Reform of the Core Public Sector: New Zealand Experience

Reform of the Core Public Sector: New Zealand Experience GRAHAM SCOTT, PETER BUSHNELL and NIKITIN SALLEE

New Zealand governments, like most others around the world over the past two decades, have been concerned with the growth of public expenditure and the necessity to search for ways to increase the effectiveness of the use of resources which are channelled through the public sector. International approaches have been applied including Organization and Methods (O&M); Planning, Programming and Budget- ing Systems (PPBS); Management by Objectives (MbO); Program Analysis and Evaluation (PAE); use of a public sector discount rate for capital projects; and corporate planning. During the past five years the New Zealand Government has carried through a program of changes to the public sector which is more far-reaching and complete than any in the past. These recent reforms have followed two main strands: removal of the main trading operations from the core public service with the establishment of the State-Owned Enterprises (SOEs), and the later reform of the remaining public service with the passage of the State Sector Act and financial management reform based on a new Public Finance Act.

In this article we describe the recent changes in public sector management and why they came about. Our focus is on government expenditure and the way government agencies are managed. Other important roles of government such as the formation and execution of regulation are discussed only to the extent relevant to the main topic. The current process of reform is still in its early stages.’ The first SOEs were created in April 1987, and the main financial management reforms were approved by Parliament only in July 1989. Therefore, only very early indications can be given of the effects of the policy changes.

THE CONTEXT

The timing and nature of public sector reforms can be better understood when placed within the context of general economic policy within New Zealand. Prior to the election in July 1984, the previous government had combined initial moves to liberalize controls in some areas with greatly increased controls in others.2 In particular, a wage and price freeze was in place together with comprehensive controls of the financial sector and

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REFORM OF THE CORE PUBLIC SECTOR 139

large subsidies which were being paid to farmers and exporters. New Zealand had a highly sheltered private sector which consequently did not face the true costs or benefits of the resources it used.

The public sector was legally governed by the Public Finance Act of 1977, the State Services Act of 1962, the State Services Conditions of Employment Act of 1977, and the Health Service Personnel Act of 1983. Cabinet also had a significant influence through specific directions on departmental management which were codified into manuals of instruc- tions. Departments had heads who were appointed with permanent tenure and whose staffs were employed by a central employing body, the State Services Commission, under an industrial relations regime substantially different from that of the private sector. In general, individual departments encompassed a wide range of functions: policy advice, the administration of legislation, and the provision of services. The objectives of departments were often conflicting and were rarely articulated with clarity.

In this environment accountability was seen mainly in terms of compliance with written rules aimed at limiting discretion, the absence of corruption, and the avoidance of mistakes or political embarrassment. Consistent with this philosophy, cash accounting was widely used. (However, accrual accounting was standard for departments within the public sector until there was a shortage of accountants during World War Two. At this time a change was made to cash accounting.) Limited information was available to assess performance, partly because there was limited scope to use what was available.

As has been noted, various attempts had been made to improve public sector operations prior to 1984. For example, departments had continually sought extra funding without cutting existing spending which was low priority, so the first changes gave some incentives to critically examine basic funding. They included: reviews of existing and new policies; automatic reductions in departmental staff limits (with the pool of reductions being reallocated by ministers to higher priorities); a shift to program budgeting from input appropriations; across-the-board cuts in departmental funding of various percentages; a “tit-for-tat” rule whereby new policy proposals had to be funded from existing appropriations; some moves to user-pays; experimentation with revolving funds under which departments with significant commercial functions largely spent the revenue they generated; and a grouping of expenditure items, other than salaries, into a bulk budget (similar to “running costs” in the UK).

Following the election in mid-1984 the incoming government faced very high fiscal deficits, high debt including substantial liabilities resulting from various guarantees given by previous governments, and an economy with an extended history of slow economic growth. It acted quickly to phase out

140 GRAHAM SCOTT, PETER BUSHNELL AND NIKITIN SALLEE

direct subsidies and to reform regulations which were undesirable on the grounds of efficiency and equity. The approach taken was to adopt a set of mutually reinforcing macroeconomic and microeconomic policies aimed at achieving sustainable growth in the medium term.

Reforms in almost every other sector of the economy raised the issue of the efficiency or effectiveness of the public sector. In the year ending March 31, 1984 the public sector accounted for almost 22 percent of GDP, 28 percent of gross capital formation, and government expenditure including transfers was around 39 percent of GDP. Given that inefficiency in such a large sector of the economy can impose a substantial cost burden on the rest of the economy it was inevitable that reforming the state sector would be seen as the next logical step.

In the state sector, which in New Zealand excludes local governments, there have been two main thrusts to the recent reform^.^ The first was to set up the major commercial activities as State-Owned Enterprises (SOEs), separate from (and in some cases replacing) their parent departments. The second involved changes to the employment and financial management regimes in the remaining state sector.

In contrast to past efforts to improve efficiency in the state sector, the recent changes have been more comprehensive and more fundamental. They have aimed to change the incentives acting on managers so that they support the reform process rather than oppose it. The extent of the reforms can be attributed to an unusual conjunction of three conditions. First, the 1982-84 wage and price freeze, interest controls, and changes to the tax laws created a strong climate of opinion in favor of deregulation. Second, the election was won by a government which had been out of office for nine- years and which was, therefore, unconstrained in reexamining the basis for many existing policies. Finally, the incoming administration included ministers with experience in the cabinet and in the public service. The government set out a program of economic reform in which fiscal reform played a central role.

THE CROWN'S COMMERCIAL ACTIVITIES

Government sector commercial activities can be defined as those which involve the transfer of private goods to third parties, whether or not full charges are levied. In the main they have been undertaken within departments or government-owned corporations and often under monopoly conditions. In recent years considerable attention has focused on those commercial activities which have been undertaken in a departmental form, and a number of difficulties have been identified.

REFORM O F THE CORE PUBLIC SECTOR 141

Government Departments

For some government departments commercial activities, as defined above, are the primary function. For others, the provision of goods or services is incidental to other functions of the bureaucracy.

The problems with the performance of commercial activities within departments arose for four main reasons, all of which were interlinked. First, objectives lacked clarity. For instance, the Forest Service had objectives covering commercial forestry, conservation, regional development and employment generation. The relative weights of these objectives, and tradeoffs between them, were rarely articulated explicitly, and, consequently, it was difficult to assess the performance of the department.

Second, departments operated with both advantages and disadvantages relative to private sector managers. On the one hand, their capital was provided free (encouraging oversupply of capital-intensive outputs), they were exempt from taxes and many regulations, and they were often given statutory monopolies for their output. Revenue was obtained from the supply of goods and services to the government in a way which allowed cross-subsidization of sales to third parties. On the other hand, disadvantages faced by public sector managers included the lengthy, uncertain and often tardy process of funding with parliamentary appropriations; labor market constraints on remuneration levels, working conditions, hiring, firing and promotions; and the set of general and financial rules which limited the freedom of managers to make decisions on the purchase and use of inputs. These various advantages and disadvantages made some actions profitable which would not have been otherwise and vice versa. When this happens government activities contribute less overall to the community than they might otherwise. Furthermore, it then becomes difficult to assess the quality of performance by state managers.

A lack of information was the third problem identified. This partly resulted from a failure to clarify the objectives for undertaking the activity but also from a failure to specify the criteria to judge performance and a lack of systems to supply pertinent information. Few, if any, departments were aware of the full cost of producing their goods and services.

