harnessing private funds to alleviate the australian local government infrastructure backlog

9
Harnessing Private Funds to Alleviate the Australian Local Government Infrastructure Backlog Brian Dollery, 1 Michael A. Kortt 2 and Bligh Grant 1 A series of national and state public inquiries into the financial sustainability of local government have demonstrated that all Australian local government jurisdictions face a daunting local infrastructure maintenance and renewal backlog. Various solutions to the problem have been advanced in the literature, including the establishment of an Australian municipal bond market to facili- tate the use of private sector finance to fund the remediation of the infrastruc- ture shortfall (Byrnes et al., 2008). However, despite the conceptual attraction of this particular policy proposal, as a majority of Australian local authorities are small, with limited administrative and technical capacity, they would have great difficulty in securing access to a municipal bond market. In this paper, we consider municipal banks and bond banks as alternative institutional solutions to the Australian local government infrastructure backlog. Keywords: bond bank, infrastructure, local government, municipal bank. 1. Introduction Heightened demands on the local government sector, together with limited sources of funding, have seen the emergence of a massive local government infrastructure backlog across all Australian local government state jurisdictions (PriceWaterhouseCoopers, 2006). The magnitude of the local infrastructure shortfall far exceeds the financial capacity of the local government sector under pres- ent fiscal arrangements, and there is thus an urgent need to find alternative methods of remedying the problem. Numerous solutions have been proposed, which include improved asset management by local authorities, greater reliance on developer charges (McNeill and Dollery, 2003), more extensive use of public–private partnerships in local infrastructure development (Cannadi and Dollery, 2005), increased intergovernmental transfers (Dollery and Grant, 2011), a Commonwealth government infrastructure fund (Dollery et al., 2007) and an Australian municipal bond market (Byrnes et al., 2008). However, scholars have ignored at least two other promising policy solutions to the Australian local government infrastructure problem. The fact that a majority of the Australian local authori- ties are small, with severe administrative and technical capacity limitations, together with stringent budgetary constraints, implies that private funding, as well as extensive assistance in the form of 1 Centre for Local Government, University of New England, Armidale; and 2 Southern Cross Business School, Southern Cross University, Tweed Heads, NSW, Australia JEL classifications: H54, H76, R00 Correspondence: Brian Dollery, Centre for Local Government, University of New England, Armidale, NSW 2351, Australia. Email: [email protected] ECONOMIC PAPERS, VOL. 31, NO. 1, MARCH, 2012, 114–122 114 Ó 2012 The Economic Society of Australia doi: 10.1111/j.1759-3441.2011.00153.x

Upload: brian-dollery

Post on 29-Sep-2016

215 views

Category:

Documents


3 download

TRANSCRIPT

Harnessing Private Funds to Alleviatethe Australian Local Government

Infrastructure Backlog

Brian Dollery,1 Michael A. Kortt2 and Bligh Grant1

A series of national and state public inquiries into the financial sustainability oflocal government have demonstrated that all Australian local governmentjurisdictions face a daunting local infrastructure maintenance and renewalbacklog. Various solutions to the problem have been advanced in the literature,including the establishment of an Australian municipal bond market to facili-tate the use of private sector finance to fund the remediation of the infrastruc-ture shortfall (Byrnes et al., 2008). However, despite the conceptual attractionof this particular policy proposal, as a majority of Australian local authoritiesare small, with limited administrative and technical capacity, they would havegreat difficulty in securing access to a municipal bond market. In this paper, weconsider municipal banks and bond banks as alternative institutional solutionsto the Australian local government infrastructure backlog.

Keywords: bond bank, infrastructure, local government, municipal bank.

1. IntroductionHeightened demands on the local government sector, together with limited sources of funding,have seen the emergence of a massive local government infrastructure backlog across all Australianlocal government state jurisdictions (PriceWaterhouseCoopers, 2006). The magnitude of the localinfrastructure shortfall far exceeds the financial capacity of the local government sector under pres-ent fiscal arrangements, and there is thus an urgent need to find alternative methods of remedyingthe problem. Numerous solutions have been proposed, which include improved asset managementby local authorities, greater reliance on developer charges (McNeill and Dollery, 2003), moreextensive use of public–private partnerships in local infrastructure development (Cannadi andDollery, 2005), increased intergovernmental transfers (Dollery and Grant, 2011), a Commonwealthgovernment infrastructure fund (Dollery et al., 2007) and an Australian municipal bond market(Byrnes et al., 2008).

