Public Sector Reform in New Zealand and Its Relevance To Developing Countries
Public Sector Reform in New Zealand and Its Relevance To Developing Countries
Public Sector Reform in New Zealand and Its Relevance To Developing Countries
Does New Zealand’s success story have lessons for developing countries contemplating
public sector reform? That question usually elicits one of two reactions, both inadvisable
in the authors’ view. The first reaction is to be impressed with the efficacy of the reforms
and conclude that they should be adopted uncritically in other countries. The second
reaction is that the special conditions existing in New Zealand are such that none of its
reform experience is relevant to others. The authors take a middle position, maintaining
that poorer countries can indeed extrapolate from the experience of their higher income
neighbor despite the different conditions under which they have to operate. New Zealand’s
comprehensive overhaul of its public sector affords both general principles and specific
elements relevant to countries looking to improve the quality, efficiency, and cost effective-
ness of their public service sectors, and a careful analysis of those reforms can ascertain
what might be transferable and what principles might apply.
In 1984 New Zealand’s newly elected Labor Government took over an economy
characterized by comprehensive controls on the financial sector, extensive subsidies
to farmers and exporters, and a highly sheltered private sector. Its deficit was a high
9 percent of gross domestic product GDP, and public debt, at 60 percent of GDP, was
rising. High underlying inflation and slow economic growth had reduced per capita
income from one of the highest in the Organization for Economic Cooperation and
Development to one of the lowest (OECD 1983; 1984).
The new government put in place a macroeconomic stabilization plan and broad
structural reforms to correct the core problems; the design, implementation, and
outcome of the reform program are widely cited in the economic literature and busi-
ness press and will not be elaborated here (OECD 1990–94; Bollard 1992; Evans,
Grimes, and Wilkinson 1996). But government expenditures still accounted for about
40 percent of GDP, which, policymakers came to believe, meant that the improved
The World Bank Research Observer, vol. 13, no. 1 (February 1998), pp. 103–21
© 1998 The International Bank for Reconstruction and Development / THE WORLD BANK 103
performance of the economy as a whole might be limited by the large public sector.
Government departments were viewed as bloated, inefficient, and poorly managed.
The bureaucracy behaved in ways that stereotypically undermine the capability of
any government, and service delivery was poor. Departments habitually exceeded
their budgets; unused balances were spent in end-of-year shopping sprees; creative
accounting was used to give the appearance of good performance; and the manage-
ment of assets and cash was haphazard.
Most important, politicians felt that some core ministries had their own policy
agendas and could override or outlast the wishes of elected officials. Thus the objec-
tive of the new government was to create an efficient public sector that was also
responsive to the strategic policy direction of the government.
The first step was to decide which activities the government should provide and
which could be divested or spun off to the private sector. The second step was to
undertake structural and management reforms in the remaining “core” departments—
those concerned with broad, cross-cutting, nonsectoral issues such as Treasury, the
ministries of Defense and Commerce, and the Inland Revenue Department (for
details on the privatization program, see Boston and others 1991; Scott and Gorringe
1991). To paraphrase Holmes and Shand (1994), the government wanted the ethic
of value for money and customer service to take its place alongside the ethic of pro-
bity and stewardship in the public sector.
104 The World Bank Research Observer, vol. 13, no. 1 (February 1998)
parallel with these reforms to ensure, wherever possible, competition in both the
input and output markets. The companies were given the opportunity to succeed or
fail based on their commercial performance.
Although corporatization was very successful, it had several drawbacks: the new
corporations tied up capital that could be used to repay public debt; they were not
subject to the ultimate discipline of the market because of the perception that an
implicit government guarantee existed; the large amounts of capital needed to de-
velop the businesses typically came at the expense of government investments in
social infrastructure, such as health and education; and the government was exposed
to commercial risk if the business suffered losses.