A subset of the information problem was the failure of departments to assess the value placed on their goods and services by users. For instance, despite forests having been planted since the 1920s it was not until 1985 that the Forest Service formally assessed the returns that it would expect from its current plantings. Not surprisingly, almost none of the planned new plantings met the rates of return required of other state investments.


Many goods and services were supplied by departments without charge to users or for a nominal charge only. Users did not need to take account of the resources involved when they requested extra services. The only information available to the agency was that users wanted more of the service -but little indication was given of the value attached to it other than the strength of the lobbying. Consequently services were more likely to be supplied to well-organized and articulate users even if other services were more highly valued by other users.

Over the years various governments have constrained the prices set by publicly owned enterprises in order to subsidize particular groups or, more generally, to fight inflation. Between 1972 and 1975, for instance, railway charges were frozen. Government pricing policies have contributed significantly to the poor financial performance of many state enterprises.

The final problem area has already been alluded to in the discussion of disadvantages faced by public sector managers. Constraints were placed on decision-making by managers to counter the inability to monitor performance. In general, any decision of significance had to be made by the minister. Departmental managers simply implemented those decisions within a tight set of input controls. For example, funds for a given expenditure group such as salaries could not be used for inputs such as capital, travel or contracts.

Thus the main problems identified with commercial operations within departments were: a lack of clarity in their objectives and the existence of competitive advantages and disadvantages. Related to these two was a lack of information on the value of outputs and an inability to measure performance; and as a result managers were given little flexibility because of the need to achieve some sort of accountability.

Government Corporations

In New Zealand there has been no clear pattern.to the use of the government corporation as a means of delivering goods and services. By 1984 government-owned companies included three banks, a shipping company, a hotel chain, an airline, and a petroleum and gas company, among others. Conversely, other services, often provided by public enterprises in other countries (e.g. post, telecommunications, coal, electricity, and forestry) were delivered through departments under ministerial control.

While government corporations did not face the same constraints and confused objectives as did departments, they suffered through a lack of monitoring. Corporations in the private sector have their activities monitored by equity investors and analysts, and by financiers who lend them money. The threat of corporate take-over or insolvency acts as an


incentive to management performance. Government-owned corporations lacked these disciplines since they were 100 percent government-owned and government-financed.

When the initial public corporations were set up, that is those prior to the passage of the State-Owned Enterprises Act of 1986, not all the monitoring seen in the market place was replicated. The decidedly imperfect disciplines of the core government were removed but nothing satisfactory replaced them. As one might predict, the lack of scrutiny resulted in some managements and boards of directors which not only showed poor judgment but were able to survive for many years despite their weaknesses. The record of the different corporations was mixed. Some regularly showed losses. For instance, the Shipping Corporation had a history of optimistic projections of profit which were maintained in the face of chronic actual losses. The latter were not identified because of financial transactions which, by converting assets to leases with balloon payments, generated cash to cover the losses and temporarily reduced expenditures.

The performance of some of the other corporations was harder to assess especially in cases where profitability was enhanced by either regulations or government ownership. Air New Zealand moved from losses into profit, albeit within a heavily regulated environment. The Bank of New Zealand and the Development Finance Corporation both appeared to show excellent rates of return. Both, however, also benefited from implicit government guarantees on their borrowing, and arguably the Bank of New Zealand was also under-capitalized relative to private sector standards. Both banks made risky investments and have shown heavy losses following the fall in the share market in October 1987.

Initial Steps

Initially, most attention was paid to departmental commercial operations which were seen as offering the greatest scope for improved performance. The first step taken was to force departments to pay attention to the value to users of the goods and services being supplied. In the 1985 budget, the minister of finance announced that all departments supplying goods and services to identifiable users or groups of users would be required to charge at full cost, including an allowance for a return on capital. An exception was made where approval had been given to waive payment, fully or partially, on "social" grounds. Very large increases in charges, such as for export meat inspection, were phased in over several years. However, further changes were required. The corporatization, or State-Owned Enterprises (SOE), policy was developed to remove some of the existing constraints and allow greater management flexibility and also to improve


the accountability of managers by acting as a proxy for the monitoring regime that applies in the private sector.

The corporatization program was announced in May 1986 after the principles were outlined in December 1985 (Douglas 1985, 12 and 1986, 12). The best estimate at the time was that state commercial activities accounted for some 12 percent of GDP and about 20 percent of gross investment (The Treasury 1984,275). Nine SOEs were created from former government departments on April 1, 1987.4 Subsequently other SOEs have been f ~ r m e d . ~ In addition, the government owned a number of corporations which had been formed prior to 1987, as discussed in the previous section.

Principles for Reform

The State-Owned Enterprises Act of 1986 aims to reconcile the imperative of accountability for public authorities with the objective of commercial performance comparable with similar companies which were not publicly owned. There were five main elements in the policy. These were that SOEs should have ”clear and commercial objectives;” that they should operate under ”competitive neutrality;” that there should be “greater managerial flexibility and authority over key decisions;” that greater ”performance monitoring” should occur; and that the government would make “explicit grants to cover any non-commercial objectives” it wanted the SOEs to pursue.

Clear Commercial Objectives

SOEs were set up as limited liability companies under the Companies Act, with the Crown owning all the shares. The State-Owned Enterprises Act states that the principal objective of every state business shall be to operate as a successful business. In particular, the businesses are to be as efficient and profitable as comparable concerns not owned by the Crown; to have a personnel policy that provides employees with fair treatment; and exhibit a sense of social responsibility by having regard to the interests of the community. If the government wanted to maintain for social reasons the supply of any goods or services which the SOE regarded as unprofitable, the government had to contract with the SOE on a commercial basis.

The new companies were given the opportunity to succeed or fail on their own merits. Each was regarded as a commercial entity in its own right. This led to an emphasis which is different from that given in the UK. There the external borrowing of public corporations has been included in the public expenditure planning total which is used to control the level of spending by government organizations (HM Treasury 1988, para 7).


A primary aim in setting up the SOEs was to improve the monitoring of performance. Financial institutions from which the SOEs seek funding are one important way of obtaining that increased monitoring. In order for them to give adequate emphasis to the quality of the uses to which the funds were being put, financiers needed to regard SOEs as part of the private sector and subject to failure if poor decisions were made. Consequently, the Public Sector Borrowing Requirement (PSBR), which used to feature so heavily in British policy discussions, was not accepted as a sensible construction in the New Zealand environment.

Another difference is that there is no political constraint on SOE activity to ensure that the size of the state declines: the objectives are commercial. If the SOEs are efficient enough to expand - provided they do not enjoy any statutory advantages or government support, then the attitude taken by the New Zealand Government has been that they are free to develop and thereby add to the overall growth of the economy. As an extension of this point, the SOE policy probably makes political interference with commercial objectives more difficult than is the case where governments take a predetermined view about the optimal size of the state.