However, scholars have ignored at least two other promising policy solutions to the Australianlocal government infrastructure problem. The fact that a majority of the Australian local authori-ties are small, with severe administrative and technical capacity limitations, together with stringentbudgetary constraints, implies that private funding, as well as extensive assistance in the form of

1Centre for Local Government, University of New England, Armidale; and 2Southern Cross Business School,Southern Cross University, Tweed Heads, NSW, Australia

JEL classifications: H54, H76, R00Correspondence: Brian Dollery, Centre for Local Government, University of New England, Armidale, NSW

2351, Australia. Email: [email protected]

ECONOMIC PAPERS, VOL. 31, NO. 1, MARCH, 2012, 114–122

114

� 2012 The Economic Society of Australiadoi: 10.1111/j.1759-3441.2011.00153.x

financial expertise, must form part of any remedial infrastructure investment programme, at leastin the absence of larger intergovernmental transfers or greater local revenue-raising powers.

Longstanding practice in local government infrastructure finance in other developed countries,where local authorities also have both limited funds and limited financial expertise, has seenthe evolution of two distinct institutional approaches to the problem of local infrastructureinvestment: municipal banking monopolies and municipal bonds banks. This paper considersthe applicability of these two options against the background of the Australian local govern-ment infrastructure backlog and the Byrnes et al.’s (2008) Australian municipal bond marketproposal.

The paper itself is divided into five main parts. Section 2 contains a synoptic account of the sizeof the Australian local government infrastructure shortfall. Section 3 outlines the Byrnes et al.’s(2008) proposal for a municipal bond market, and contends that despite the conceptual attractionof this model, the nature of the Australian local government means that in practice it will notassist the majority of councils. Section 4 sets out the generic characteristics of municipal banks asan alternative method of raising funds in competitive bond markets. Section 5 offers a stylisedmodel of a bond bank adapted to suit Australian conditions, which builds on Byrnes et al. (2008)and offers more promise than municipal banks. The paper ends with some brief concludingremarks in Section 6.

2. Australian Local Infrastructure ShortfallOver the past decade, a series of national and state inquiries into local government have establishedthat the financial capacity of many local authorities has deteriorated, particularly in regional, ruraland remote parts of the country. In general, local government has responded by reducing investmentin local infrastructure rather than cutting back on service provision. The result has been a mushroom-ing local infrastructure backlog in all Australian local government jurisdictions, which has beendescribed in detail in various state public inquiries (see, for instance, the South Australian FinancialSustainability Review Board’s (2005) Rising to the Challenge Report, the Financial Sustainability ofNSW Local Government’s (‘Allan Report’) Independent Inquiry into Local Government Inquiry (LGI)(2006) Are Councils Sustainable, the Local Government Association of Queensland’s (2006) Size, Shapeand Sustainability Inquiry, the Western Australian Local Government Association’s (WALGA) (2006)Systemic Sustainability Study, the Local Government Association of Tasmania (LGAT) (2007) Review ofthe Financial Sustainability of Local Government in Tasmania, the Queensland Local Government ReformCommission’s (Local Government Reform Commission, 2007) Report of the Local Government ReformCommission, the Queensland Treasury Corporation’s (QTC) (2008) Financial Sustainability in QueenslandLocal Government and NSW Independent Pricing and Regulatory Tribunal (IPART) (2009) Review of theRevenue Framework for Local Government). At the national level, several parallel inquiries have beenconducted (see, for example, the Commonwealth Grants Commission (CGC) (2001) Review of theOperation of Local Government (Financial Assistance) Act 1995, the House of Representatives StandingCommittee on Economics, Finance and Public Administration’s (‘Hawker Report’) (2003) Rates andTaxes: A Fair Share for Responsible Local Government, the PriceWaterhouseCooper’s (2006) NationalFinancial Sustainability Study of Local Government and the Productivity Commission’s (2008) AssessingLocal Government Revenue Raising Capacity).

Although most of these inquiries sought to measure the size of the local infrastructure shortfallin their respective state jurisdictions, PriceWaterhouseCoopers (2006) developed national estimatesof the pecuniary magnitude of the local infrastructure backlog based on the extrapolation of trendsfrom three state-based inquiries (New South Wales, South Australia and Western Australia), aswell as the Municipal Association of Victoria (MAV) (2005) study on Victoria. As a consequence ofdata deficiencies, PriceWaterhouseCoopers (2006) computed three measures of the Australian localgovernment infrastructure backlog (i.e. a mean estimate, an upper estimate and a lower estimate).These estimates are reproduced in Table 1.

