Public infrastructure spending - KPMG

1 KPMG Economics January 2017 Public infrastructure spending :Show me the moneyThe June 2016 National Accounts reveals government expenditure on infrastructure , as measured by nominal Gross Fixed Capital Formation, has experienced only a minor increase in FY16 as compared to FY15. This is despite the fact that politicians have been talking up infrastructure spending as a key government platform to help deepen and grow the Australian a jurisdictional perspective, it would seem that New South Wales and Victoria are increasing their relative spend on Public sector capital compared to every other jurisdiction, with most notably Queensland spending less in FY16 than it did in FY15. However, this overly simplistic analysis fails to take into consideration several important factors, including expenditure per capita and expenditure relative to the underlying asset is more appropriate to consider capital expenditure in the context of the assets owned by each jurisdiction, as those States and Territories with greater assets in Public ownership will necessarily need to spend more on capex to maintain, replace and enhance their infrastructure base than those States and Territories that have privatised some Public sector capital stock is consumed at a rate of about percent per annum.

2 Ignoring inflation, Public sector investment expenditure equivalent to percent of the asset base is required each year just to stand still . This means we need to spend in real terms about $40 billion on Public sector assets each year just to maintain the operational functionality of Australia s $ trillion Public sector asset , capital spend just equivalent to depreciation does not maintain the status quo if there is growth in the population. Moreover, it does nothing to help grow the economy and enable improvements in productivity through the provision of infrastructure and other Public goods. In equilibrium, the Public sector net capital stock should be growing at a rate equivalent to the target rate of economic growth across the whole recommend the minimum level of efficient Public sector capital expenditure should average between percent and percent of the value of non-financial Public sector assets per annum over the longer term, which represents a percent depreciation component and a percent to percent real growth factor.

3 If this investment target was achieved for FY16 then gross capital expenditure by the Public sector in Australia would have amounted to between $95 billion and $105 billion, based on the current value of non-financial Public sector , given gross fixed capital formation amounted to only about $75 billion in FY16, current investment by governments in Australia is insufficient and should be raised by between 25 percent and 40 percent to ensure economically enhancing Public good assets and other enabling infrastructure are being delivered in a timely manner. 2017 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMGI nternational Cooperative ( KPMG International ), a Swiss entity.

4 All rights reserved. The KPMG name and logo are registeredtrademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Classification: KPMG Confidential3In KPMG s recently released November 2016 Quarterly Economic Outlook it was highlighted that Government expenditure on infrastructure , as measured by Gross Fixed Capital Formation (GFGC)1, had experienced only a minor increase in FY16 as compared to FY15. This is despite the fact that politicians have been talking up infrastructure spending as a key government platform to help deepen and grow the Australian economy. On first blush it would seem that growth in Commonwealth real expenditure on GFGC has been very modest since the beginning of the new century, while real expenditure by State and Local governments rose strongly in the first decade of the millennium before declining in recent becomes even more pronounced when considered in the context of total government expenditure.

5 As shown in Chart 2 below, government expenditure on capital represents only about 15 percent (on average) of total spend at the Commonwealth level, and about 21 percent (on average) at the State and Local Government level2. Capital spending by State and Local governments grew considerably since the mid-2000 s, initially in the transport and communication sectors, but was then bolstered by spending in the education sector in FY10 and FY11 as a consequence of the Federal Government stimulus package, Building the Education Revolution (BER). 2016 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMGI nternational Cooperative ( KPMG International ), a Swiss entity.

6 All rights reserved. The KPMG name and logo are registeredtrademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Classification: KPMG Public4 2016 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMGI nternational Cooperative ( KPMG International ), a Swiss entity. All rights reserved. The KPMG name and logo are registeredtrademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Classification: KPMG Public5 From a jurisdictional perspective, it would seem that New South Wales and Victoria are increasing their relative spend on capital compared to every other jurisdiction, with most notably Queensland spending less in FY16 than it did in FY15.

7 However, this overly simplistic analysis fails to take into consideration several important factors, including the per capita expenditure and expenditure relative to the underlying asset base. 2016 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMGI nternational Cooperative ( KPMG International ), a Swiss entity. All rights reserved. The KPMG name and logo are registeredtrademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Classification: KPMG Public6 However, even this analysis fails to properly explain the situation, as different jurisdictions own different assets, and therefore have different capital expenditure patterns.

8 For example, the Victorian government privatised their electricity sector assets, including generation, transmission, distribution and retail elements, in the mid-to late-1990 s, and therefore no longer incurs major Public capital expenditure within this sector. However, New South Wales, which privatised its generation assets in 2013 and partially privatised some of its network businesses in 2015 and 2016, still incurs capital expenditure within this is therefore more appropriate to consider capital expenditure in the context of the assets owned by each jurisdiction, and those States and Territories with greater assets in Public ownership will necessarily need to spend more on capex to maintain, replace and enhance their infrastructure base that those States and Territories that have privatised Public assets.

9 In simple terms, the Public sector net capital stock grows when annual capital expenditure is greater than the amount of capital that is consumed each year through depreciation. On a per capita basis it appears that the smaller jurisdictions are spending relatively more than the more populous States3. 2017 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMGI nternational Cooperative ( KPMG International ), a Swiss entity. All rights reserved. The KPMG name and logo are registeredtrademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Classification: KPMG Public7 2017 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMGI nternational Cooperative ( KPMG International ), a Swiss entity.

10 All rights reserved. The KPMG name and logo are registeredtrademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Classification: KPMG Public8As shown in the stylised diagram above, the opening value of Public sector capital stock K0 is maintained in real terms if annual Public sector capital expenditure matches the value of depreciation ( ) associated with the Public sector assets, which is shown by the black line K0-Ka. The general form of the equation describing how the value of the capital stock adjusts over time is described below, = 0 1 + =0 1 1 1where: 0= base period stock of capital = year T capital stock where T = 1, 2, ( )= investment in years, where s = 0, 1, 2,3.