Ministers do, however, pay careful attention to the scope of business activity declared in the annual statement of corporate intent. Expansion into new areas might be declined if this substantially increased the business risks faced by the Crown as the shareholder and residual risk- taker or conflicted with the government’s desire to reduce its exposure in particular sectors. As an example, Electricorp was not allowed to buy Coalcorp even though that might have been good for Electricorp, because of the government’s desire to end its involvement in the coal business and pending decisions to be taken on the structure of the electricity industry. Electricorp was also refused permission to expand into oil and gas exploration and development, even though this might have been a sensible commercial decision for Electricorp because of the implications for the Crown’s overall portfolio and its exposure to the petroleum industry and the associated risk. To take another example, Postbank was sold to a private sector institution, the Australia and New Zealand Bank, despite an expression of interest from the Bank of New Zealand in which the government held a predominant stake.

Competitive Neutrality An aim of the SOE policy was to achieve competitive neutrality in both input and output markets. This means that, as far as possible, all competitive advantages and disadvantages arising from statutes should be removed. On the input side, SOEs were set up with a capital structure relevant to that industry and were required to pay taxes and earn a rate of


return on equity in line with the riskiness of the business. They had to raise debt in capital markets explicitly without a government guarantee.

A contrary view has been expressed that there will always be an implicit government guarantee, since any government would be unwilling to allow a major SOE to default on its debt because of the adverse political consequences.6 Thus a policy of corporatization may have some inherent limits in reaching competitive neutrality, simply arising from the fact of government ownership. As mentioned earlier, individual SOEs may be constrained in the extent of diversification they undertake because of concerns about the overall shape and risk of the total Crown portfolio.

Regulatory reform has proceeded alongside corporatization. The aim has been to achieve the greatest allocative and technical efficiency within the economy, even where the extra competition might make the SOE less profitable. With the exceptions of the air traffic control functions of Airways Corporation of New Zealand Ltd. and the monopoly on standard letters enjoyed by New Zealand Post Ltd., all statutory monopolies enjoyed by the SOEs have been removed. They have thus been exposed to competition from other public or private suppliers.

In some cases this was done prior to corporatization, such as with the requirement that departments buy their inputs through the Government Stores Board (now the Government Supply Brokerage Corporation Ltd.). Others, such as the monopoly held by Telecom on the supply and installation of telephone equipment, or competition in supplying phone services themselves, were removed after a period of notice.

One of the most difficult areas for policy involves activities with the properties of natural monopolies. This is particularly relevant for networks such as those with the electricity and telecommunication industries. Considerable work is currently under way on defining the appropriate industry structures and regulatory environment.

Managerial Flexibility and Authori ty

Each year ministers agree on the business direction for each SOE, set performance standards for rates of return and monitor the performance of the companies. Boards and managements are given the authority for major investment and strategic decisions. They are free to decide on recruitment, remuneration and dismissals, and procurement of inputs. When the SOE Act was passed in 1987, SOEs were subjected to the legislation covering private-sector labor practices rather than being covered by state-sector legislation (although the latter was itself subsequently changed to mirror the private sector). Thus, managements have the usual authorities held by private-sector executives in comparable organizations.


Performance Monitoring

In the absence of the information provided by equity markets, shareholding ministers must rely on advice and assistance from bankers, credit rating agencies or their own advisers. These advisers include analysts in the Treasury, independent analysts with private companies, and an SOE steering committee which includes a number of experienced business people.

Board and management performance is compared against both their own plans and also the performance of other companies in the industry. In particular there is an annual in-depth review of strategic (three years or longer) and annual operating plans, quarterly reviews of financial and operating results against budget, and reviews of six-monthly and annual audited accounts. In addition, any reports prepared by the SOEs for bankers or credit rating agencies are supplied to Treasury analysts for advice to the shareholding ministers.

Explicit Grants to Cover Noncommercial Objectives

One of the consequences of departmental delivery of services in the past was that there were large cross-subsidies between different users. Demand for some of these services would have been considerably less if full costs were charged. Examples include banking and postal facilities in low- volume locations, local or rural telephone services, urban rail services for passengers and the universal postal service.

With corporatization, the government undertook to enter into explicit contracts for any noncommercial services that it believed should be continued. These services could still be provided but the real cost of the transfers would be known and would be transparent. This approach can be contrasted with that of earlier periods. For instance, unit charging for local telephone calls was rejected. That would have removed some of the cross- subsidization between business and local users and would also have raised questions about the cost of supplying telephone services to remote and rural users. It could have led to an identification of the magnitude of the transfers that were being granted.

Whether all the costs of providing a service are recognized or not, they exist and must be borne by someone. To the extent that commercialization of a department leads to greater efficiency the real costs of providing a "non-commercial" service should be reduced even if they become more obvious. This would be even more likely in those cases where the SOEs were required to compete against other public or private suppliers to win the subsidy. Costs may be reduced by another effect as well. With better information, any subsidies may be able to be better targeted and thus the desired social benefit achieved with a lower total level of subsidy.


A policy of explicit subsidization requires proposals to be developed and placed before ministers. This ensures that ministers are aware of the details and can weigh the merits of the proposal against other types of spending. It means that a more strategic approach can be taken toward social services, under which the question is not merely, "Is this service being provided to these people as efficiently as possible?" but also "Is this service consistent with our other social policy decisions and is it a sufficiently high priority compared with alternative uses for the money?"

One of the suspicions of some opponents of corporatization is that the answer to the last question may be "No!," and that governments will not be prepared to continue to pay for these "non-commercial" or "social" services. They tend not to accept that such a decision would simply reflect a judgment that the social good obtained from the subsidy is not worth the cost, and that the SOE policy merely gives politicians more complete and transparent information to consider the tradeoffs.

Results of the SOE Policy

A full and definitive review of the performance of each SOE before and after the change is not available. It is difficult to reconcile performance as a department with that as a company for several reasons. Accounting methods have moved to a full accrual basis from cash accounting for most departments, some departments have been split into several SOEs (e.g., the Post Office) or have changed their focus. Furthermore, the regulatory environment has changed. Disentangling the various effects would be an extremely interesting exercise, but it has not been possible so far with the resources-available.

Therefore, in the meantime, conclusions about the results of the policy changes will have to be drawn from partial information. A few illustrations are given below. While care needs to be taken in the interpretation of this information, some common results have emerged from most SOEs. Labor productivity has been increased substantially, prices have been held in real terms or reduced, profits have been made, and dividends have been declared even for activities which have had long histories of losses. Responsiveness to consumers has increased at the same time for most SOEs, although in some cases this has meant reduced levels of service.

The Coal Corporation of New Zealand Ltd. was formed from State Coal Mines, a division of the Ministry of Energy, which had made cash losses (revenue less direct cash expenses) in 20 of the previous 22 years, with a loss in 1986-87 of $11 million. These cash-in cash-out losses do not allow for depreciation, interest payments, levels of capital investment or any employer superannuation liabilities. The corresponding statistics for the


first two years of operation as an SOE were cash surpluses of $12.8 million, in 1987-88, and $13.4 million for 1988-89.

State Coal had a policy of producing from high-cost underground mines rather than from more efficient open-cast mines. There were several reasons for this business strategy. It was based on some high forecasts of demand for coal. If that demand had eventuated it could have been met only by developing some very large underground fields. Divergences of actual demand from the forecasts, however, did not lead to a reexamina- tion of the business strategy and the emphasis on underground mines was retained. A further reason was the unwillingness to shed staff - underground mines required more staff for each ton of coal mined. Finally, the plans were greatly influenced by the increases in energy prices during the 1970s. As a state-owned institution State Coal believed that it should extract coal to the maximum extent technically feasible. Closing mines was seen as a “waste” of the resource.