It is evident from Table 1 that the national local government infrastructure backlog ranges froma low of AUD 12.0 billion to a high of AUD 15.3 billion, with an annual deficit in outlays on

� 2012 The Economic Society of Australia

2012 AUSTRALIAN LOCAL GOVERNMENT INFRASTRUCTURE BACKLOG 115

infrastructure of between AUD 0.9 billion to AUD 1.2 billion. Thus, between AUD 1.8 billion andAUD 2.3 billion per annum is needed to eliminate the current local infrastructure backlog, equiva-lent to between AUD 2.6 million and AUD 3.3 million per council per annum.

Under existing financial arrangements, the sheer size of the infrastructure backlog is such thatthe local government sector simply does not have the financial capacity to solve the problem.Given the magnitude of the backlog, three policy options are proposed: (i) substantially increasedintergovernmental transfers; (ii) much higher property taxes, fees and charges and other ‘own-source’ revenue-raising; or (iii) much greater reliance on private financial capital. Given Common-wealth and state governments’ budgetary constraints, the prospects of substantial increases inintergovernmental grants are negligible. Furthermore, following the Productivity Commission’s(2008) Assessing Local Government Revenue Raising Capacity report, it is evident that local politicalreality means that property taxes, fees and charges offer negligible hope of much greater revenue(see Dollery and Grant, 2011, for an analysis of ‘‘own-source’’ revenue finance).

This means that much more extensive use of private-sector investment capital through borrow-ing seems to be the most feasible solution. The question thus arises as to the most efficaciousmethod of harnessing private finance. In general, three possibilities seem to exist: (i) the establish-ment of an Australian municipal bond market along the lines proposed by Byrnes et al. (2008);(ii) the creation of a national municipal development bank based on similar models used inEuropean local government; and (iii) the founding of a national local government infrastructurebank or ‘‘bond bank’’ mirrored on North American experience. We shall examine each of theseoptions in turn.

3. An Australian Local Government Bond MarketIn their pioneering paper, Byrnes et al. (2008, p. 117) proposed ‘‘a funding solution to the localinfrastructure problem centred on the issuance of asset-backed securities by local government intocapital markets along the lines of similar longstanding arrangements in American local governmentfinance.’’ The key to their model lay in the fact that the Australian local government sector‘‘already has access to a relatively attractive asset in the form of rates and charges, which couldform an income stream payable on a fixed income security issued by the Australian local govern-ment sector.’’ They then provided a detailed illustration of the model using the institutionalcontext of the infrastructure renewal problem facing the water and wastewater operations of non-metropolitan New South Wales local government.

Byrnes et al. (2008, p. 127 ⁄ 128) argued that non-metropolitan New South Wales councils withLocal Water Utilities ‘‘could use the stream of income that they raise through fees and charges tofund a low-risk bond issue on Australian capital markets that would yield sufficient funds for infra-structure investment at the minimum feasible interest rates and transactions costs.’’ The advan-tages of this scheme would be twofold: (i) it would yield cheaper ‘‘long-term capital’’ thanalternative sources of borrowing available to these local authorities; and (ii) it would address theproblem of intergenerational equity by spreading the costs of local infrastructure maintenance andrenewal over several different generations.

Table 1. Estimates of Australian Local Infrastructure Backlog

Type of estimate Backlog ininfrastructure

renewals (AUD m)

Underspend onexisting infrastructurerenewals pa (AUD m)

Estimatedfunding

gap pa (AUD m)

Estimated fundinggap per council

pa (AUD m)

Total NSW ⁄ WA ⁄ SA ⁄ VIC AUD 9156 AUD 711 AUD 1362 AUD 3.1Low-case national estimate AUD 12,012 AUD 922 AUD 1826 AUD 2.6Mid-case national estimate AUD 14,533 AUD 1129 AUD 2163 AUD 3.1High-case national estimate AUD 15,305 AUD 1190 AUD 2281 AUD 3.3

Source: Adapted from Dollery and Mounter (2010, table 1).