Thus successive governments have moved to sell their interest in activities, a rela-
tively straightforward procedure under commercial law. The government had a single
criterion in each sale—to maximize the value to the taxpayers by selling the enter-
prise in a competitive environment. By mid-1997, 35 companies had been sold, at a
value of approximately $1.5 billion. Most of the proceeds have been used to retire
sovereign debt. The privatized entities have prospered, benefiting from the addi-
tional capital available from the private sector. Telecom New Zealand, for instance,
went from one of the most inefficient telephone systems in the world to a position of
international leadership in telecommunications services (Duncan and Bollard 1992).
All the remaining government-owned companies now run as profitable businesses
and pay substantial dividends and taxes. For example, the quality of services pro-
vided by New Zealand Post has improved greatly. Although almost 80 percent of its
revenue in 1994 came from activities that are competitive, it paid $22 million in
taxes, paid dividends of $55 million to the government, and posted net profits of
$46 million. In 1995 it lowered the cost of first-class postage from 29 cents to 25
cents and in 1996 offered users a “postage free” day. In 1997 its exclusive franchise
over first class mail was removed so that its business is now fully contestable.
Defining Performance
Because vague or unachievable performance specifications undermine good account-
ability arrangements, it was necessary to define the performance that departmental
chief executives were expected to deliver. Four elements of departmental performance
were considered.
106 The World Bank Research Observer, vol. 13, no. 1 (February 1998)
THE OUTPUT–OUTCOME DISTINCTION. In New Zealand accountability between min-
isters and their departments is based on the conventional distinction between out-
puts (goods and services produced) and outcomes (the effect of those outputs on the
community). Chief executives are responsible for specified outputs from their de-
partments, while the minister chooses which outputs will be purchased to achieve
certain outcomes. That is, the minister, not the department, is responsible for the
outcome. The distinction is important. Governments are interested in achieving
outcomes and would like to contract for them if it makes sense to do so. Outcomes
are often not within the control of the chief executive, however, and he or she cannot
be held accountable for them. But chief executives can be held accountable for out-
puts, which can be relatively well-defined and are within the executive’s control.
Say, for example, the police commissioner contracts with the minister of police to
provide a certain level of policing services, patrols, community security programs,
road safety commercials, and so forth. These are clearly outputs. The commissioner
does not contract to lower the crime rate. That outcome may be forthcoming, but
the crime rate is affected by many variables beyond the control of the commissioner,
such as the level of unemployment, immigration policy, social policy, perhaps even
the result of certain sporting events. Thus, holding the commissioner accountable
for outcomes is not operationally useful; this distinction between who is accountable
for outputs and who for outcomes is common in the private sector as well.
Accountability processes are much more effective if the outputs to be delivered are
well specified in advance. Vague specifications allow managers to determine exactly
what it is their organization will produce. For this reason, the minister and chief
executive prepare annual purchase agreements, or contracts, that set out in reason-
able detail the outputs to be delivered. The quality and robustness of this system
depend on the careful specification of outputs in the agreement. Many ministers
have “purchase advisers” to assist them with this task.
A common concern is that this approach emphasizes outputs at the expense of
outcomes. Critics maintain that unless departments are held accountable for out-
comes, they will not focus on these issues and therefore are less likely to achieve
them. That is not necessarily the case. Greater clarity over what is being produced
(outputs) can increase the attention to outcomes. Since 1990 the government, as
part of the annual budget process, has reviewed all the outputs produced by depart-
ments against the criterion: How does this help achieve the outcomes the govern-
ment wishes to pursue? This focus makes clear that policy advice should be about the
relationship between interventions (including outputs) and outcomes, about what
the government is trying to achieve and alternative ways to achieve it. This frame-
work has helped departments understand that, just as in the private sector, their
survival is dependent upon meeting the needs of their customer. Because their cus-
tomer is interested in outcomes, departments, given sufficient competitive pressure,
will strive to design and provide public services to help achieve those outcomes.
108 The World Bank Research Observer, vol. 13, no. 1 (February 1998)
concern of the minister, whose political antennae should be well attuned to such
feedback.