Under the Coal Corporation some of the high-cost underground mines were closed down and staff numbers were cut in half. Despite this reduction in staff, total output increased (mainly from the open-cast mines), and prices were held.

The Electricity Corporation of New Zealand Ltd., another former division of the Ministry of Energy, dominates the generation and distribution of electricity throughout New Zealand. Since its creation in April 1987, it has held prices in real terms while reducing unit costs of production by 23 percent over a two-year period. Output of electricity per employee increased by 14 percent in 1988-89 and is expected to increase by another 4 percent in 1989-90. Net profit after tax increased from $141 million in 1987-88 to $332 million in 1988-89. This latter figure represents a return of 11 percent on shareholders’ funds.

The case of the Airways Corporation illustrates the effect of having to operate as an independent business rather than as part of a department. As part of the Ministry of Transport the air traffic control equipment was to be upgraded. A state-of-the-art system was chosen at a cost of approximately $200 million, but corporatization occurred before a final decision had been made. Airways, using its new criteria as an SOE, decided the planned system was not a viable business proposition and would not have been convincing to external financiers. After further review, Airways settled on a system costing around $70 million. This system met the necessary technical standards and was cheaper to run.

Another illustration is given by New Zealand Post Ltd. The postal business of the Post Office lost $38 million in 1986-87. This was projected to increase to losses of $68 million for 1987-88. In its new corporate form New Zealand Post achieved a tax-paid profit in 1987-88 of $72 million due to a combination of unusually favorable circumstances. In the following


year the tax-paid profit was $31 million. Prices for the standard letter were held constant, and those for bulk mail to householders were cut by 30 to 50 percent. Service delivery performance improved by 5 to 10 percent despite an increase in the volume of mail delivered. All postal locations were reviewed and a substantial number of underutilized dedicated post offices were replaced by agencies in local shops. Over the two years from April 1987 to April 1989 the number of New Zealand Post outlets (including agencies) rose from 1200 to 1400. Considerable complaints and lobbying from the public occurred as a result of these changes although the main focus of concern was the perceived lack of banking services as a result of cessation of full-time banking facilities by Postbank in remote locations.

One of the effects of corporatization has been labor shedding as the new companies downsized. In essence some of the disguised unemployment, or underemployment, that had occurred within departments was recognized explicitly. This was similar to the changes with the manufacturing industry generally as it responded to lower levels of protection and subsidy. Some regions have been more severely affected with high levels of unemployment than others. Part of this effect has been due to the liberalization of markets, including corporatization, and part has been due to the policies needed to lower the rate of inflation. The approach of the government has been to encourage efficiency throughout the economy and to develop measures to facilitate the operation of the labor market where necessary and to take various direct approaches to the unemployment problem.

The examples listed above provide some indications that significant gains appear to have resulted from moving commercial activities from a departmental to an SOE form. Nevertheless, the SOE model has some deficiencies which may increase with time. These are derived from the monitoring regime and the insulation of managements from removal by takeover and the perceived protection from insolvency.

Weaknesses of SOE Model

Private companies are monitored by financiers and investors. SOEs do have to borrow from the debt market without an explicit government guarantee and thus lenders take some care to ensure that their loans are secure. However, to the extent that a government would be embarrassed by the bankruptcy of a major SOE, it may be perceived as more likely to step in to support any creditors. This perception reduces the concern that lenders might have about loans to SOEs, and therefore the scrutiny of creditors may not be as useful as with a private-sector firm.

In contrast to the situation with private sector companies, SOEs do not have tradeable equity and takeovers of SOEs are not permitted. Managements thus avoid an important discipline on accumulating free


cash and on the quality of investment decisions. With private-sector companies, if free cash is not being returned to shareholders or is being invested in inferior options, there are gains which can be made by takeovers. The alternative discipline, of reconstructing the board, is difficult to apply in other than extreme cases, and has other costs. In short, the lack of tradeable equity is likely, in the longer term, to make it difficult to keep the interests of the shareholders and the managers aligned.

As they increase efficiency, a number of SOEs are beginning to generate large profits. This has been achieved by boards of directors and managements who are among the best and most entrepreneurial in the country. Once the current set of changes has been made it would be natural for such people to look for other opportunities and challenges, and in particular to seek diversification.

Diversification raises two main risks for the Crown. First, it may increase the total risk faced by the Crown by increasing the exposure to a particular sector or industry. Without sale of equity the Crown would not be able to reduce its risk to acceptable levels. Second, it may increase the risk for the company in question. This means that, for reasons relating to the Crown’s overall portfolio, government owners might inhibit the growth or efficiency of SOEs. In the private sector this would, in many cases, be solved by selling the business to a new owner.

Other potential weaknesses of the SOE model include the possible reluctance of ministers to sack poor-performing boards because of the political embarrassment that might cause, as well as the sheer workloads ministers undertake and the consequent limits on the time they can devote to SOE matters.

Some of these problems were referred to by the then-minister of state- owned enterprises in a speech in 1987:

There are difficulties in properly tracking SOE performance, in the absence of the normal sanctions of the share market, We recognize that monitoring of an SOE’s performance by shareholding ministers is far from perfect; but it does provide a substitute for the incentives and sanctions of the market (Prebble 1987, 20).

Despite this reservation, we believe that the accountability of SOEs does represent a vast step forward from that of commercial operations within a departmental framework.

Privatization

Over the 18 months to June 1989 the government had sold seven of its businesses. These ranged from a full-fledged SOE, through shareholdings in private sector corporations to government-owned corporations and

152 GRAHAM SCOTT, PETER BUSHNELL AND NlKITlN SALLEE

parts of government departments.7 The sale of another nine businesses or business assets has also been announced.8

Two principles guided a case-by-case evaluation of whether or not to retain ownership of each business. These were first, that a sale would only be made if taxpayers received more from the sale than they would have through continued ownership, and second, that the sale must make a positive contribution to the government’s economic and social policies (Douglas 1988, 15). This latter consideration led to a decision to retain ownership of television and radio stations.

These principles rested on a judgment that while SOE status had significantly improved performance, it was doubtful whether that improvement could be sustained in the longer term, given the lack of share market pressures, second-best monitoring, and diverse incentives for ministers. There was therefore a belief that, on average, the businesses would tend to perform better in the private sector.

This was also considered in the context of New Zealand’s public debt. To the extent that the private sector would manage a particular business more efficiently and profitably, a competitive tendering process will lead to the private sector offering more for the businesses than they are worth to the Crown itself. In other words, the sale price will be higher than the net present value of the dividends the Crown expects if it retained ownership, and sale will enable a greater reduction of public debt than would retention.

In some cases the government chose to get out of some businesses, such as petroleum and gas mining, because it considered the risk of investing in such industries was inappropriate for governments to undertake and manage on behalf of taxpayers.

Regulatory reform generally has been a prerequisite to privatization. (In the case of New Zealand Post, where for social reasons a statutory but regulated monopoly is to be retained on standard letters, the earlier decision to sell the enterprise was rescinded.) Overall economic efficiency has been a priority, even if this results in a lower price being achieved for the sales.