� 2012 The Economic Society of Australia

116 ECONOMIC PAPERS MARCH

Byrnes et al. (2008, p. 128) took care to stress that although ‘‘this article has demonstrated thatit is feasible to make use of a revenue bond in the context of the Australian local government, asimilar argument in support of a ‘tax-backed’ bond has not been advanced.’’ The primary reasonfor this lay in the fact that ‘‘recent inquiries into the financial status of local government in Aus-tralia have noted that local councils are reliant upon a set of relatively ‘slow growth’ taxes to fundgeneral expense obligations.’’ However, for a successful tax-backed bond market to occur in Aus-tralia, ‘‘local government finance would most likely need significant reform, perhaps in the formof access to a growth tax, such as the Goods and Services Tax.’’

Given the magnitude of the infrastructure backlog, the inability of most local authorities in thelocal government sector to fund the backlog from ‘‘own-source’’ revenue, as well as the unlikeli-hood that higher tiers of government will provide the necessary funding in transfer income, theByrnes et al.’s (2008) municipal bond model has obvious attraction as borrowing represents theonly feasible option available.

However, the Byrnes et al.’s (2008) model neglects to take into account the nature of the Austra-lian local government. In particular, it disregards the incapacity of small local authorities to takeadvantage of a municipal bond market. This is problematical as it is well known that small localauthorities – as measured by total population size – frequently do not possess adequate administra-tive and technical capacity, especially the sophisticated financial skills required for local councils toparticipate efficaciously in competitive financial markets, such as bond markets. Moreover, mostAustralian local councils and shires, often found in regional, rural and remote areas, are prepon-derantly small. The recent losses incurred by some small rural local councils in sub-prime mortgageinstruments serves to illustrate this point. Table 2 provides a breakdown of the Australian localgovernment entities by the total population size.

Table 2 demonstrates that 389 or 56 per cent of local authorities had total populations fewerthan 10,000 people, mostly in rural and remote areas, with only forty-six councils or 6.6 percent with populations in excess of 120,000 residents in 2007. Although no specific thresholdscan be adduced, it can be argued that as financial expertise generally correlates with council size,a majority of Australian local authorities would have been unable to use a municipal bond mar-ket economically if it had been established. Furthermore, most of the public inquiries into localgovernment, including PriceWaterhouseCoopers (2006), found that the local infrastructure back-log was most acute in small regional, rural and remote local government areas, where popu-lation densities were low. In other words, those local authorities most afflicted by aninfrastructure backlog would have been least benefited by the introduction of a municipal bondmarket.

A viable solution to the Australian local government thus requires at least two elements to bepresent simultaneously: (i) a reliable source of cheap private long-term capital to fund local infra-structural investment; and (ii) financial expertise and capacity-building assistance for small councils

Table 2. Population of Local Government Areas in 2007�

Council population Rural areas Urban areas Total

Up to 10,000 373� 16 38910,001–30,000 69 67 13630,001–70,000 — 82 8270,001–12,000 — 42 42120,001–200,000 — 40 40More than 200,000 — 6 6

Total number of entities 442 253 695

Notes: �Pre-dates recent amalgamations in Queensland and Northern Territory and includes some non-elected bodies. �Includesthirty small Indigenous councils in Queensland officially classified as ‘urban’.Source: Adapted from Australian Centre for Excellence in Local Government (ACELG) (2011, p. 14, table 2.2).

� 2012 The Economic Society of Australia

2012 AUSTRALIAN LOCAL GOVERNMENT INFRASTRUCTURE BACKLOG 117

without the requisite skills. By itself, the Byrnes et al.’s (2008) model only meets (i). We thus needto explore alternative institutional avenues that can provide (i) and (ii). As we have seen, twopromising options exist: municipal banking and bond banks.

4. Municipal BankingMunicipal banking has traditionally represented an alternative approach to municipal bond financeas a means of mobilising private-sector capital for local government infrastructural investment. Incontrast to the North American model, with its heavy reliance on private funds raised in competi-tive municipal bond markets, municipal banking was the predominant method of financing muchof European local government for most of the twentieth century (Chandavarkar, 1994; De Fioreand Uhlig, 2005). Numerous European countries established specialist municipal banks in order toprovide capital and related financial services to local government, with well-known examplesincluding Credit Local de France and the Municipal Bank of the Netherlands. In general, municipalbanks enjoyed monopoly status not only in dealing with local authorities, thus obliging them tomaintain accounts and deposits with these banks, but also frequently had exclusive access tocheap, long-term savings, which enabled them to supply low-cost, long-term loans to their respec-tive local government sectors.

