Young C. Park
Over the past two decades, the number and variety of public enterprises in developing countries have greatly expanded. The overall performance of these enterprises, however, has been rather disappointing. In most developing countries they have suffered staggering losses—becoming a major drain on national budgets and the principal source of heavy external borrowing—and have failed to generate the expected job opportunities.
In recent years, new approaches to public enterprises have emerged in both developed and developing countries: The size of the public sector has been reduced to a level commensurate with available managerial and resource capabilities, and policy and institutional reforms have been employed to make the remaining public enterprises more efficient. Greater attention has also been paid to the role of managers in public enterprises. Reforms have frequently accorded them increased autonomy but in turn made them more accountable for the performance of their enterprises. One of the key tools used to strengthen the role, and performance, of managers has been ex-post evaluations of performance, combined with appropriate awards or penalties.
The Republic of Korea is one of the few countries to have installed such a system. (Another is Pakistan. See “Evaluating Public Manufacturing Enterprises in Pakistan” in the September 1985 issue of Finance & Development.) Established in 1983, Korea’s system appears to be achieving its goals. This article briefly reviews the role and performance of government-invested enterprises in Korea, and the impact of the Government-Invested Enterprise Management Act, which introduced the performance evaluation system. In addition to describing the system’s principal characteristics and assessing its performance, the article attempts to identify some of the ingredients critical to the system’s success and discusses its possible adaptation elsewhere.
Korea’s public enterprises
The public enterprise sector plays a critical role in Korea’s economy. In 1981-83, public enterprises accounted for about 9 percent of GDP, 7 percent of employment in the manufacturing sector, and about 23 percent of the country’s fixed capital formation. But the influence of the public enterprise sector extends considerably beyond these numbers. Public enterprises have been pioneers in strategic and technology-intensive fields and, through the prices of public enterprise products such as coal or electricity, have also had a significant impact on overall price levels.
Some 85 public enterprises could be classified into four categories according to the degree of government participation in ownership and intervention in management: governmental enterprises, composed of various government departments; government-invested enterprises, where the government holds at least 50 percent of the equity and appoints top management, such as is the case of the Korea Development Bank or the Korea Electric Power Corporation; subsidiary companies of government-invested enterprises, which allow the government to invest indirectly through government-invested enterprises; and other government-backed enterprises, where the government holds less than 50 percent of the stock.
By far the most important are the government-invested enterprises. Currently Korea’s 25 government-invested enterprises account for 45 percent of the employment, 47 percent of the total budget, and 43 percent of the sales of the public enterprise sector, and they are extending their activity in banking and finance, manufacturing, construction, and services. In 1984, their combined budget amounted to more than the general-account budget of the central government, and total investment in them was 17 percent of Korea’s gross domestic investment.
Although the performance of the government-invested enterprises compared favorably with most other developing countries, their estimated 3.7 percent rate of return on operating capital in 1982 contrasted with a 10.1 percent return for Korea’s industry as a whole. Underlying the poor efficiency of these enterprises were problems very similar to those commonly found in other developing countries: obscure and sometimes conflicting managerial goals, inadequate management accountability and autonomy, excessive government interference in day-to-day management, poor personnel and incentive systems, complicated budget and procurement processes, and inappropriate pricing and credit policies. Even a slight improvement in the efficiency of the government-invested enterprises could bring about substantial gains in the national economy.
Performance evaluation system
In 1983 the Government of Korea launched a comprehensive public enterprise reform program, with special emphasis on a phased privitization of financial public enterprises. As an important element in the reform program, the Government-Invested Enterprise Management Act was adopted in March 1984. Several important innovations in management were introduced, including (1) a management-by-objectives system of budget preparation; (2) greater management power over procurement, budgeting, and personnel policy, and a two-tier management organization, with the Board of Directors as the decision-making body and the public enterprise’s president as chief executive in charge of implementation; (3) the simplification and unification of external audits, and the elimination of day-to-day interference by technical ministries; and (4) an objectives-oriented ex-post evaluation system and related incentive systems.