In contrast to the UK practice, the aim is that before the sale is made, a regulatory regime should be put in place to ensure the maximum degree of contestability in the market. In particular, monopoly rights are not sold with the enterprise (and built into the price). For example, when Air New Zealand was sold there were no guarantees that the airline would have exclusive access to routes negotiated by the New Zealand government as part of its bilateral aviation agreements with other countries. In contrast, when British Airways was sold, potential investors were given assurances about future access.


Once a sale had been decided, the method for making the sale was chosen on the basis of getting the maximum return to the Crown. Thus the choice of making a public float or selling as a package by tender was made solely on the grounds of value. The approach of "popular capitalism" adopted in the UK has not been applied as the assets sold so far have been seen to entail a significant premium for control when the sale was made to one or a few new owners. This reflects the fact that in these cases the long- term development of the business required more concentrated shareholding to tackle issues of management and business strategy. Also, if a public float failed to maximize the sale price, it would transfer wealth from taxpayers in general to those who were able to buy shares.

THE REMAINING CORE PUBLIC SECTOR

A key premise behind the shift of state trading activities from the core public sector was that better commercial performance relied on changing the constraints and incentives facing managers. A similar notion lay behind recent changes to the core public sector, which is the residual non- SOE public sector. Two pieces of legislation are central: the State Sector Act of 1988, and the Public Finance Act of 1989.

With the removal of the SOEs the remaining core public service included a mix of policy, regulatory and operational functions. The latter group ranges from the supply of defense, policing and justice services, social services such as health, education, and the administration of benefit payments through to production of various services such as research and development, valuation, printing, and financial services. Of the operational activities, the Rural Bank and the Government Printing Office were due to be sold in the latter half of 1989. Some of the other activities in this group may well be converted to SOE status if state ownership is to continue.

State Sector Act

This act took effect on April 1, 1988. It had two main aims. The first was to redefine the relationship between ministers and the permanent heads of departments, as they were then. The second was to apply similar labor- market regulations to both state and private-sector employment.

Under the act departmental heads lost their permanent tenure, and are now known generically as "chief executives" rather than by their previous title of "permanent heads." They are appointed on contracts of up to five years, with the possibility of reappointment. Appointments are made by the State Services Commission. All recommendations for appointment must go to the governor-general in council who decides whether or not to accept the recommendation.9 If the State Services Commission is directed


by the governor-general in council to appoint someone not recommended then that fact must be published as soon as is practicable. Each chief executive works under a specific contract, the terms of which have been negotiated with the State Services Commission and approved by the prime minister and minister of state services.

Chief executive performance is monitored by the State Services Commission on behalf of the minister in charge of the department. The review is expected to cover how well the chief executive carried out the functions of the department and how efficiently he managed it. Remuneration levels will be influenced by this assessment. While the criteria are not spelled out in any detail, the act does establish the relationship between the minister in charge of the department and the head of the department in a way that allows the minister to hold the chief executive accountable for performance.

This is in marked contrast to the relationship under the previous legislation which was based very much on the Westminster system. Under the State Services Act of 1962 a permanent head of a department was responsible to the minister in charge of the department for its efficient administration. However, the minister could do little in response to actual performance. The initial appointments were made by a panel of three permanent heads (drawn from a larger panel) and two members of the State Services Commission, which was required neither to consult with ministers nor to take any account of their views. In practice though, the relevant minister was always consulted and effectively had a veto power. Once appointed, the tenure of departmental heads was permanent, other than for gross breaches. Remuneration was set by an independent group, the Higher Salaries Commission. In all, ministers had little ability to influence the identity of departmental chiefs, other than at initial appointment, or any of their conditions of employment.

The 1988 act also took a very different approach from its predecessor to personnel issues. Under the 1962 act all public servants were employed by the State Services Commission although departments were delegated the right to make appointments. However, all appointees from outside the public service had to show ”clearly more merit” than any internal applicant. In practice this discouraged managers from incurring the cost or taking the risk of appointing an outsider. The commission set the grading for each job and negotiated with state-sector unions for any changes to pay and conditions based on a formula which gave heavy weighting to relativities, both internal and those with the private sector. Any pay increases then had to be funded by the departments concerned, although in most cases appropriations were automatically increased by the rise in salaries. Departmental managers had almost nothing to do with this process.


With the 1988 act the chief executive of each department became the employer of all staff within the department. All decisions on the number and type of staff, appointments and dismissals became the responsibility of chief executives. Over time they are taking over the negotiations with the unions on pay and conditions for staff, with assistance and overall coordination coming from the commission.

The act changed the labor-market regulations under which these negotiations take place to mirror those in the private sector. In particular, the compulsory arbitration that had applied previously was removed and agreement had to be reached voluntarily between the parties. One innovation introduced by the act, applying to the whole public service apart from the armed services and police, was final-offer arbitration, whereby if both sides agree an arbitrator can select the proposals of one of the parties, but cannot compromise between the two options.

Any agreements reached have to be afforded within the overall budget for the department. Although it was not directly required by either the State Sector Act or by the financial management reforms, ministers decided, for 1988-89, not to provide departments with additional funds to cover wage settlements. During the 1988 wage negotiations most departments settled for a wage raise of around two percent. The police, however, settled for an increase of five percent. Subsequently, the minister accepted that numbers had to be retrenched when the police budget was not increased to cover those extra costs.

As with the SOE reforms, monitoring of performance provides the critical incentives for chief executives and departments to perform. The State Sector Act is only part of the picture because, while it enables ministers to take action on the results of monitoring, it does not establish the criteria for that monitoring. That task is addressed by the financial management reforms in the Public Finance Act 1989.

Financial Management Reform

The ultimate aim of the financial management reforms is to achieve better value from public spending. This requires attention to the management of government agencies and to the choices of goods and services and the transfers paid for by taxpayers. It also requires attention to the quality of policy advice since regulatory interventions and legal changes need to be considered as alternatives to spending options. Conditions for the appropriation and use of funds, the flexibility given for management decisions, and the nature of reporting all bear on the accountability of managers and ministers and provide incentives for better performance.

Many of the changes adopted in New Zealand are similar to those adopted in the UK under the Financial Management Initiative (FMI) begun

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in 1981, or Australia with its Financial Management Improvement Program (FMIP) started in 1984.

In addition to the contractual relationship between ministers and departmental chief executives, there are two other key differences between the New Zealand approach and that adopted in those two countries. The first is a distinction between the interest the government has in the goods and services it is purchasing from a department and in the efficiency with which the department is run. This is the distinction between purchase and ownership. The second is in the extent to which the distinction between outputs and outcomes has been applied. These differences have influenced the methods of appropriation, the nature of reporting, and the organization of policy advice.

GRAHAM SCOTT, PETER BUSHNELL AND NIKITIN SALLEE

Purchase and Ownership

The rather obvious fact that governments both purchase goods and services from their departments of state and also own those departments has some interesting implications. Monitoring of ownership is aided by the introduction of full accrual accounting. This has greatest value where there are substantial physical assets, or outstanding debts or revenue.

In purchasing from departments, the government is just as concerned to get value for money as it is when buying from independent suppliers. Buyers generally want to pay as little as possible for goods of the required quality. If it was prepared to incur a loss on the production side, the government could achieve a "price" as low as it desired. Yet lower prices reduce the rate of return. As owner, however, the government desires the best return possible from the resources tied up in the department. If the government cannot achieve a rate of return with the resources in the department equivalent to the level they would have earned in private ownership then public production lowers the wealth of society. Therefore there is a tension between the government's aims as owner of its agencies and its aims as consumer of their outputs. As a result, measurement of both the value for money of the purchases and the value of ownership can be very difficult.

