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Towards stronger, more efficient and effective public sector enterprises: the case for selective capital restructuring



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TOWARDS STRONGER. MORE EFFICIENT AND EFFECTIVE

PUBLIC SECTOR ENTERPRISES: THE CASE FOR SELECTIVE

CAPITAL RESTRUCTURING

Address by 'Senator Gareth Evans, Minister for Transport and

Communications, to ACOA/ACOSS et al Conference on "The Public

Sector, Privatisation and Social Justice: Future Directions",

Sydney, 22 March 1988.

Before embarking on my own further contribution this morning to

the so-called privatisation debate - which can more precisely,

and less emotionally, be described as a debate about the

desirability of restructuring the capital base of some

Commonwealth government business enterprises - I think it is

important to put matters into context by mentioning several

points which have tended to get lost as the debate gets

increasingly lively.

First, the whole debate on the restructuring of the public sector

is only part - and by no means the most important part - of a

much broader debate that is going on within the Government, and

to some extent the community (one wishes more vigorously in the

business community), on the restructuring of Australian industry

generally. This is the long overdue debate on what is necessary

to get us, as a nation, into the kind of lean, taut and hungry

shape we need to be in to survive in an increasingly globalised,

competitive and hostile economic environment.

Secondly, the government business enterprises on which the debate

has focused are only one part of the public sector: other areas,

such as the Australian Public Service itself, also make crucially

important contributions to the nation. There have been very

significant achievements already in restructuring the Public

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Service, bringing greater equity to Public Service employment,

and strengthening and making more efficient the public sector

generally, and those efforts are continuing.

Thirdly - and getting to the nub of what I want to say today -

the entire debate on enterprise policy has tended to bog down in

a simplistic "to sell or not to sell" argument, which in many

ways has obscured more fundamental questions of enterprise

efficiency and the fairest and most effective use of public

resources.

The pursuit of greater efficiency in the public sector is not

being undertaken out of any peculiar ideological conviction, or

for its own sake. The immediate imperative is simply that the

Government's ability to deliver the desired level of services,

let alone to pursue new initiatives in social policy areas,

depends to a significant extent on limiting competing calls on

the Budget dollar both from public administration generally, and

from public enterprises.

Of course, efficient government business enterprises have the

ability, through returns to the Budget in the form of dividends

as well as their pursuit of national or other objectives, to

contribute in a major way to the common good of all Australians

and not only those who utilise their services.

But even the most efficient public enterprises can create

dilemmas for their owners - in particular, dilemmas which arise

in the Budget context from the need, in many cases, to keep

expanding their capital base if they are to be able to maintain

their efficiency and competitiveness in the market and thus to

continue making an effective economic contribution to the nation.

When problems of this kind arise, it is only common sense to re­

examine why it is that a particular enterprise is in the public

sector in the first place, and whether the advantages that flow

f t

from keeping it there, in whole or part, outweigh the risks and

difficulties of doing so.

If one looks historically at Commonwealth government business

enterprises, a common pattern rapidly becomes evident. The

essential factor in each case for the Government's becoming

involved in an enterprise was that there was either a clear

social purpose, or a national interest which was required to be

met, which was not being met effectively by the private sector or

was unable to be met by the private sector. Each enterprise was

acquired or set up in different circumstances, with a different

history, sphere of activity, market and charter: but each

essentially meets this description.

Naturally, each enterprise, as a provider of services, has grown

as the economy has grown. Enterprises such as Qantas and

Australian Airlines are much larger and more complex entities now

than they were in the 1940s when they were set up, or acquired,

by the Government.

Concomitantly with that development of the economy, the

conditions which existed when enterprises were established have

changed. Several clearly continue to perform an essential social

function and rightly need to remain in full government ownership:

I am referring particularly to enterprises such as Australia Post

and Telecom, which the Prime Minister made absolutely clear last

September were not even being looked at as candidates for sale in

whole or part.

Others were set up to carry out a commercial type activity either

because there was no viable Australian-owned alternative (such as

ANL and Qantas) or to preempt the emergence of undesirable

private monopolies (such as Australian Airlines). For this

latter group of enterprises, the growth in both the Australian

and world economy has led to an expansion of markets and greater

competition.