The evaluation system and related incentives have had the greatest impact on performance. Designed to spur managers to better performance and greater efficiency by providing them with increased autonomy and independence from government controls and by installing strong incentive systems based on the results, the system incorporated several notable principles:
• Evaluation of management’s performance rather than the company’s. In a deficit-producing government-invested enterprise, for example, an improvement in management efficiency can reduce losses. Management is credited for such an improvement.
• Evaluation of both short- and long-term management performance.
• Evaluation limited only to the variables within the control of management.
• Evaluation normally based on public profitability rather than private profitability.
Korea’s performance indicators measure the results of a specific year against trends in previous years and also determine the degree to which pre-agreed targets have been achieved. The system uses two kinds of performance indicators: quantitative indicators, which account for 70 percent of the final “score,” and qualitative indicators, which account for the remaining 30 percent. Unlike Pakistan’s scoring system, where public profitability and private profitability account for 50 percent and 20 percent of the final score, respectively, the concept of a single primary indicator has not been applied in Korea. Other quantitative indicators are also used and their weights vary according to the specific activities of the enterprises. (An example of the indicators used is provided in the table.)
Qualitative assessment is based on the performance of a government-invested enterprise in three major fields: its medium-and long-term corporate strategy, its research and development activities, and improvement of management information and internal control systems or the quality of the services offered to its customers. The absence of a long-term corporate strategy may, for instance, affect a score negatively, especially for public utilities, as may the poor quality of audits and accounting procedures.
Impact of performance evaluation
After two rounds of trial and experimentation (1984 and 1985), the performance evaluation system has now become a basic control system for the government-invested enterprises.
At the enterprise level, managers have modified their behavior in response to the signals of the system, and they now use the criteria for performance evaluation as their standard. Boards of Directors also tend to give special attention to the system’s indicators when making policy decisions. There is considerable motivation to earn high scores. Most of the enterprises have established their own internal performance evaluation units to carry out government guidelines and improve their corporate planning and internal control. These units are generally staffed with the company’s best personnel and play two critical roles: as negotiators with the Government in setting the annual targets and as designers of the corporate plan.
At the government level, staff members of Korea’s Public Enterprise Evaluation Bureau in the Economic Planning Board believe that the system’s overall impact has exceeded all expectations. They are convinced that since the system does promote socially and economically desirable behavior and the achievement of targets, the signals provided by the indicators must be technically correct. The technical issue then becomes how to tailor the indicators to the specifics of each enterprise. Indeed, several government-invested enterprises have already complained that the indicators are not specific enough and that, in some instances, the noncommercial objectives of companies were not properly reflected in the indicators. Partly in response to these criticisms, the Public Enterprise Evaluation Bureau recently expanded its staff from 12 to 20, and established a Special Task Force in the Korea Development Institute to serve as a think-tank for the Bureau over the next two years.
The sectoral or technical ministries are also important actors in the performance evaluation system. They are encouraged, however, to avoid direct interference in the government-invested enterprises. They are directed to pass along their guidelines on sectoral policies and orientations indirectly or to discuss them with enterprise management when management objectives are set up during the first stage of the performance evaluation process
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The degree of receptiveness that all the principal participants have exhibited has significantly contributed to the system’s effectiveness. Even before the introduction of a system of performance evaluation, however, enterprise managers compared favorably with those of most other countries in terms of their high degree of accountability for enterprise results. The new system appears to have strengthened consciousness of this accountability even further.
While detailed assessments vary according to who makes them, managerial autonomy is generally agreed to have increased under the system, especially in the manager’s power over budgeting, procurement, and personnel policy. As a result, the system has virtually eliminated, or reduced to the bare minimum, the pressure or interference that sectoral ministries exert on the day-to-day management of most government-invested enterprises.
The question of whether the evaluation system has actually increased the efficiency and effectiveness of these enterprises cannot yet be answered conclusively. Indeed, no data exist to show any actual improvement or worsening of the nation’s economy attributable to the performance evaluation system. A very rough indication of the system’s impact would be the increase in the “nominal” operating surplus for 25 government-invested enterprises which rose 40 percent in 1985. Some of this, however, is obviously due to general price increases and to improved macroeconomic conditions.