This tension can be resolved if the price is set through the process of normal market forces. In general the government should be satisfied that its interests as purchaser are met if it pays the same price as would be charged by the best alternative supplier.'O Given this price, the ownership interest can be assessed by applying normal accounting ratios, such as return on funds employed, to measure the efficiency of management of the department. Over time, a significant group of departmental functions should be able to use such contestability standards to demonstrate the reasonableness of the prices being charged.


Where contestability is not possible between the public and private sectors because, for some reason, the service must be supplied by a government agency, it may still be possible and efficient to arrange for contestability between different government agencies or even within a single agency. For example, while importing countries might specify that only employees of a government agency could inspect export food products it might be feasible to establish competing government agencies to carry out those inspections. The net benefits from adopting this approach will depend on the size of the gains from competition and better assessment of performance compared with any costs of duplication.

There will, nevertheless, be many cases where this is not possible on a routine basis. A problem arises then in assessing performance. When it is able to set its own prices uncontested, a department could achieve any target rate of return regardless of its real efficiency. Some direct assessment of departmental efficiency is needed for both the minister in charge of the department and for the cabinet which has overall responsibility. This could be done by comparisons of performance measures from different units or locations, or by traditional management audits.

Outputs and Outcomes

While the distinction between outputs (the goods and services produced) and outcomes (the effects of those outputs on the community) has long been recognized in the accounting literature (Ramanathan 1985), that information had not been used in assigning responsibilities between ministers and their departments. The approach taken in the New Zealand financial management reforms is to require chief executives to be directly responsible for the outputs produced by their departments, while the ministers choose which outputs should be produced and should therefore have to answer directly themselves for the outcomes.

Chief executives remain responsible to ministers for their performance and hence ministers remain accountable for the efficiency with which their department is run and the way in which outputs are produced. The financial management changes do not alter the existing constitutional conventions that ministers are responsible for the actions of their departments. They are liable to questions and debate in Parliament over any aspect of the performance of their portfolio.

Under the current legislation chief executives must report on their production of outputs. There is no provision for ministers to report on the reasons why particular outputs were chosen nor on the effects of those outputs on the Community. In his submission to the Finance and Expenditure Select Committee of Parliament on the Public Finance Bill the controller and auditor-general commented that:


Outcomes, and the effect that outputs have on these, are the responsibility of ministers. There is, however, no provision made in the bill for ministerial reporting on outcomes. This is a significant omission in what is otherwise a well- structured set of accountability and reporting provisions (FEC 1989, 18).

The select committee acknowledged the point being made by the controller and auditor-general. Under the Public Finance Act of 1989, Parliament will receive new and much more detailed information than in the past. Parliament therefore intends to review its processes for scrutinizing expenditure proposals and dealing with ex post reports in order to make the best use of this information. The select committee suggested that as part of this re-examination Parliament should also consider the points raised by the controller and auditor-general.

Often there are complex judgments to be made about the best way to describe outputs, involving the level of aggregation and the characteristics which distinguish one output from another. This can be particularly true in the case of providers of social services such as health and education. However, especially in the difficult cases, departments have found that applying this approach has clarified what they are actually doing and has helped the management of the department considerably.

Policy Advice

The role of policy advice is clarified under the new financial management regime. The first task is to identify the connection between the outputs and outcomes. If a connection cannot be made then there is no demonstrable justification for that spending.

Other tasks for policy advisers prior to the decision being made include identifying the tradeoffs between different outcomes, and identifying the best source or process for finding the source for the supply of outputs. The desirability of particular expenditures depends on the costs and benefits of other approaches such as the use of regulations or changes in legal property rights. Advisers must evaluate spending proposals against the full range of alternative interventions. Advice is also needed on the quality of departmental management and especially on the outcomes resulting from any outputs or transfers.

Policy advice is an output of advisory agencies. Therefore the performance of those departments will be assessed by ministers, in part, by checking that the advice tendered covered all the above sorts of issues. This emphasis on policy advice should keep to the fore strategic issues of what to buy as well as how much to pay. In this way it should help avoid the criticism sometimes expressed of the UK Financial Management Initiative that it has resulted in an undue focus on short-run efficiency savings


without addressing the underlying rationale for particular types of activities.

The importance of high-quality policy advice has raised questions about potential bias from advisory agencies which also have a significant role in providing the service. A number of government agencies have been reviewed. The approach taken generally has been to separate policy and operational functions unless there are strong reasons in terms of informational efficiency to combine them.” This represents a somewhat different emphasis than that recommended for the UK under “Next Steps” (Jenkins, Caines and Jackson 1988, 9) with operational agencies being set up but under the responsibility of the permanent head of the policy department.

Public Finance Act 1989

Resources are provided by Parliament for the use of departments through ”appropriations.” The budget and appropriation process under the Public Finance Act of 1989 aims to link appropriation to performance, while allowing parliamentary control to be exercised over the level of resource use and the purposes to which resources are put, and at the same time providing administrative simplicity.

The basis of appropriation depends on the ability of the department to supply adequate information and meet certain standards of proof of performance. Three modes of appropriation are possible, recognizing that departments are in different stages of adopting the reforms, and that some provide goods and services which are less “commercial” and “contestable” than others. (In the descriptions which follow, it should be noted that a single department can be responsible for outputs produced under more than one mode, depending on its internal organization and the nature of the goods and services produced. Transfers such as welfare benefits can be accounted for under any mode, so the following comments concentrate on the other payments.)

Under Mode A, cash outlays for the purchase of inputs are appropriated. This mode applies when the department has not developed accrual accounting systems and been able to specify its outputs which are both needed for performance assessment. The only change from the current system is that separate appropriation must be made for any capital expenditure. This mode is transitional, since all departments are required to have moved to either Mode B or Mode C by July 1, 1991.

Mode B appropriations cover costs incurred in producing outputs measured on an accruals basis. These costs exclude tax and the return on funds employed. For this mode, Parliament appropriates the cost of the resources used, including depreciation, for outputs produced whether for


the government or for third parties. Any increase in the level of the Crown’s net asset holding in the department is also appropriated. It is expected that all policy agencies will remain in this mode indefinitely, as will any activities which include an element of compulsion for the buyer.

Essentially Mode B is set up for agencies which supply traditional, noncontestable services to the government. Placing the department on Mode B should allow better decisions by managers about the use of capital, and should also encourage more routine examination of the efficiency with which the department is being managed. Use of accrual accounting will attribute costs more accurately to the outputs produced so that ministers will have better information on the costs to balance against the benefits produced.

Some Mode B departments will have revenue from third parties that is not produced under statutory monopoly, and may also have a product- costing system that can demonstrate the absence of cross-subsidization. If so, they would be able to use the revenues from those trading activities to fund their own operations without further appropriation. In this case, the appropriations would be only for the outputs supplied to the government and for any net change in the capital employed in the department.

Under Mode C, the appropriations are for the value of outputs produced by the department and for any changes in the Crown’s net asset holding in the department. In addition to changes required for Mode B, departments in Mode C must pay interest, taxes, and dividends and need to have established a capital structure. If the department‘s performance is to be assessed by comparison with private sector firms then it needs to be set up in a competitively neutral manner.