Peterson (2002) contends that municipal banking of this kind rested on three main pillars:(a) ‘‘relationship banking’’; (b) ‘‘delegated monitoring,’’ and (c) ‘‘bundled services and bundledpricing.’’ With respect to (a), European banks established long-standing relationships with munici-palities in which banks assisted local councils to ‘‘prepare and structure their budgets, designinvestment projects, and conduct financial analysis of cost recovery strategies,’’ and often managedcouncil ‘‘financial accounts and maintained the municipality’s deposits,’’ as well as long-term loansto fund municipal investment projects. Moreover, in some cases, municipal banks ‘‘served asthe designated intermediary between the central government and municipalities by handling tax-sharing arrangements or administering local government grant allocations on behalf of the centralgovernment’’ (Peterson, 2002, p. 5).

Despite the fact that the creation of a monopolistic institution violated well-known efficiencyconditions, the monopoly rights enjoyed by municipal banks were defended on grounds that localauthorities possessed poor administrative and technical capacity and thus required extensive sup-port for prolonged periods of time in order to operate as adequately run financial entities. By thesame token, it was argued that municipal banks could afford to ‘‘nurture communities through thelearning process only if the bank is subsidised by central government policy or enjoys partial pro-tection from competition so that it can create a long-term client.’’ Thus, as the financial and mana-gerial capacity of the local government sector improved, ‘‘relationship banking’’ would becomeprogressively less important.

The second pillar advanced by Peterson (2002) focused on ‘‘delegated monitoring,’’ which refersto the fact that municipal banks act as financial intermediaries between borrowers and lendersinstead of individual councils performing this role themselves. Delegated monitoring is justified ongrounds that ‘‘it is inefficient for each saver to try to monitor financial conditions and all other fac-tors affecting loan payment’’ and a single municipal bank can more effectively gather ‘‘savingsfrom numerous sources, assemble specialised professionals capable of loan appraisal and loan over-sight, allocate capital, and then monitor loans and borrowers’’ (Peterson, 2002, p. 5 ⁄ 6). If problemsarise, then ‘‘a well-functioning municipal bank will initiate loan-restructuring discussions with aborrower when the client encounters serious financial difficulty’’ as ‘‘loan restructuring is prefera-ble to accumulating nonperforming loans’’ (p. 6).

The final pillar of municipal banking consists of ‘‘bundled services and bundled pricing.’’ In effect,municipal banks charge all client local authorities the same prices, regardless of individual differ-ences. In this instance, Peterson (2002) has in mind that prices of services and loans offered bymunicipal banks reflect neither the marginal costs nor the underlying risks involved. For example,‘‘the bundled services that municipal banks offer rarely are broken out or priced to correspond withincremental costs for a particular service,’’ and price discrimination to reflect the creditworthiness of

� 2012 The Economic Society of Australia

118 ECONOMIC PAPERS MARCH

borrowing councils is unusual as ‘‘municipal banks lend to all municipal clients at the same interestrate.’’ As financial markets across the world have been deregulated, and sources of ‘‘below cost’’funds from fiscally constrained public sector agencies have dried up, the ‘‘one price’’ world of muni-cipal banks has become increasing parlous. In particular, in most countries, municipal banks havelost preferential access to cheap long-term savings, which has forced them to compete in capital mar-kets for loan finance.

From the perspective of contemporary Australian local government infrastructure finance, muni-cipal banks, in principle, have much to offer when we bear in mind the fact that a majority ofAustralian local authorities are not only small, but tend to lack adequate financial expertise, asestablished in almost all of the public inquiries. This makes relational banking a desirable policyoption as, unlike commercial financial institutions, municipal banks have taken a proprietary viewof client councils and offered extensive advice, expertise and monitoring. Indeed, for those localgovernment entities with minimal financial capacity, there is much to be said for this model.Moreover, from the point of view of higher tiers of government, including the CGC, which partlyfund local government, a national municipal bank with a strong oversight role has many advanta-ges, not least acting as a safeguard for the prudent expenditure of public funds. In addition, anational municipal bank could play an important role in the drive to improve local asset manage-ment by assisting in financial capacity building in the local government sector.