EX ANTE BUDGETING. The reforms also changed the budget and appropriations sys-
tems in two ways to fit with the performance management system. First, appropria-
tions for departmental outputs (not inputs) are now made on an accrual accounting
basis, and managers are free to acquire their inputs from any provider. Second, only
capital injections into departments are appropriated (not capital expenditures), re-
flecting the chief executive’s authority to manage assets within a defined capital base.
Budgetary reporting at both departmental and national levels mirrors ex post report-
ing. Financial forecasts are prepared using generally accepted accounting practices
and are identical in form to financial statements produced by private corporations.
CAPITAL CHARGE. Twice a year departments pay a capital charge, calculated on the
basis of their net assets, for the cost of the capital the government has invested in
110 The World Bank Research Observer, vol. 13, no. 1 (February 1998)
them. This charge has several benefits. First, it ensures that the cost of capital is
reflected in output prices because a department’s total cost must be allocated to its
outputs to ensure comparability with nongovernment producers. Second, the charge
encourages departments to manage their balance sheets carefully and to divest sur-
plus or redundant assets. Third, it encourages management to consider the mix of
assets needed to produce services efficiently. If a manager finds it more efficient to
purchase more computers and sell some cars, he or she is free to make this decision.
If the sale of assets reduces the overall capital charge, the savings can be applied to
other expenses.
Results
The core sector reforms have succeeded in improving both service delivery and effi-
ciency. The system is widely supported by departmental managers, although the
effect of the reforms on managerial behavior has varied depending on the quality of
leadership and the levels of efficiency prior to the reforms. In general, performance
has improved in tandem with the development of wage scales linked to performance.
Savings from improved cash management have been substantial (enough to pay for
all the system costs of the reforms), and unappropriated expenditures, which were
112 The World Bank Research Observer, vol. 13, no. 1 (February 1998)
with the budget policy statement (and if not, why those intentions have changed);
three-year economic and fiscal forecasts at the half-year point and within two to six
weeks before a general election; and a current year fiscal forecast with the supple-
mentary estimates that are normally tabled in the last quarter. On the reporting side,
aggregate financial statements of the Crown must be released within five weeks after
the end of the month. The existing requirement for audited, annual Crown financial
statements remains. All aggregate fiscal reporting, including fiscal forecasts, must
comply with generally accepted accounting practices.
The Reserve Bank Act is regarded as highly successful and is credited with New
Zealand’s good record on inflation in recent years. The value of the Fiscal Responsi-
bility Act has yet to be fully tested. It was enacted after the major fiscal correction
was completed and has yet to apply during a period of economic downturn. It has,
however, provided a frame of reference for public debate over the Crown’s fiscal
position, and most political parties have cast their economic policy with its prin-
ciples in mind. The quality and quantity of fiscal reporting has been welcomed by
the financial markets and rating agencies.
114 The World Bank Research Observer, vol. 13, no. 1 (February 1998)
• Whether agencies can be made more efficient and responsive to their customers’
needs, either by increasing competition or by direct customer purchasing of
services (rather than by the minister purchasing the services on behalf of
consumers)—the evidence is that they can
• Whether all aspects of the management system are sending the same signals
to managers—often budget and accounting systems define and measure
performance in totally different ways
• Whether the actual performance of all the actors in the systems is transparent;
• Whether the system is empowering or controlling
• Whether the systems encourage managers to actively manage all their re-
sources—the purchase of cleaning services, motor vehicles, or even personnel by
central agencies at no cost to operating departments discourages those
departments from efficiently managing their costs
• Whether the personnel system encourages good performance.
116 The World Bank Research Observer, vol. 13, no. 1 (February 1998)
• If personnel performance is a concern, performance-based personnel systems are
likely to improve the staff’s incentives to perform. Such contracts may be
politically difficult, but they have been a central part of institutional reform in
New Zealand, are viewed as very effective, and were the key to changing the
public service culture. Even if this model is not fully acceptable in developing
countries, changing the appointment, appraisal, and promotion systems so that
they are based on performance is likely to be possible and beneficial.
• Transparency is an important incentive device; providing that voters are able to
replace their politicians if they do not make decisions in the public interest,
developing countries can require improved specification and reporting of
performance to government and to the public.