Similarly, if a department is to be assessed by comparison with like ”businesses” it should receive no more than a “fair market price” for the outputs supplied. In general, this will mean that the department must show that it is receiving no more than the next-best alternative supplier would require for providing the outputs. This price pressure should give chief executives the incentives to contract out some of their production if that is the most efficient option. If so, this might avoid the hands-on approach that UK ministers have needed to take at times to ensure that contracting out was considered.

A department under Mode C will be similar to an SOE in many ways but would differ in that it will not be permitted to borrow on its own behalf nor to invest outside the business. As a department any borrowing relies on the name of the Crown, hence neither chief executives nor lenders would need to be as careful about the extent and nature of the borrowing as would a company. Consequently, departments may take on risks that were unacceptable to the Crown. If borrowing was sufficiently rash it might seriously affect the cost of the Crown’s borrowing.


Reporting on performance provides a key incentive for departments to perform efficiently. Each month, each department is to supply reports to its minister, with a copy to the minister of finance, summarizing the financial position and cash flow for the department as a whole and the resource usage and revenue by output. Variances against budget are calculated and explanations provided.

External reporting covers both departmental reporting, which includes audited annual and half-yearly financial statements, and consolidated financial statements for the Crown. Departments have produced annual reports for some considerable time. The main innovation for them will be in providing a statement of financial position and an operating statement.

Preparing full financial statements for the Crown, including a balance sheet for the Crown as a whole, is also a new approach. When the act was passed the exact method of handling the Crown’s interest in its SOEs had not been resolved. The two alternatives were to use equity accounting to include only the value of the equity, or full consolidation, which would include all the assets and liabilities of the SOEs. Whichever method is chosen it should provide the first comprehensive picture of the overall state of Crown assets and liabilities, and enable comparisons to be made from year to year.

Another change brought in with the act was to move the end of the financial year from March 31 to June 30. Budgets are normally presented in June or July. This shift will enable departmental managers to know what funding they have at the beginning of the year, rather than one-third of the way through. It should enable managers to operate more efficiently. It will remove one well-worn excuse for poor performance - a lack of time to implement savings.

Results of Financial Management Reforms

Given that the act has applied only since July 1989, it is too early to draw firm conclusions about its effects. Nevertheless, there are some initial indications. Chief executives have commented on several benefits that they have observed. One is that the existence of the chief executive’s contract and the link to the performance of the department can be used to convince staff that requests by the chief executive are not arbitrary, since poor performance by departmental staff can adversely affect the position of the chief executive. Arguments put along these lines to staff members have been very well received, since the chief executive’s own job was seen to be on the line.

Another benefit that has begun to show up is the improved organiza- tional direction that results from greater clarity about the outputs of the department. In the past many departments have been very unclear about


the boundaries of their responsibilities. By placing the focus clearly on outputs as opposed to outcomes the Public Finance Act has removed one source of uncertainty.

What of the Future?

Bipartisan support was expressed for the financial management reforms when the Public Finance Act 1989 was passed by Parliament. This indicates that the reforms are seen as providing a technical approach toward improving the operations of government agencies which was neutral with regard to the outcomes desired by the government of the day. It also indicates that the success of the reforms will be judged by their practical effects and not on ideological grounds.

The financial management reforms have put in place a new set of incentives for both bureaucrats and politicians. Incentives, nevertheless, merely provide a framework within which the various parties act. Three conditions, in particular, are likely to influence the success of this framework.

The first is the extent to which ministers are able to adopt a role of focusing on the key strategic and tactical decisions. With the new financial management processes they should have better information to allow them to do this. Short-run pressures will always arise, but these need not prevent a strategic focus being taken. They often provide insights for strategic views, anyway.

The willingness and capacity of ministers to make the system work as intended are central to the success of the reform. As other monitors (including media, parliamentary committees, the auditor-general, and lobby groups) will all be better informed with hard data, it can be expected that ministers will have incentives to do so. Thus, it is likely that ministers will give greater emphasis to the strategic planning needed for coping with the new environment.

A second condition is the extent to which the new approaches are consistently applied. Compliance with the prerequisites for entry into Mode C is one important area. Mode C involves greater flexibility for the managers of departments, accompanied by higher standards of reporting and proof of performance in order to maintain (and enhance) the accountability of those executives. If managers gain the flexibilities without meeting the other conditions then accountability will decline and overall performance suffer.

Experience with the application of PPBS provides some indication of the costs of not strictly following the principles of a new approach to financial management. When PPBS was introduced in New Zealand many pro- grams were accepted which were really input or overhead activities. For


instance, corporate services was a program listed for many departments. Subsequently, some parliamentarians commented that they did not find the program structure helpful to know what was really going on in a department. Parliamentary debate was reduced following the changes.

The third condition that will influence the success of the changed processes is the degree of support given to them by ministers and chief executives. The Public Finance Act is empowering in that it lays out processes and standards. For success it depends on a willingness to abide by the processes. If ministers and chief executives were determined over a long period to thwart the approach then it would almost surely fail, as would any system of financial management.

There are the same difficulties with valuing some of the intangible assets of government departments as currently exist for private companies. Accounting methods do not deal adequately with the human capital bound up in the staff of the advisory agencies which comprise an important part of the core public service. Another example of intangible assets occurs with the investments into research and development prior to the project identifying clearly commercializable outputs. Under conventional accounting treatments this initial research and development expenditure should be assessed and only capitalized once the venture is seen to be commercializable. This can lead to considerable problems in interpreting the performance of research agencies, especially during a development phase.

Any process of change inevitably involves some risks, since not all eventualities can be foreseen. Some of these risks have been reduced because while the changes are significant they have been implemented in stages. The 1985 decision to introduce full charging for all services to identified users is still being phased in; the SOE policy was announced in 1986 and implemented for only an initial group of nine “businesses” in 1987, with others being brought in at a later stage; the State Sector Act was implemented several months after the parallel Labour Relations Act for the private sector; and the financial management reform policy was announced in the 1988 budget and is being progressively implemented between April 1989 and July 1991.

There have been several concerns expressed about the public sector reforms in New Zealand which may be loosely labelled as “public interest” arguments. These tend to be of three main types. The first is that inadequate weight may be given by ministers to key issues, such as the value attached to future outcomes. The second is that the quality of policy advice may decline because of a loss of ”institutional memory.” The final concern relates to a fall in the quality of services because of the application of private sector techniques.


Put crudely, the first argument is that ministers will have an unduly short-run focus in their decision-making and therefore important decisions relating to the long run should be left for departmental managers. To adopt this approach would leave to the judgment of the manager employed at the time the weighting to be applied in any case. Whether those weighting reflected community preferences would be largely a matter of chance. Under the new approach these judgments will continue to be made, but ministers will expect to make the major choices. The nature of the public interest will become an explicit focus for decision-making.

The second line of argument is directed at the potential loss of policy advice tendered in the “public interest.” Under this variant of the argument the public interest is represented as ensuring that when ministers are making their decisions they are provided with disinterested and objective advice covering all aspects of relevant issues. The concern appears to be either that advisers will temper their advice to what the minister wanted to hear (perhaps because of the potential effect on their own employment or pay), or that there might be a loss of institutional knowledge because of the turnover of chief executives.

