Testing the mettle of the NBN is a must for taxpayers

IT is widely recognised that the National Broadband Network played a key role in allowing the Gillard government to retain power.

IT is widely recognised that the National Broadband Network played a key role in allowing the Gillard government to retain power.

 Not only were parts of the electorate attracted to this large-scale infrastructure project, but the independents were charmed by the presumed benefits for regional Australia.

Post-election, there has been a further campaign conducted in several media outlets, claiming that it is either inappropriate or impossible to undertake a cost-benefit analysis of the NBN.

The objections to undertaking a proper CBA for the NBN are many and varied. They include:

lThe benefits are simply so huge that it is not worth undertaking the exercise.

lBecause the project is so long-lasting and there is so much uncertainty about the benefits, any CBA would be worthless.

lThe price tag is not $43 billion but closer to a government investment of $27bn.

l$40bn was "spent" on tax cuts since the 2007 election but were never subject to a CBA.

lCBA is not undertaken for all sorts of government spending, so why should it be undertaken for the NBN?

The point needs to be made very clear at the outset that there is no technical reason why a CBA cannot be undertaken for the NBN. Indeed, most of the data that would be required is contained in the McKinsey/KPMG study undertaken on behalf of the Australian taxpayer to the tune of $25 million.

Included in this study -- the full details of which have not been released at this stage -- are estimates of both costs and demand, essential elements for the CBA.

The benefits are so huge. This argument for refusing to undertake a CBA is, of course, ridiculous. Moreover, the key to decision-making is not the total quantum of the benefits of the NBN, but the additional benefits that will flow as a result of the government spending on this project. Given current levels of investment in broadband, particularly by health and educational institutions, a public case needs to be made that the NBN will yield very substantial benefits unlikely to emerge from a market-based arrangement.

The project is long and the benefits are uncertain. While the technology of the NBN is expected to last a very long time, the duration of this project is not exceptional, either by the standards of private investment (long-lasting ore bodies and shopping centres are examples) or public infrastructure.

In fact, CBA of telecommunications investment has been commonplace for decades. Moreover, the assumption that the uncertainty associated with the benefits of the NBN is necessarily greater than those of other long-living projects is dubious.

One way of handling the issue of uncertainty is to assess the likely commercial returns to the project: any shortfall between the costs and private benefits is indicative of the scale of the external or social benefits of the NBN. This, in turn, will provide guidance as to whether or not the NBN is appropriate: an implausibly high estimate of these (implied) external benefits would undermine the case for government investment in the NBN.

The price tag is actually lower than the $43bn. Even if the figure on government investment is closer to $27bn, this is an extraordinarily large sum of money. The case for a CBA of the NBN is unaffected by revelation of this lower figure.

Depending on the conditions attached to the private investment -- rates of return guaranteed by the government, for example -- the fact that the private sector may be pitching in is neither here nor there. Given that the preliminary results of the McKinsey/KPMG study suggested a rate of return well below the risk-adjusted cost of capital, we can be confident this is not a project that the private sector would be interested in funding, even partly, without substantial sweeteners.

In any case, the key issue is the commitment of economy-wide resources to the building and operation of this infrastructure project and the spending and/or tax cuts that are forgone as a result.

No CBA was undertaken for the $40bn tax cuts. Well, no, because CBA applies to government spending. Moreover, after taking into account the compliance and distorting costs of taxation, the benefits of such tax cuts are likely to be substantially higher than the $40bn. In any case, tax cuts involve returning monies to the earners of income on which the tax is paid, who then determine the use of these funds.

All sorts of government spending are not subject to CBA. While this is true, although arguably more projects should be subject to CBA, the NBN is an explicitly commercial operation and users will be charged commercial rates to access the broadband. This justifies the finances of NBN Co being held off-budget. To state that the costs and benefits of building schools and hospitals should not be key to decision-making because schools and hospitals provide public services has no bearing on the argument about the NBN.

The bottom line is that there is absolutely no reason why the NBN should not be subject to a rigorous CBA. Of course, the assumptions would need to be fully disclosed, including in relation to the discount rates to be applied. Sensitivity analysis would allow for various scenarios, thereby providing a range of CBA ratios depending on the assumptions.

One facet of the NBN operation that will need to be modelled relates to the agreement with Telstra. The restriction on competition involving the decommissioning of perfectly adequate infrastructure, in the form of copper but also HFC, will need to be added to the costs.

Estimates will also be required on the longer-run consequences of imposing a technology monopoly where otherwise there would be competing technologies available to meet consumers' broadband requirements.

By undertaking a CBA of the NBN, there can be a more mature debate about whether committing such a large sum of taxpayer funds to one project is really sensible. There is little doubt that there are pockets of market failure in the provision of broadband -- in the regions, for instance, where the lack of population density renders private provision unprofitable -- but to muscle into territory where competing private provision is possible is a very big call.

We simply need to follow the advice of Ken Henry, Secretary of the Treasury: "Government spending that does not pass an appropriately defined cost-benefit test necessarily detracts from Australia's wellbeing. That is, when taxpayer funds are not put to their best use, Australia's wellbeing is not as high as it otherwise would be."

So let the work on the CBA of the NBN begin.

Professor Judith Sloan is an economist and company director