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Will hidden taxes and competitive pressures make the NBN unsustainable?

Is the National Broadband Network sustainable?

I do not mean this in a technical sense. While I am wary of the government using taxpayers' money to ‘pick winners’ in technology, there are many people better placed than I am to crystal ball gaze into the best technology for the internet.

Rather is the NBN economically sustainable?

The NBN is based on a tried-and-true scheme of hidden cross subsidies. The scheme is quite simple. The government provides a service that is much cheaper to provide in urban areas than in rural Australia. The government bans any private firms from providing this service. Then the government sets a single, uniform price for the service to customers across Australia. The price is high enough to cover all costs, which means that it is much higher than the underlying cost in the cities while it is usually below cost in the bush.

The uniform pricing means that the city-based consumers are effectively being taxed in order to cross subsidise the bush. If competition were allowed, businesses would enter the city market, undercut the government price and make profits. Prices to city customers would fall. Of course no private businesses would go into the bush. You can’t make money competing against a government price that is below cost.

Australia Post has used this type tax-and-subsidise scheme for decades. Australia Post sets a uniform price for delivering a standard letter any where in Australia and it is (effectively) illegal to compete against Australia Post to deliver a standard letter. Indeed, this model is so common for postal systems around the world that uniform pricing is sometimes called ‘postage stamp pricing’.

It is important, however, to understand the economics behind the scheme. The NBN version of the scheme has three key features.

First, high-speed internet services will be sold to rural and regional Australia at a price below the cost of providing the services.

This type of subsidised service is not necessarily a bad thing. It is important to make sure that rural and regional Australians have adequate services, including the internet, and the government has a role in providing those services. And sometimes this will mean that the service is sold below cost in rural Australia.

Second, because the loss on rural Australia must be funded, the government is effectively placing a ‘tax’ on high-speed fixed-line broadband delivered through the NBN in urban areas. This ‘tax’ will raise the funds to pay for the rural subsidy. Or as the Australian Financial Review put it:

“[T]he NBN relies on money from dense urban areas like apartment blocks subsiding broadband for unprofitable and sparsely populated rural and regional Australians.”

Of course, it is not called a ‘tax’, but that is what it is. Urban consumers will pay higher prices for fixed-line internet services in order to fund the losses in the bush. This is the only way the NBN can make money.

I have problems with this part of the scheme. It is far from clear that artificially raising the price of internet access in the cities is a good way to raise money to cross-subsidise internet for the bush. Why not push up income or sales taxes instead? Why would we think that it is a good idea to tax new technology rather than other sectors of the economy?

Of course, the NBN cross subsidy keeps the tax hidden and off the government budget. And it has worked for Australia Post for a long time.

Third, because competition in internet services in the city will prevent the government from raising money through its NBN tax, private competitors will be banned from competing against the NBN.

But preventing competition is hard.

The NBN is already facing competition from mobile broadband, but with current technology, mobile broadband is expensive and relatively slow. The NBN also faces competition in central business districts where fibre networks are common. As the Business Spectator has noted it is not clear “why small to medium enterprises need the NBN when they have the option to utilise fibre Ethernet readily available from major providers in many areas.”

But the real competitive challenge may come from TPG installing Fibre-to-the-Basement in major apartment buildings. In September last year, TPG announced that it was planning to connect 500,000 apartments to high speed internet by bring fibre connections into the ‘basement’ of the buildings. TPG’s planned price is significantly less than what Optus is charging for similar services over the NBN.

The communications minister has referred TPG’s plans to Michael Vertigan as part of his cost-benefit inquiry into the NBN. But other telecommunications, companies like Telstra, have let it be known that if TPG can go ahead with its plans then they will be right behind.

This is a nightmare for the NBN. As Alan Kohler noted:

“The government must either legislate for the National Broadband Network to be a monopoly or ditch it. There’s other no alternative.”

But that is the problem. The government has legislated to prevent competition. That is why Telstra and Optus have to sell their HFC networks to the NBN – so they can be incorporated into the NBN or shut down. Either way, they can’t compete against the NBN.

However, it is hard to stop competition from breaking out, especially when there is demand in the cities for fast, cheap internet. Even if the government is able to fend off the TPG threat, it is just the first of many. Indeed, the problem is that the government doesn’t know what competitive threats will face the NBN in the near future. The internet is not snail mail and the NBN is not Australia Post. Innovation will always create ways to undermine a legislated monopoly in a fast moving area of technology. So in the absence of (further) draconian legislation that will stifle innovation, the government can’t effectively legislate for the NBN to be a monopoly.

So what should the government do?

