses the value of competition and contestability and the value of preceding changes in ownership by the introduction of competition.  Most important is competition, since privatisation without it can lead to the continuation of the same problems under a new owner. At least competition for the market or regulation of the critical infrastructure, whose owners might otherwise capture the gains from trade, is required.

2.    Take a forward looking view and provide a leadership commitment

A forward looking view that is regularly and clearly explained helps avoid a trajectory of reform which leads to a landing in an ‘undesirable equilibrium’, that is, becoming stuck at some bad point because of the emergence of new vested interests.  Along with this, it is important that there is a commitment by leaders to structural reform (e.g., to a set of national development goals) and that they have the ability to explain structural reforms.

3.    Be aware of ‘the gap’ in regulatory practice

It is important to have some sense of ‘the gap’, that is, how far away the current policy or regulatory regime is from relevant ‘good practice.’ This level of performance is not the same as ‘best practice’ in global terms but it is the regulatory process that would be regarded as efficient at the state of development.

4.    Know the costs of the current regime

For reform to proceed it is important that the community has some sense of the costs of the gap, which might be poor performance and choice in various dimensions, for example, low quality services or prices too high. Reform driven by efficiency gains to the general public may be important in terms of economic welfare but the dilemma is that reforms of this type may be very difficult to implement and manage. How can it be done? Is this a case where compensation is required? How could efficiency gains be presented as a benefit to the public or small business? Some more appealing communication of the challenges as well as the likely gains will be important.

5.    The commitment to structural reform is continuous and never stops

Structural reform is a dynamic process resulting in dynamic benefits. Yesterday there may not have been a performance gap of note but as times change, gaps will re-emerge. For example, investment in capacity lags behind the growth in demand – this was a driver of reform in the electricity sector in Russia where a key figure in the industry played a lead role in identifying that ‘gap’. Markets will continue to anticipate where momentum exists. The choice, therefore, is not simply one between good and bad practice in a static sense. There is a need to adjust the regime as new gaps to good practice emerge. This is not easy. Also, since structural reform is dynamic (as are its benefits), it is important to avoid the problems of ‘reform indigestion’, that is, a build-up a valuable reforms which are not implemented. Monitoring of performance and reporting on it is part of the process to avoid indigestion.

6.    Promote engagement from within

Is there pressure from the regulated businesses within a sector or constrained businesses in a contestable position? And when can it work as a source of pressure for reform?

Relevant factors might be:

• reform to help correct an internal weakness and improve performance;
• pressures from shareholders;
• pressure from competitors (who might operate in a different regulatory environment, for example, the same market in technical terms providing substitute services but a different institutional setting);
• financing constraints; and
• pressure from downstream sectors which place flow-on pressure.

Reform happens faster when motivated from within.

A clearly defined end point is required for a particular reform initiative. Otherwise, incumbents can recapture a process. But, due recognition needs to be paid to the need to keep up with competitive and regulatory benchmarks set by others.  It is also easier to prevent special pleading from particular regulated industries if structural reform is taken as a package across all state owned enterprises, or at least a group of them. It also helps to establish structural reform as part of a better governance campaign or a budget ‘clean-up’ based on good principles. It need not be simultaneous but it can be a rolling reform.

7.     Use experiments

Experiments can be useful to demonstrate the value of reform.  Criteria for selection (or acceptance) might be the extent of change required or the capability to execute change and the capacity to quantify effects. Complementary research efforts are important to capture the experience end distribute the messages.

8.     Arrange independent evaluation for designing options

Independent evaluation can be very important, either in the formal sector or utilising the second track. Those organisations help to offset the lobbying efforts of the vested interests. They also can challenge the ‘good performer’ myth, that a structure looks to be working well because it is profitable (perhaps too much so) or financing its own investment and maintaining capacity (to too great an extent).  These agencies are also important in that they identify options, engage the stakeholders in a process to choose between options, maintain attention on the efficiency case, then propose a reform plan, publicise targets, monitor reform and report back on progress.

9.    Coordination when it matters

Some problems demand coordination across infrastructure services for a solution, for example, in public transport where coordination across modes is important to avoid congestion. This is also relevant to logistics, as illustrated in the case of Indonesia where policy across a number of modes of transport has to be coordinated. According to experience to date, the case study of Indonesian in the projet report provides a checklist of action items for success in setting up and managing this coordination. Critical activities include:

• establishing a formal process in which all relevant parties are involved;
• providing funding for it;
• providing the process with relevant powers to make changes to policies and practices;
• including all the stakeholders, not just suppliers but also users of the services – public and private – from the beginning;
• having a functional organisation; and
• monitoring progress.

10.  Deal with Universal service obligations

Experience in the telecommunications sector in ASEAN demonstrates yet again the value of dealing with universal service obligations directly. To embed them in the commitments of incumbents creates a disincentive for reform. Separating them makes the cost transparent.

This material is extracted from (and further information is available in) Chapter 1 by Christopher Findlay of the report of the project on The Impacts and Benefits of Structural Reforms in the Transport, Energy and Telecommunications Sectors in APEC Economies APEC#211-SE-01.1. The material is reproduced with the permission of the PSU. The views expressed in that chapter are those of the author and do not necessarily represent those of the APEC Secretariat or APEC Member Economies.