- 3 -

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In order to foster increased efficiency of all these bodies

within their market sectors, the Government has encouraged them

to adopt a more commercial ethos. In 1984, for instance, the

Hawke Government completed major reviews of the four transport

authorities (AN, ANL, Qantas and Australian Airlines) which

resulted in a freeing up of some of the then existing government

controls over these bodies, and capital injections into Qantas

and Australian Airlines.

Subsequently, with the Government's continuing determination to

fundamentally restructure the economy, it became clear that all

classes of inputs to industry costs needed to be examined,

including those services provided by Government enterprises.

There are a number of ways in which the Government has sought to

increase efficiency in this structural adjustment process,

including

- introduction of greater competition,

- addressing with new vigour management and work practices

and over-generous benefits and tax breaks, and

- removal of unnecessary government controls and

constraints.

The Government is now engaged in an examination of the

enterprises to see what needs to be done to enable them to

operate more efficiently, and at the same time to identify and

resolve some particular problems that are fast emerging as very

major and very intractable.

This examination process involves many quite complex policy

questions, but they boil down essentially to two:

- what is the most appropriate degree of government control

of various business enterprises; and

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- how can the Government ensure that enterprises have

sufficient capital to operate efficently and

competitively while ensuring that funds are not diverted

from the Government's other priority areas.

Government Controls

The most intensive phase of Government action to increase the

efficiency of its commercial enterprises started in October last

year when my colleague Senator Walsh released the "Policy

Guidelines for Commonwealth Statutory Authorities and Government

Business Enterprises".

An important feature of these guidelines was a recognition that

each enterprise is different and that measures to increase

efficiency, had to be tailored to meet individual circumstances.

A case by case examination of each enterprise is essential in any

review of enterprise policy, and the Government currently has

work in hand to examine all the remaining government controls

which are applied to each enterprise - and there are many of them

- to see if any or all of them can be relaxed to allow the

enterprise boards greater freedom of action to respond to changed

market and economic circumstances. A lot of fine judgement is

involved in ensuring accountability while allowing adequate

management flexibility.

Some of the most important control issues relate to such matters

as borrowings, executive remuneration, industrial relations

coordination and superannuation arrangements. Governments in the

past have loaded enterprises down with controls which their

competitors do not have, and which constitute barriers to

efficiency, including numerous restrictive controls on management

operations, restrictive capital raising policies and, in some

cases, poor board appointments.

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One less than desirable outcome of this has been the maintenance

of a culture which emphasises caution and reliance on government

decisions, where a competitive and risk-tolerant commercial

emphasis is required. A great ,deal of improvement can be

achieved by removing controls, and tackling inefficiencies, while

at the same time retaining enterprises in public ownership.

A good example of how this can be done is Australian Airlines.

The Government has just put legislation in place to convert

Australian Airlines to a company incorporated under the Companies

A ct. The legislation also allows the airline to be reorganised

into a more commercial structure prior to incorporation, and

provides for the removal of detailed Government controls when the

airline becomes a company. Any controls which the Government

decides should remain over the airline will be clearly defined in

either the Memorandum and Articles of the new company or in the

Guidelines to Directors. The sort of controls which will be

removed include the need for approval for:

- all but exceptionally significant expenditure decisions;

- detailed terms and conditions of borrowing and leasing

arrangements (but not Loan Council constraints, the need

for which is being separately addressed and which I will

mention again below);

- investment of surplus money;

- choice of auditor;

- dividend recommendation;

- provision for insurance against risk.

As a public company, Australian Airlines will be subject to the

normal provisions relating to control, performance,

accountability and reporting of company activities. As a

government owned enterprise it will be subject to an agreed

- corporate plan and target rates of return, but it will be very

much allowed, and encouraged, to get on with the job of preparing

for the much tougher competitive environment that will exist

after 1990 without the government continually looking over its

shoulder as happens at the moment.