However, despite these attractions, the traditional municipal banking model has several disad-vantages. The Australian local government infrastructure backlog has arisen at least partly becauseCommonwealth and state government transfers to local government have not kept pace with thefiscal demands placed on the local government sector. This has meant that private capital fundinghas become essential for remediation of the infrastructure crisis. As municipal banks would not beable to effectively compete for scarce finance with the commercial banking sector, this wouldremove the main rationale for their existence, given that they require preferential access to cheaplong-term finance to operate successively. Under these circumstances, there is only a limited poolof Commonwealth funds available for local government infrastructure investment and a nationalmunicipal bank would thus be most unlikely to be able to expand this pool.

5. An Australian Bond BankAn Australian bond bank provides a feasible method of enabling the Australian local governmentsector to secure access to long-term private capital to tackle its infrastructure shortfall. Accordingto the American Council of Infrastructure Financing Authorities (CIFA) (1997), a bond bank is‘‘a state-sponsored entity that makes local infrastructure projects feasible by providing access to themunicipal bond market and by providing direct and indirect financial subsidies to localities primar-ily through debt issuance.’’ The main aim of a bond bank is thus to provide local government withlow-cost infrastructure financing by means of debt issuance, usually with government support.

Bond banks exist in many industrialised countries, such as the Scandinavian nations, a largenumber of American states and Canadian provinces, a new entity initiated in New Zealand in2011, as well as in South Australia in the form of the Local Government Finance Authority ofSouth Australia (LGFA). The LGFA was set up as an independent corporate body established underthe Local Government Finance Authority Act 1983, it is governed by a Board of Trustees, all SouthAustralia councils are members and the South Australian government guarantees its liabilities,including deposits. However, the use of LGFA investment and loan services is entirely voluntaryand local authorities are free to seek local infrastructure funding elsewhere.

Although substantial differences exist between bond banks in different local government juris-dictions, many common basic structural and operational characteristics can be identified. Thus, thegreat majority of bond banks were established through national and state government legislation,which generally did not confer taxing powers to these entities. Similarly, most bond banks areindependent statutory authorities with autonomous governance arrangements, which incorporatea permanent secretariat possessing financial expertise. Initial capital for bond banks is typicallycontributed to by some combination of central ⁄ state government and local government finance

� 2012 The Economic Society of Australia

2012 AUSTRALIAN LOCAL GOVERNMENT INFRASTRUCTURE BACKLOG 119

(Hildreth and Zorn, 2005), which in turn determines the composition of governing boards, as wellas some form of ‘‘credit enhancement’’ through governmental subsidies and guarantees (Gilbertand Pike, 1995). Moreover, as a general rule, bond banks depend on a variety of sources of incometo fund ongoing operations, including fees and charges levied on borrowers, such as lump-sum feesat the close of an issue, an annual fee based on outstanding loans, as well as interest rates.

It is possible to identify a common pattern of operation for most bond banks (Hildreth and Zorn,2005). Lending usually takes three main forms: (i) long-term bond pools for funding infrastructuralinvestment; (ii) cash-flow financing to smooth income and expenditure over the fiscal year; and(iii) equipment lease financing to purchase machinery. In general, two methods of raising fundson capital markets are typically employed, often by the same bond bank: small debt issues of mul-tiple local governments are pooled together into a single large bond sale, and bonds are issued onbehalf of a large municipality. Although it can be argued that bond pools have some of the fea-tures of collateralised debt obligations (CDOs), as we shall see, borrowing constraints and credit-worthiness checks mean risk is much lower than standard commercial CDOs.

Given the size composition of Australian local authorities, as shown in Table 2, an Australiannational bond bank needs to focus on long-term bond pooling in order to accommodate the largenumber of small councils. Long-term bond pooling occurs when a bond bank issues securitiesunder its own name and the revenue raised is employed to purchase debt obligations from smallmunicipalities that have applied for funds through the bond bank. Under Australian federalarrangements, local government is a creature of its state legislature. In order to be able to borrow,all state governments legally oblige local authorities to seek explicit permission from the relevantstate agency, often a loan’s council or state department of local government. From the point ofview of an Australian national bond bank, this process would assist in determining whether a par-ticular council would be eligible to borrow through the bond bank. However, if the Common-wealth government guaranteed bond bank debt, it is likely that it would also require the bondbanks to apply further credit tests to municipal borrowers in order for them to qualify for loans.