Ditch the ‘National’ Broadband Network and replace it with the “Rural and Regional Broadband Network” (RRBN). Then set a reasonable price for the RRBN. This will be below cost but any loss should be funded using standard taxpayer receipts. Then allow urban internet competition through copper, fibre, mobiles and any other technology. This will ensure that the cities have fast internet at the lowest possible prices. Finally, forget any plans to eventually privatise the RRBN. It will be loss making. That is the point.

Of course, this will require two characteristics of the government.

First, the wisdom to say that the original NBN plan, with its hidden tax, was always flawed. That should be easy because the plan was developed by the previous government. It is easy to blame them.

Second, the courage to make the cost explicit and put it back in the budget. This is where it should be with transparent taxes funding a transparent loss. But the previous government hid the cost using government accounting conventions for ‘future profitable’ projects. The current government can and should come clean on the cost to fix up the mess they have inherited.

What should the government do about Qantas?

The headline from today’s Qantas media conference should be simple:

Qantas attempts to rip off domestic customers and Australian taxpayers”.

In the media conference today the CEO of Qantas, Alan Joyce claimed that:

  1. Qantas domestic is profitable.
  2. Jetstar domestic is profitable.
  3. Other domestic airlines operating in Australia, such as Virgin Australia, are not profitable.
  4. Qantas’ domestic advantage is due to its “network” and because its domestic operations have a “scale advantage” compared to its domestic competitors.
  5. All of Qantas’ losses are due to its international operations.
  6. But Qantas sees its Asian international operations of Jetstar as a key part of Qantas’ future.

These points raise three questions for Australia’s taxpayers, airline customers and politicians.

First, if the domestic operations of Qantas are profitable, and all the losses are due to the international operations, why is Qantas complaining so long and hard about the domestic competition that is lowering airfares and benefiting customers?

The official Qantas answer is that its domestic competitors are somehow competing unfairly.

How?

Well, for example, they are increasing domestic capacity and trying to expand operations to match Qantas’ “scale advantage”. Apparently it is fine for Qantas to have a large market share and enjoy network and scale advantages, but if its competitors try and expand their capacity and market share by competing hard against Qantas, this is unfair.

Sorry Mr Joyce, that is competition. And it is the competition that is pressuring your profits, prices and service on domestic routes. Your domestic profits are falling due to this competition and the lower fares and improved service are benefiting domestic customers.

However, there is a second element to this argument. Apparently these domestic competitors, like Virgin Australia, have major overseas shareholders. Even worse, some of these shareholders are themselves partly or fully-owned by foreign governments. How can we trust them to be competing fairly and maximising profits?

Sorry again Mr Joyce, but hopefully Australia has moved on from that sort of xenophobic, nationalistic claptrap. The fact that the New Zealand government owns part of Air New Zealand, which owns part of Virgin Australia, does not raise the spectre of evil intent by our kiwi friends. And for Qantas, with its Emirates partnership, to be complaining about Etihad owning part of Virgin Australia smacks of hypocrisy.

So the answer to the first question is simple. Qantas would like to limit domestic competition to raise its own profits and make its shareholders better off. And it appears that Qantas doesn’t care if this profit increase is through a subsidy from domestic taxpayers, via a government debt guarantee and/or through higher prices to domestic customers.

Second, does Qantas have legitimate grievances and if so what should the federal government do about them?

Yes, Qantas have legitimate grievances. Qantas is a private company. The Australian government hasn’t owned it since the mid-1990s. However, the Qantas Sale Act prevents Qantas from restructuring and accessing international capital markets like Virgin. The restrictions that prevent Qantas from being majority foreign owned are unnecessary and simply restrict Qantas’ viability. The federal government (with the support of the opposition) should remove them.

But the government reforms should not stop there. Australia continues to have out-of-date restrictions on international air competition under the Air Navigation Act. This places ownership restrictions on any Australian international airline and restricts competition to and from Australia by international carriers. These restrictions, that go back to the 1920s, should be replaced by an ‘open-skies policy’ for international air travel which will allow all legitimate international carriers who want to service Australia to do so. The ownership restrictions on all Australian international airlines should be removed.

Finally, should the federal government guarantee Qantas’ debt?

This sounds like a free lunch. It is not. A debt guarantee means that Qantas gets a one-sided bet, underwritten by the Australian taxpayers. Qantas will pay less when it borrows money and this will boost its profits and benefit its shareholders. But the risk will be borne by Australian taxpayers. If Qantas continues to bleed money on its poorly performing international services, then it may face insolvency. And under a government debt guarantee, that means that the Australian taxpayer will have to bail Qantas out.