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Capital Formation and the Restructuring Debate

What the Government has been doing, and continues to do, so far

as freeing up government business enterprises from managerial

controls and constraints, has been comparatively

uncontroversial. The same cannot, however, be said for the issue

of restructuring the capital base of some of these enterprises,

which has generated a torrent of noisy controversy likely to

continue now until the June National Conference of the ALP.

I should like to begin by spelling out the assumptions on which I

base my own approach to that current debate, and make it

absolutely clear again (as I hope I did in my H R speech last

November, when I sought to place the focus of the then

privatisation debate on the question of enterprise capital

structure problems) that neither I nor any of my senior

colleagues are closet Thatcherites. My starting assumptions are

threefold:

. first, I believe that, other things being equal, the public

sector is likely to be more responsive to social policy

issues than the private sector (which is, after all, the

central assumption underlying the ALP's traditional

socialisation objective), and that there is a good reason in

principle for retaining a mix of private and public ownership

in the competitive economy;

. secondly, I strongly believe there is no reason why a public

sector enterprise cannot be run as efficiently as any private

sector enterprise (although this does mean, as I have already

indicated, abandoning many of the controls and constraints to

which we have traditionally subjected such enterprises);

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. thirdly, I accept that the onus is very much on those who

would seek to modify or dilute present public ownership in

any way.

It would be nice to be able to stop there: there are less

masochistic ways of enjoying political life than confronting

issues that lie at the very heartland of the ALP's traditional

sensitivities. But wearing my present Ministerial hat, and being

as acutely conscious as I am about the problems confronting at

least some of the eight major government business enterprises for

which I am responsible, there is a question I have to ask.

It is simply this: are there capital problems confronting some of

the government business enterprises of such a kind, or on such a

scale, that they may only be capable of solution with some

modification of traditional policy, albeit in a way which is

consistent with the underlying principles of the Labor movement?

As I have said from the outset of this debate last year, the only

way that questions of this kind can sensibly be approached is on

a case by case basis. There is only time today to look at one

such case, but let me choose the one that seems to me to pose the

most dramatic and difficult capital problems of all the ones that

arise in my portfolio - the case of Qantas Airways Limited.

The Qantas example

When the Chifley Government purchased Qantas in 1946-7 from BOAC

and Australian private interests, it did so

. to ensure complete Australian ownership of the Australian

flag carrier;

. to enable greater capital investment than the Australian

private capital market could then supply; and

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. to compete effectively with the then competition, which was

strongest from the wholly UK government - owned BOAC.

Forty two years later, Qantas has 30 very expensive planes, an

annual revenue of $2.45 billion, flies 3 million passengers a

year and employs nearly 14,000 people, and finds itself:

. competing internationally with 30 other airlines, most of

them privately owned; and

. facing an international aviation environment which is not

only fiercely competitive, but dominated increasingly by

mega-carriers who can take big marketing risks on particular

routes while hardly noticing the pain (e.g. British Airways

with 164 planes, United with 364, Continental/Texas Air with

497) .

The basic prospect facing Qantas, and other airlines of similar

size, is to get big or get out. Qantas is, accordingly, planning

a massive re-equipment program to replace and extend its fleet

from 30 planes to 51 by 1992, at a capital expenditure of $5,400

million (this figure has been revised upward, as a result of a

major market reevaluation and corporate planning exercise over

the last few months, from an earlier 1987 estimate of $4

billion). The airline can raise most of this ($4.8 billion) by a

combination of

. borrowing (assuming no limits from the Loan Council), and

. retained earnings from profits

but Qantas argues very strongly (and I think persuasively) that

it needs another $600 million (most of it before the end of 1989)

by way of capital injection to meet its capital expenditure

target.

The argument essentially is that so long as the airline stays in

full public ownership, that $600 million is going to have to come

straight out of the Budget - which in turn is going to cause huge

pressure, and pain, on other areas of Labor Government spending

(areas that are likely to have much more immediate, and positive,

impact on the Labor Party's traditional base).

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There are three kinds of argument now in circulation which claim

that this scenario is over-simplistic, and does not really compel

us to rethink existing policy. Let me respond to each of them.