• The performance of civil service managers is often impeded by a lack of author-
ity. New Zealand’s approach of delegating authority for input management to
managers is likely to be useful in many developing countries providing that a
meaningful output accountability system is implemented. In cases where del-
egating process decisions, including personnel and capital matters, may not be
appropriate, separating the role of politicians and managers may be useful. The
former can determine the output to be produced, while the latter determine the
method of production.
Transplanting the system and structures in one country unchanged into an-
other is seldom possible because the efficacy of a system depends so much on the
complementary structures. At the same time, countries commonly study and adapt
systems and structures from other countries to fit their particular circumstance. In
the last decade, many industrial societies have moved to narrow the government’s
role in the economy and insist on a more sharply focused and less intrusive con-
duct. Part of that process has been not only a questioning of what governments do,
but also a reexamination of how they do it. Thus even if developing countries must
adapt the reform agenda to their own circumstances, policymakers can learn from
what may well be a best practice and draw lessons and principles from New Zealand’s
experience.
Principal-Agent Theory
At the core of this theory is the idea that interchange between parties can be charac-
terized as a series of contracts where one party, the principal, enters into agreements
with another party, the agent, who agrees to perform tasks on behalf of the principal
in return for compensation (Moe 1984, 1990; Pratt and Zeckhauser 1985; Bendor
1988). Moe (1984:765) notes that politics can be seen as a series of principal-agent
relationships from citizen to politician to senior bureaucrat to subordinate bureau-
crat to service providers.
Agency theory assumes rational, utility-maximizing behavior by individuals. Hence
conflicts will arise between principals and agents as their self-interests differ. Add to
this asymmetric or incomplete information, the difficulty of observing and monitor-
ing agents’ behavior, and the imperfect mapping of agents’ outputs and the out-
comes desired by the principal, and an even larger ground for conflict will exist.
Principal-agent theory is concerned with the best way to construct and monitor
contracts so that these kinds of conflicts are minimized. The theory is useful in ana-
lyzing the selection of agents, designing incentives and pay systems, and choosing
between in-house or outside contractors.
Transaction-Cost Theory
This approach compares the costs of planning, adapting, and monitoring under al-
ternative governance structures. Decisionmakers wish to minimize their aggregate
costs of production and transaction. But like agency theory, this approach assumes
that principals and agents will act in their own self-interest and thus may be unreli-
able parties to a contract.
118 The World Bank Research Observer, vol. 13, no. 1 (February 1998)
The literature on transaction costs indicates that some transactions are better suited
to market-type arrangements, while others are better suited to hierarchical or rule-
driven organizations. For example, contracting out is likely to be desirable where the
supply of a good is contestable, quality and quantity can be easily measured and
specified, and suppliers are numerous. In-house provision is likely to be more effi-
cient when the opposite conditions exist. When transactions occur frequently, are
associated with uncertainty, and involve specific assets or skills, hierarchical organi-
zation tends to be more efficient.
Where the supply is competitive and transactions costs are “average,” the preferred
organization is less clear. But generally, in-house provision is likely to be more efficient
where there is a high risk of self-interest, conflicts of interest, substantial uncertainty,
and recurrent, complex transactions. According to Williamson (1985), these factors
explain the concentration of production in some sectors in a few large firms. Thus
direct provision may be preferable when maintaining quality is critical and opportun-
ism poses a serious threat. It is for these reasons that governments are hesitant to con-
tract out the gathering of military intelligence and the collection of taxes.
Notes
Malcolm Bale is principal economist, East Asia and Pacific Region, the World Bank, and Tony Dale
is a principal of Public Sector Performance (NZ) Ltd., a public management consulting business.
1. Accrual accounting is an accounting method that recognizes transactions and other events
when they occur and not as cash transactions or their equivalent. The events are recorded in the
accounting period and reported in the financial statements in the periods to which they relate.
2. The five principles of responsible fiscal management are (1) reducing total Crown debt to
prudent levels by ensuring that total operating expenses for the Crown are less than total operating
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