There are always limits to the amount of advice that can be tendered if the minister is opposed to a line of argument. This situation existed before the State Sector Act of 1988 and will continue in the future. Nevertheless, the importance of frank and independent advice has been recognized in the contracts set up under the act. A standard condition for all chief executive contracts is that free and independent advice be offered.

A knowledge of past policy successes and failures is an important dimension of good policy advice. The concern expressed is that limited tenure appointments may reduce this knowledge. This argument appears exaggerated. The increased impermanence of tenure for chief executives under the new regime can be overstated. Contracts may be renewable, and the tenure of successful chief executives will probably be similar to that of the past. In any case, most employees will not be on short term contracts. Further insurance on the quality of policy advice should come from contestable sources of advice and from the demands from ministers for ideas to be tested thoroughly before announcement to prevent embarrass- ing post-launch failures.

The final line of ”public interest” arguments is that private sector techniques are being used in an inappropriate way, leading to a loss in the quality of the services being applied. In part, this is thought to arise from the difficulty in measuring the quality of many outputs, particularly outputs of social services. It is feared that measurement practices, and a focus on efficiency will lead to people being hired who are less concerned than they ought to be with providing quality services.

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This risk needs to be acknowledged. However, a basis of a democratic system is that the elected officeholders, and not the bureaucrats, should make the significant choices. Choices between quality and cost are part of that. There may need to be a number of different ways of ensuring that the selected quality of service is actually delivered. For instance, there might be ways of directly gauging the satisfaction of affected citizens. Alternatively, the chief executive might agree with the minister that certain production processes should be followed. The design of the system is sufficiently flexible to allow a range of accountability methods.

C 0 N C L U S I 0 N

At present departmental staff are supportive of the reforms, including the chief executives of policy agencies wh,ere the approach might seem less applicable. A concern arises, though, over the possibility that this initial interest will wane and the bureaucracy could sink back into old habits. We believe that the financial management reforms, in total, provide a number of checks against that possibility. These include the pairing of the Public Finance Act with the State Sector Act and the incentives for chief executives and ministers within the latter; the greater clarity about relative responsibilities of chief executives (and departments) and their ministers; the distinction between the purchase and ownership interests of the government; the greater flexibility given to departmental managers; and the improvement in the quality of information reported on departmental performance.

Notes 1 For a review of the economic analysis behind the public sector reforms see

Bushnell and Scott (1988) and Scott and Gorringe (1988). Cameron and Duignan (1984) provide one of the key reviews of the framework for state "commercial" activities. Other analyses are available in The Treasury (1984, 275-294; and 1987, 49-120).

2 These moves included: reducing import protection, entering into a free-trade area with Australia, allowing road transport to compete with the railways for long-haulage freight, introducing voluntary unionism and allowing Saturday shopping.

3 A fundamental reform of local government was announced in December 1987, and changes to the boundaries and functions of local authorities are expected to be in place for the local authority elections in 1989.

4 The nine SOEs were: Electricity Corporation of New Zealand Ltd., and Coal Corporation of New Zealand Ltd. (formed from divisions of the Ministry of Energy); New Zealand Post Ltd., Post Office Bank Ltd. and Telecom Corporation of New Zealand Ltd. (from the former Post Office, which was disbanded); Land Corporation Ltd. and New Zealand Forestry Corporation Ltd. (from the NZ Forest Service and the Lands and Survey Department, whose noncommercial activities went to the new departments of Conservation, and


Survey and Land Information); Airways Corporation of New Zealand Ltd. (from the operational activities of the Civil Aviation Division of the Ministry of Transport); and Government Property Services Ltd. (from the Government Office Accommodation Board of the State Services Commission).

5 On April 1, 1988 Works Corporation was formed from the Ministry of Works and Development. Noncommercial activities were either discontinued or distributed among other departments such as the Ministry of Agriculture and Fisheries, Ministry for the Environment, Ministry of Transport, and the Department of Scientific and Industrial Research. The Government Supply Brokerage Company (formed from the Government Stores Board) was separated from The Treasury. Two superannuation funds for public sector employees were taken out of the Treasury and set up as separate departments pending their establishment as SOEs. The Government Computing Services was split off from the State Services Commission.

6 This argument has been advanced by Dr. R. S. Deane, Chief Executive of Electricity Corporation (1989).

7 The full list is New Zealand Steel, Development Finance Corporation, Petrocorp, Shipping Corporation, Air New Zealand, Postbank and the Health Computing Service. Postbank had been an SOE, NZ Steel was a publicly listed company in which the government held shares, and the Health Computing Service had operated as part of the Department of Health. All the others had been wholly-owned government companies.

8 The businesses which had been announced for sale in June 1989 included: Coal Corporation, Forestry Corporation assets, the Government Printing Office, Government Property Services, various irrigation schemes, Landcorp financial assets, the Rural Bank, the business assets of the Tourist and Publicity Department, and the Tourist Hotel Corporation.

9 The governor-general in council is the governor-general acting together with the cabinet.

10 In some cases, it would be more expensive to contract in a market for certain goods and services to be supplied. Instead it would be more efficient to produce in-house. In these cases, the best alternative price would be the cost of producing in-house using the best alternative arrangements.

11 This has been done with the Ministry of Health, the Ministry of Education, the Ministry of Maori Affairs, and the Ministry for the Environment. In each case major operational functions were placed with relevant operational agencies. The main exception would be the retention of a property management function within the Ministry of Education

References Bushnell, Peter and Graham Scott. 1988. Devolution and Accountability: An

Economic Perspective. In Devolution and Accountability, eds. John Martin and Jim Harper. Wellington, New Zealand: New Zealand Institute of Public Administration.

Cameron, R. L. and P. J. Duignan. 1984. Government Owned Enterprises: Theory, Performance and Efficiency. Paper presented to February Conference of the New Zealand Association of Economists. Wellington, New Zealand.

Deane, R. S. 1989. Corporatization and Privatization: A Discussion of the Issues. Address to the Napier Chamber of Commerce, May 31.

Douglas, R. 0. 1985. Economic Statement. Statement to the House of Representa- tives. December 12. Wellington, New Zealand: Government Printer.


Douglas, R. 0. 1986. Statement on Government Expenditure Reform 1986. Statement to the House of Representatives. May 19. Wellington, New Zealand: Govern- ment Printer.

Douglas, R. 0.1988, Budget 1988Part I : Speech. Wellington, New Zealand: House of Representatives, July 28.

Finance and Expenditure Committee. 1989. Report on the Public Finance Bill 1989. Wellington, New Zealand: Government Printer.

HM Treasury. 1988. The Management of Public Spending. London: HMSO. Jenkins, Kate, Karen Caines and Andrew Jackson. 1988. Improving Management in

Government: The Next Steps. London: HMSO. Ramanathan, K. V. 1985. A Proposed Framework for Designing Management

Control Systems in Not-For-Profit Organizations. Financial Accountability and Management. 1:75-92.

Scott, Graham and Peter Gorringe. 1989. Reform of the Core Public Sector: The New Zealand Experience. Australian Journal of Public Administration. 48(1):81- 91.

The Treasury. 1984. Economic Management. Wellington, New Zealand: The Treasury.

The Treasury. 1987. Government Management. Wellington, New Zealand: The Treasury.

Documents

Reform of the Core Public Sector: New Zealand Experience