(1) "Qantas can raise the money by borrowing - it doesn't have

to come from the Budget"

People who argue this way often forget that, on the scenario

I have sketched out, the $600 million is only a residual

figure, and there is already a huge borrowing commitment: of

the $5.4 billion required, it is assumed that $4.8 billion

will be raised by a combination of retained earnings and,

mostly, borrowings.

The argument assumes that either there are not, or need not

be, any Loan Council restrictions on the amount borrowed.

That may be achievable, but it can't be assumed - the

Commonwealth is not in complete control of the Loan Council,

and a delicate balancing act is required to ensure that

Qantas and other Commonwealth public sector enterprise

borrowings do not become an excuse for major breakout by

State authorities, which has been very economically

destructive in the past.

Even with Government guarantees backing Qantas's borrowing,

there is a limit to the extent to which Qantas can blow out

the proportion of debt to equity on its balance sheet. The

airline's 'gearing' ratio is already 80:20 and Qantas has

been strongly advised to haul that back to at least 70:30,

and preferably 65:35, which would bring it more into line

with the international aviation industry (though not with

most of the international airline "success stories", whose

gearing tends to be much lower still).

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Everyone acknowledges that a higher gearing ratio is generally

bad news for private sector companies

- high interest commitments bring the danger of plunging into

loss in a downturn;

- capacity to borrow, invest and respond flexibly and quickly

to new opportunities is drastically weakened; and

- the capacity to survive prolonged price or service wars from

competitors is much reduced.

Higher gearing is not quite the same bad news for a government

backed enterprise, because borrowers will lend money on the

assumption that government will bail the enterprise out if the

going gets rough. But -

- there is a point beyond which lenders will be very reluctant

to go on lending (i.e. when they see the price of the bail­

out as getting too high, with the government facing a

liability of hundreds of millions of dollars which it may not

be prepared to pay out at short notice);

- higher gearing can be very destructive of commercial

effectiveness: enterprises operating in a highly competitive

environment have to be able to compete on level terms and

make strategic and other investment decisions without being

dependent on endless government approvals;

- very high dependence on borrowings tends to be destructive of

managerial morale, directors' responsibility and the general

corporate culture: being forced to play by different rules to

one's competitors, with a different capital structure and

total dependence on a government being sympathetic, able and

willing to bail the enterprise out if it gets into trouble,

is not the best environment from which to take on the world.

The way in which these various factors balance out is usually for

there to be an acknowledgement that some marginally higher degree

of gearing is permissible for a government owned, as compared

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with a wholly private sector, corporation, but that for the sake

of the ongoing health of the organisation that gap should not be

too wide. In the case of Qantas, facing the kind of capital re­

equipment program that lies ahead of it, the acceptable top of

the range gearing would be of the order of 70:30.

(2) "If the Government does put money in, this needn't create

a Budget problem at all - it's just a matter of redefining

what goes into the Budget accounts,"

The argument here is that a capital injection of $600 million, or

whatever, to an enterprise like Qantas should not be regarded, or

does not have to be regarded, as contributing to the Budget

deficit, or reduced surplus.

The starting point of the argument is reasonable enough - viz

from a strictly analytical viewpoint, there is no economic

difference between

. the private sector borrowing money from capital markets here

and overseas to put capital into a productive enterprise like

Qantas, and

. the government borrowing money to meet a Budget deficit or

shortfall produced as a result of a Government injecting

money into such a productive enterprise.

That much is true enough, but it .is. only the beginning of the

argument. What the government then has to do is persuade the

rest of the world that this kind of expenditure, and the

government borrowing associated with it, should not be taken into

account in assessing our Budgetary performance.

Obviously we are not going to get very far if we simply publish

the Budget aggregates with all these figures included in the

surplus or deficit outcome in the usual way, but then ask the

world financial markets to 'mentally discount' the Budget outcome

by $600 million or whatever the total figure for capital

injections comes to - on the basis that this represents

productive investment different in character from other Budget

outlays.