The governance and structure of an Australian national bond bank need not be complicated andit could simply mirror the recently established New Zealand Local Government Funding Agency(LGFA) (Local Government New Zealand (LGNZ) (2011), although it is too early to judge the effec-tiveness of the LGFA. In essence, the Commonwealth could contribute half of the initial capitalfunding, with each state Local Government Association (LGA) combining in some approved pro-portion, like total rate base or population size, to contribute the remaining capital endowment. Aboard of directors would govern the new entity, with the federal government occupying half ofthe board positions and other board members appointed by their respective LGAs. An executivedirector would run the secretariat.

With respect to the costs of its operations, two factors would be present that would give a bondbank a significant comparative advantage over either a municipal bond market or a monopolymunicipal bank. In the first place, a financial guarantee by the Commonwealth government,together with the stringent credit requirements imposed by both the bond bank and state govern-ment agencies, would serve to ensure that bond bank issues would succeed on the market at thelowest possible interest rate (Solano, 2005), even in a post-global financial crisis market with itsmodified liquidity, volatility and risk premia. This would give the Australian local government thecheapest possible source of long-term finance. Secondly, a combination of scale economies derivedfrom bond pooling, and the financial acumen possessed by the bond bank, would mean that thelowest possible operational costs would be attained (Robbins and Kim, 2003). Thus, the local gov-ernment sector would pay less for the use of the bond bank than it would for equivalent municipalbanking or standard municipal bond finance.

6. ConclusionUnanimous agreement exists that the Australian local government faces a massive local infrastructurebacklog and that, under current fiscal arrangements, it simply does not have the financial capacity toremedy the problem. Moreover, the prospects of substantial additional intergovernmental transfers

� 2012 The Economic Society of Australia

120 ECONOMIC PAPERS MARCH

from federal and state governments are bleak. Against this background, this paper has argued thatadditional borrowing by the Australian local government sector as a whole represents the only feasi-ble method of financing adequate infrastructure shortfall remediation.

Various institutional avenues exist, which could assist local government in raising the substan-tial sums of private capital funding required. As we have seen, Byrnes et al. (2008) proposed theestablishment of an Australian municipal bond market along the lines of the long-standingAmerican municipal bond market. Although this represented a promising option, its principallimitation lay in the fact that, in common with its American counterparts, the majority ofAustralian local authorities lack the requisite expertise to participate effectively in a bond marketof this kind. This implied that precisely those small regional, rural and remote local authoritiesmost in need of infrastructural investment would not benefit from an Australian municipal bondmarket.

We then considered the establishment of a national municipal bank, which have been usedextensively in many European local government systems, as an alternative policy option. Althoughmunicipal banking would resolve the problem of financial management incapacity on the part ofsmall Australian councils through ‘‘relational banking,’’ in contrast to the Byrnes et al.’s (2008)competitive municipal bond market, deregulation in the Australian financial system, together withan absence of a potential monopoly over low-cost public-sector funds, would starve a nationalmunicipal bank of the kind of finance it would have required to operate efficaciously.

Having discounted the role of competitive municipal bond markets and national municipalbanks as viable approaches to financing the Australian local government infrastructure backlog,the paper considered the establishment of an Australian national bond bank. It was argued thata Commonwealth guaranteed bond bank, which sold pooled debt in regular issues, thus reapingscale economies, would provide the local government sector with the cheapest long-term creditat the lowest possible transactions cost. After securing state borrowing permission, local councilswould apply for bond bank funding for approved infrastructure projects, secured by individualcouncil debt. The problem of financial incapacity would also be overcome as disinterested expertfinancial advice would be offered by the bond bank to individual local authorities. As a conse-quence, small local councils, afflicted by a combination of financial stress and financial incapac-ity, would have an inexpensive and reliable source of financial expertise. In addition, the bondbank could offer assistance to local authorities in asset management practice as a capacity-build-ing service.

REFERENCESAustralian Centre for Excellence in Local Government (ACELG) (2011), Consolidation in Local Government:

A Fresh Look. ACELG, Sydney.Byrnes, J., Dollery, B.E., Crase, L. and Simmons, P. (2008), ‘Resolving the Infrastructure Crisis in Local Govern-

ment: A Bond Market Issue Approach Based on Local Council Income’, Australasian Journal of Regional Studies,14 (2), 115–31.

Cannadi, J. and Dollery, B.E. (2005), ‘An Evaluation of Private Sector Provision of Public Infrastructure inAustralian Local Government’, Australian Journal of Public Administration, 64 (3), 112–8.