A survey of managers in 1985 indicates that a more important long-range contribution to the economy may emerge from the significant changes brought about in managers’ perceptions of their function. Managers have become much more cost-conscious and efficiency-oriented, and these changes are expected to translate into future net gains for the economy.
Why did the system work?
The answer appears to lie in a number of factors. The single most important factor in the system’s likely success is the high degree of political commitment. This commitment is critical where, as in Korea, government leadership is a major driving force for economic growth. From the outset, the performance evaluation system has not only enjoyed the strong support of top officials from the President on down, it has also had strong leadership from those who originated and promoted the system.
The responsiveness of the government-invested enterprises to the system’s performance-based rewards and sanctions is the second most important explanation for the system’s success. Pecuniary rewards for all employees in the form of extra bonuses determined by relative ranking contribute to the success: “outstanding” firms receive a sum equivalent to three months’ salary/wages; “excellent” firms, two and a half months’; “good” firms, two months’; “satisfactory” firms, one and a half months’, and “poor” firms, where the bonus is one month.
What may be most important, however, are the system’s nonmaterial incentives or sanctions. Public recognition has traditionally been a powerful motivating force in Korea. It can exert immense influence in promoting behavioral change. The personal interest of the country’s President and the wide publication of evaluation results in the mass media have probably heightened this impact.
Other contributing factors include the relatively simple data requirements of the system; the highly qualified manpower available to government-invested enterprises; the professionalism, neutrality, and devotion of the private experts; the ready disposition of Koreans to a relative ranking system because of their early exposure to highly competitive entrance examinations in almost all fields; and flexibility in setting enterprise-specific indicators and management objectives.
To improve the system, however, a number of problems must be addressed. The most urgent is the need to design more enterprise-specific indicators which would measure solely the performance of management, free of changes in general economic conditions. The use of a schedule of targets that would adjust to changes in demand would be one of the possible solutions.
The second problem is duplication in the current set of indicators. Performance evaluators and government officials in Korea believe that a single indicator, such as public or private profitability, cannot measure management efficiency and effectiveness, and that multiple indicators should be used, even at the risk of some duplication. The question is clearly far from settled, and still needs a thorough re-examination.
Officials elsewhere who are considering the introduction of a performance evaluation system may be able to draw several lessons from the Korean experience. A number of basic factors may have played a part in the system’s acceptance and likely success:
• High-level political leaders provided a strong, consistent commitment to the system; the system also drew strong support among government officials, academics, and research institutes.
• In its initial phase, the system was simple in design and functioned with crude indicators and limited data requirements. Its basic framework permitted it to make additional data demands, and grow in complexity, as experience accumulated.
•Top priority was given to training the key officials in government and public enterprises who were responsible for running the system.
•Appropriate incentive and career development systems were developed, based upon performance evaluation.
From country to country cultural, political, and economic factors vary markedly and will certainly affect both the design and implementation of a performance evaluation system. Korea’s system enjoyed unusually strong and broad-based support from its political leadership and top-level government officials. Interministerial struggles, which tend to pose serious stumbling blocks for programs elsewhere, were notably absent or weak in Korea. Korea was also fortunate to be able to draw on a ready pool of its own experts. In some countries two years of training have been needed before an evaluation system could be launched.
The element in Korea’s system that might most easily be adapted in other countries is the simplicity of its conceptual framework and the flexibility of its data requirements. The system carefully avoided overly complicated procedures or burdensome data requirements in its first stages. But as experience grew and participants became more familiar with its procedures, the system was able to employ more sophisticated indicators and require more complex and sophisticated data.
Incentives are likely to be most influenced by cultural factors. In Korea public recognition and other nonpecuniary rewards and penalties have been a significant motivating factor. In other cultures, however, this may not be so. In designing a system, material and nonmaterial incentives will have to be weighed carefully and balanced to reflect their relative weights in the society. Getting the incentives right will ultimately be an important factor in determining whether the system is accepted or not.