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What immediately impacts upon markets, particularly overseas

financial markets (and what in turn immediately impacts upon our

interest rates, currency and investment) are the published

aggregate figures. It would be hard enough to sell a 'discount

factor' in Sydney, let alone in Zurich or Tokyo. But we would

have to be sure that we could sell it, to overcome the impact

that higher overall outlay figures would have on market

sentiment.

But those who argue that the Budget expenditure problem is not a

real one take their position a considerable stage further than

all this. They say, in effect, not that the market should be

asked to mentally discount the Budget outcome for productive

government investment, but that the Budget itself should be

redefined - i.e. that the Budget accounting conventions should be

changed (and announced as such), so as to leave out both

expenditure on productive capital investment and the revenue

raised from asset sales.

There is a quite respectable theoretical argument, and some

support to be found in OECD accounting practices, for doing

this. To rewrite the definition of Budget aggregates, and the

definition of public sector borrowing which stands behind them,

so as to cover 'General Government' services, and to exclude

market-sector related activities, recognises the fact that the

biggest economic grounds for concern arise when a country has to

borrow excessively to finance expenditure which is essentially of

a consumption nature (e.g. on public administration, health,

welfare and warfare) rather than that of an investment nature,

adding to productive capacity.

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But once again it is much too simple, when it comes to the real,

practical, sceptical world we inhabit, to say that we can simply

define away our expenditure problems in this way. There are a

whole series of considerations, both presentational and

substantive, which lead to the conclusion that this is difficult

to the point of impossibility:

. Any change to the accounting rules would need to be explained

to and be accepted by a sceptical audience of international

investors, many of whom are likely to question our motives if

the change apparently suits our case: the fact is that

Australian investments represent a miniscule proportion of

, the world's total portfolio and potential investors can only

rationally invest a small proportion of their resources in

researching Australian conditions and accounting conventions.

. Any change would necessarily have to be accompanied, for

purposes of assessment and comparison of rates of change, by

a revision and republication of the historical data. We

would need to be very clear that any new accounting

conventions would not result in some changed perceptions

about the nature and extent of our economic improvement.

. Expenditures on capital injections and the like don't simply

disappear by being treated as 'off-Budget' - they have to

show up somewhere in the government accounts and must be

taken into account in making, and evaluating, macro-economic

policy. The actual outlays and the actual capital borrowings

that government ends up making, for whatever purpose, will

have to be published as aggregate figures, and will end up

having an impact on market sentiment, however those figures

are initially presented.

. There is no simple or generally accepted formula for

determining how to split outlays and receipts and borrowings

between Budget (or 'General Government') and non-Budget

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categories. Even leaving aside expenditure on things like

roads and education, which would certainly be regarded by

economists as 'productive' rather than 'consumption' in

character, there are innumerable kinds of Budget expenditures

- amounting in my calculations to nearly $5 billion - which

are directly and immediately comparable to Qantas-type

capital injections, and would have to be defined out of the

Budget outcome if any systematic new set of conventions were

applied. For example:

- structural adjustment contributions to various industries

(e.g. $90 million to steel, TCF, automotive and heavy

engineering);

- research grants to particular industry sectors (e.g.

NERDDC $21 million, water resources $47 million, wheat

$13.6 million - a total with other small programs of $94

million);

- assistance to export industries and tourism promotion

($136 million);

- tax expenditures of various kinds, e.g.

R&D write offs (an estimated $150 million),

Prime cost depreciation allowance ($500 million),

Concessions on retirement benefits (superannuation and

life insurance: $3500 million),

Gold tax exemption ($120 million),

Accelerated depreciation on trading ships ($37

million),

Special deductions for primary producers ($32

million), and

Management Investment Companies ($21 million).

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To leave out all these categories at once would make a massive

change to our Budget presentation, and would prove formidably

difficult to sell to sceptical international markets. But if we

were to leave out just some payments of a manifestly productive

investment kind, but include others in a piecemeal way, this

would also add immeasurably to the presentational problem of

selling the Budget as we must year by year - as an absolutely

reliable guide to a whole set of factors crucial to the nation's

economic health.

(3) "Why not spend the money out of the Budget? We shouldn't

think of $600 million as being thrown away in any

sense - it is a productive investment on which the

government will get a return; it's better that that

return be to the public sector than the private."