Chandavarkar, A. (1994), Infrastructure Finance: Issues, Institutions, and Policies. World Bank, Washington.Commonwealth Grants Commission (CGC) (2001), Review of the Operation of the Local Government (Financial

Assistance) Act 1995. AGPS, Canberra.Council of Infrastructure Financing Authorities (CIFA) (1997), An Analysis of State Bond Banks. CIFA Monograph

No. 9, CIFA, Washington.De Fiore, F. and Uhlig, H. (2005), Bank Finance Versus Bond Finance: What Explains the Differences Between US and

Europe. Working Paper Series No. 547, European Central Bank, Frankfurt.Dollery, B.E. and Grant, B. (2011), ‘Financial Sustainability and Financial Viability in Australian Local Govern-

ment’, Public Finance and Management, 11 (1), 28–47.Dollery, B.E. and Mounter, S. (2010), ‘Local Government Investment, Maintenance and Renewal: A Compara-

tive Analysis of Contemporary Australian and New Zealand Local Government’, Australasian Journal of RegionalStudies, 16 (2), 217–32.

Dollery, B.E., Byrnes, J.D. and Crase, L. (2007), ‘The Infrastructure Crisis in Australian Local Government:A Proposed Federal Asset Fund Solution’, Australasian Journal of Regional Studies, 13 (1), 3–19.

� 2012 The Economic Society of Australia

2012 AUSTRALIAN LOCAL GOVERNMENT INFRASTRUCTURE BACKLOG 121

Financial Sustainability Review Board (2005), Rising to the Challenge. South Australian Local Government Asso-ciation, Adelaide.

Gilbert, M. and Pike, R. (1995), ‘Credit Enhancement of Municipal Debt’, Canadian Public Administration, 38 (2),195–203.

Hildreth, W.B. and Zorn, C. (2005), ‘The Evolution of the State and Local Government Municipal Debt MarketOver the Past Quarter Century’, Public Budgeting & Finance, 25 (4), 127–53.

House of Representatives Standing Committee on Economics, Finance and Public Administration (‘HawkerReport’) (2003), Rates and Taxes: A Fair Share for Responsible Local Government. Commonwealth of Australia,Canberra.

Independent Inquiry into Local Government Inquiry (LGI) (2006), Are Councils Sustainable? Final Report: Findingsand Recommendations. NSW Local Government and Shires Association, Sydney.

Independent Pricing and Regulatory Tribunal (IPART) (2009), Revenue Framework for Local Government: DraftReport. IPART, Sydney.

Local Government Association of Queensland (2006), Size, Shape and Sustainability: Guidelines Kit. Local Govern-ment Association of Queensland, Brisbane.

Local Government Association of Tasmania (LGAT) (2007), Review of the Financial Sustainability of Local Govern-ment in Tasmania. Local Government Association of Tasmania, Hobart.

Local Government New Zealand (LGNZ) (2011), New Funding Agency to Save Millions. LGNZ, Wellington.Local Government Reform Commission (2007), Report of the Local Government Reform Commission, Final Report.

Queensland Local Government Reform Commission, Brisbane.McNeill, J. and Dollery, B.E. (2003), ‘Calculating Developer Charges for Urban Infrastructure: A Feasible

Method for Applying Marginal Cost Pricing’, Engineering Economist, 48 (3), 1–23.Municipal Association of Victoria (MAV) (2005), Trends in Local Government Finance. Municipal Association of

Victoria, Melbourne.Peterson, G.E. (2002), Banks or Bonds? Building a Municipal Credit Market. Urban Institute, Washington.PriceWaterhouseCoopers (2006), National Financial Sustainability Study of Local Government. PriceWaterhouseCoopers,

Sydney.Productivity Commission (2008), Assessing Local Government Revenue Raising Capacity. Productivity Commission,

Melbourne.Queensland Treasury Corporation (QTC) (2008), Financial Sustainability in Queensland Local Government. QTC,

Brisbane.Robbins, M.D. and Kim, D. (2003), ‘Do State Bond Banks Have Cost Advantages for Municipal Bond Issuance?’,

Public Budgeting & Finance, 23 (3), 92–108.Solano, P.L. (2005), ‘An Appraisal of the Interest Cost Savings of State Bond Banks’, Municipal Finance Journal,

25 (4), 13–48.Western Australian Local Government Association (WALGA) (2006), Systemic Sustainability Study: In Your Hands.

Western Australian Local Government Association, Perth.

� 2012 The Economic Society of Australia

122 ECONOMIC PAPERS MARCH