Of course, if Qantas is able to turn itself around, the debt guarantee will not be exercised. Qantas will have gained the extra profits by borrowing cheaply, thanks to the guarantee, but these will go to shareholders, not returned to the taxpayers.

The federal government should not be guaranteeing the debt of any private company.

So the federal government should act to unshackle Qantas. Indeed, it should unshackle Australia’s international air transport market from old-fashioned, out-dated regulations. But it should not support Qantas to restrict domestic competition so that Qantas can use its profits from domestic air travellers to fund its loss-making overseas operations. And the federal government should not enter into a one-way bet at taxpayers expense by guaranteeing Qantas’ debt.

The NBN makes Australia Post’s privatisation inevitable and desirable

Australia Post, and its predecessors, go back over 200 years. The first Australian postmaster began work in the colony of New South Wales in 1809. At federation, the colonial post offices were combined into the Post Master’s General department, and in 1975 the name ‘Australia Post’ was born.

So with such a long history of government ownership, why should Australia Post be privatized?

Australia Post is a parcel and delivery company, like DHL, UPS, FedEx and TNT Express. And Australia Post is pretty successful in competing against these private competitors. It owns Star Track Express (a company that began as a privately-owned distribution service) and in 2012/13 made a group profit of $312m for its taxpayer-owners.

But, unlike its private competitors, Australia Post has community service obligations. It must provide accessible and affordable letter services to all Australians, regardless of where they reside. And for more than a century, Australia Post has helped link the city and the bush.

In recognition of its community service obligations (CSOs), and to avoid private entrants from ‘cream skimming’ letter profits in the cities while neglecting the bush, Australia Post has an effective legislated monopoly over ‘standard’ letters up to 250 grams. The problem, however, for Australia Post is that standard mail volumes are falling, raising the cost of the CSOs. And the issue for the Australian Government is that the Postal CSOs will soon be redundant, replaced by the CSOs on the National Broadband Network (NBN).

In 2012/13, regulated mail volumes dropped 5.4%. Indeed, they have been falling at 3% or more per year for the last six years. Australia Post’s loss on regulated mail was $91.3m in 2010/11, $148m in 2011/12 and $312m in 2012/13. And this is despite increasing the price for a stamp: from 50c to 55c in 2008, to 60c in 2010, and with a proposal for the price to rise to 70c this year.

The reason is the internet. As more people move on-line, standard mail volumes drop. Every electronic bill, on-line payment or e-mail puts another nail in the standard letter’s coffin. And this trend will accelerate, not decline.

Australia Post is not alone in facing this problem. It is faced by postal services worldwide. Most recently, the government-owned Canada Post decided to stop all home mail deliveries. Rather:

“every person … will now have to traipse to a community “super-box” to pick up their mail.”

Australia Post could try similar cost saving innovations, such as reducing the number of home deliveries each week or setting different prices depending on the speed of delivery. And if it doesn’t do this then the taxpayer burden will just keep on rising. Every dollar of loss on the standard mail service is a dollar less federal government revenue to spend on other things.

Fortunately, in Australia, the NBN means that Australia Post’s CSOs will be redundant – replaced by the NBN’s CSOs.

“[T]he NBN will provide the necessary infrastructure for every premises in Australia to be able to have broadband access to the internet …”

The NBN will also have uniform pricing Australia wide and, as with post, private competition to the NBN has been legally restricted to prevent ‘cream skimming’ by private entrants in urban areas.

Now, you may or may not think these restrictions are a good idea. But one thing is clear. Once the NBN is rolled out to the bush, we do not need BOTH the Australia Post CSOs and the NBN CSOs. One set will do. Just as the internet is making standard mail redundant, the obligations on the NBN make Australia Post’s CSOs redundant.

Without its CSOs, however, Australia Post is just another delivery company. So there are two sets of questions for the federal government:

First, how is the government working to transition the ‘standard mail’ obligation from paper (with Australia Post) to e-mail (with the NBN)? And if not, why not, given the growing burden on taxpayers from the standard letter?

Second, once Australia Post’s CSOs are gone, what justification is there for the federal government to own a parcel company that would be underwritten by taxpayers while competing against numerous private businesses? And if this means Australia Post should be privatised once the NBN is up and running, how is the government planning the transition towards a private Australia Post?

Partial and full privatization of postal services is not new. Examples include Germany, Holland, Austria and, more recently, the UK. But the key driver is that technology has changed the way Australians communicate. The NBN will link all Australians. For the small number who need special assistance, that should be available, as it is for the current mail service. As the internet, via the NBN, takes over the CSO under government ownership, it makes sense to remove the CSO from Australia Post. And once that occurs, privatization of a profit-maximizing parcel company makes sense.