This argument again has some initial attraction. Of course one

expects to get a return on any investment, i.e. to generate more

funds over time than the face value of the investment; it

wouldn't be made otherwise.

But the crucial element here is the time factor involved in

getting such a return. The simple facts of government budgetary

life are that making a large payment now in order to get a

(bigger) return later cannot always be readily justified. The

question for government, like any other investor in these

circumstances, is simply whether the investment is an affordable

one in the circumstances that exist now. This involves

considering, in short, whether the rewards later justify the loss

of other expenditure opportunities now.

If we do not want to increase the budget outlays then the

Government does have a problem with Qantas: we can spend $600

million on Qantas and expect a flow of returns which will finance

social expenditure in the future, but we cannot take away from

the fact that we are left with a budgetary problem in the initial

year because the Government has $600 million less to spend on

other things in that year. $600 million could buy, for example:

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. 600,000 traineeships (12 months' on-the-job training), or

. 240,000 child care places, or

. 126,000 full TEAS scholarships, or

. more than the whole full year cost of the Family Assistance

package announced in 1987, or

. substantially more than the entire ABC and SBS budgets

combined.

Under these circumstances, it must be proper to ask, I would

suggest: ,

- Just what are the social policy objectives, or socialist

objectives, that demand that the capital needs for Qantas be

served in this way?

- In the present climate of severe budgetary restraint and

difficult economic circumstances for many individuals, should

we forego these current expenditures in the hope that our

investment in Qantas will generate sufficient benefits in the

future?

- Is there another way out of the dilemma?

A solution for Qantas. There is, in fact, another solution for

Qantas's present problems, which does not involve either changing

the character of the airline as a publicly owned one, or the loss

of any degree of government control over it . What it does

involve is floating a minority interest in the airline, and

applying the proceeds to its capital base, while still retaining

for the government majority shareholding and control.

The arithmetic is simple. Shareholders' funds as at March 1987

were $485 million, and by 1989-90 should (with further retained

earnings) be over $600 million. This means that - especially if

we take into account the premium that will undoubt ably be payable

on any share issue (meaning that the enterprise receives more

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money than the face value of the shares floated) - Qantas should

easily be able to raise $600 million without diluting

Commonwealth ownership beyond 51%, and perhaps not even as much

as that.

This is an area, then, where it is possible to solve the

investment problems and budgetary problems that presently

confront us in relation to Qantas, without at the same time

sacrificing - on the basis that these continue to be thought

important in the airline industry, for whatever reason - public

ownership principles and Commonwealth control.

There are other incidental advantages that flow from such a share

float, which for present purposes I can only mention in passing,

including that:

. it makes possible an employee share ownership scheme, and

. it enables sharemarket monitoring of the airline's commercial

performance, which will help to keep it hungry and effective

(as it has to be to survive in the shark pool of

international aviation).

Conclusion

I am basically an old fashioned public sector supporter - with a

commitment to public ownership not as an end in itself, but

usually as the best available means of securing values that

democratic socialists, and all of us in the Labor movement, are

all about.

But I am someone who, wearing my Ministerial and Cabinet hat, has

to confront real world problems and try to find solutions to them

which don't sacrifice any of the principles that we are about,

and which at the same time are saleable both to the community at

large and to the ALP's traditional constituency.

I believe that there are solutions to the kinds of problems I

have identified, but they have to be carefully looked at and

tailored on a case by case basis.

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The debate on public sector efficiency, appropriate government

controls on public sector commercial management, and above all

else on public sector capital restructuring, can only be sensibly

advanced if it does proceed on this basis: judging each case

calmly on its merits, looking at the issues and orders of

magnitude involved in that case, and not searching for hidden

agendas or thin-edged wedges where none exist.

This is the way that I and the other Cabinet Ministers

immediately involved in these issues are approaching the debate,

and we are confident that - provided a similar spirit prevails

elsewhere within the Labor movement, and that forums like this

continue to enable the issues to be aired systematically and in a

rational and constructive way - that solutions will emerge that

will be acceptable both to the general community and our

traditional constituency within it.