The reforms of OECD budget systems have given rise to fundamental institutional changes in the way governments operate. Underlying all of these changes has been the perceived need to move away from highly centralized budget systems and associated control mechanisms and toward more decentralized arrangements, which have come in many guises. This section provides a simplified typology as a framework to review the advantages and disadvantages of the most popular of the various institutional approaches. From this review, some lessons for emerging economies are distilled. First, the move to institutionalize decentralized decision making should take place in stages, and some arrangements that are more risky than others should be avoided. Second, it is necessary to put critical enabling conditions in place and not to neglect the wider control and accountability environment in which the new arrangements must operate. Third, all solutions involve considerable investment in human resources to develop skills not only in the newly created decentralized units but also within supervising ministries, and especially in the MoF.
The Impetus for Performance Budgeting
Recent budget management reforms emphasize the need to create an institutional environment that will ensure performance—one that lets managers manage and also makes them manage. This stress on performance has been triggered by two mutually reinforcing trends within the OECD membership: a downsizing of government operations, combined with attempts to make these operations more efficient and effective. The first trend arose from a basic questioning of the rationale for government intervention. Failure of the market mechanism creates a prima facie case for government intervention, and this was pursued rigorously by most governments after the Second World War. Experience has since shown that there is no guarantee that government can do any better. The new public sector economics grew out of an increased awareness both of government failure (partly through information asymmetries) and of the incentives for bureaucracies to pursue their own interests (which may not entirely conform to the public good), which led to a questioning of the technical and allocative inefficiency of government operations. The result was a move to downsize government operations by outsourcing or transferring them to the private sector.
The second trend arose from growing budgetary pressures, which spurred reforms aimed at making government interventions more effective—or more performance oriented. These initiatives sought to tackle the usual causes of government failure by “re-inventing” government through innovative institutional arrangements to better align incentives within government and thereby to better meet declared government objectives. The way this has been implemented has been influenced by developments in institutional economics, and in particular, principal/agent principles. In contrast to more traditional approaches to government service delivery, a key characteristic of these innovations is that the focus is on seeking to define objectives and to specify expected performance in terms of outputs (or in some cases outcomes) rather than inputs.
A result of these two mutually reinforcing trends has been a shift in the predominant budget management model used in the majority of OECD countries—away from traditional, hierarchical, centralized decision making and toward an accountability framework emphasizing decentralized decision making. This fundamental shift in the way that government operates can not be accomplished without complementary institutional changes.
Different Approaches to Less-Centralized Budget Management
The case for greater decentralization in budget management is summed up in Box 37. An important objective of decentralization is to introduce managerial flexibility in order to give budget institutions the necessary freedom to devise the best ways of organizing their resources and to thereby generate productivity gains as a way of coping with budget pressures. Another objective is to provide more effective service by being more responsive to client needs. One channel to accomplish this is to improve the division of labor in government by separating policy and implementation functions. This move does not come without a price. Decentralized decision making raises issues about how to ensure transparency and accountability, especially given the difficulties of defining, measuring, and monitoring performance.122 Several concerns are also raised about the capacity of central agencies to adapt to their new role and the considerable transaction costs involved in establishing and maintaining the new decentralized control mechanisms. The way various governments have addressed these issues has determined the institutional arrangements employed to operationalize the move to decentralization.
The Pros and Cons of Devolved Budget Management
Pros
Reduces transaction costs associated with layers of hierarchical controls.
Increases efficiency and innovation.
Makes management of services more responsive to customers.
Allows more effective partnerships between different levels of government.
Enables central ministries to concentrate on policy.
Provides greater transparency in all aspects, operations, appointments of boards and chief executives; parliamentary reporting.
Promotes clarity between responsibility and authority.
Cons
Increases transaction costs in designing and implementing contract management.
Raises greater accountability issues, due to lack of strategic management by activity, clear definition of outcomes, and transfer of greater authority to officials.
Increases the risk of patronage and corruption (moral hazard).
Limits the capacity of central ministries to specify performance, monitor, and analyze data.
Carries risk that “civil service ethic” will be lost and that unified career structure will be undermined.
To emphasize their main features, these new institutional arrangements can be broadly grouped according to how they represent a progressive move away from centralized government decision making.123 The latter can be characterized as organized through the classic, generic, vertically integrated ministry or department of the executive, which is under direct hierarchical control of a minister or president. The degree to which a given decentralized solution moves away from this model revolves around a number of key characteristics: the power of the minister over the ministry’s or department’s day-to-day operations; the scope of discretion of the chief executive; the determination of the organization’s budget; the staffing arrangements of the organization; and its legal status. For expository convenience, the institutional arrangements can be ordered by degree of decentralization, here characterized as the five “Ds”—five progressively more decentralized management models—deconcentration, decentralization, delegation, devolution, and divestment. Of course, within the OECD there are so many institutional hybrids that any all-encompassing categorization is nearly impossible. This typology therefore only represents the stylized characteristics of each approach; in reality, many overlapping arrangements exist.124
Step One: Deconcentration
As a first step away from centralized decision making, deconcentration represents no reallocation of administrative authority from the center to the operating agencies. Centralized decision making is maintained, but local managers are given some flexibility in administering centrally determined policies that are difficult to implement centrally. Unit managers, however, are not managers in the true sense but are instead administrators of centrally determined decisions. In terms of the budget, the unit is still integrated into the ministry’s budget, so that the ministry determines the unit’s budget and has the right to reallocate resources among units. Under most traditional budget systems, there is a need to deconcentrate operations for effective service delivery.
Step Two: Decentralization
A further step away from centralized decision making, characterized here as decentralization, represents a full reallocation of implementation from the central level to the line agencies, again with no major reallocation of decision-making authority. In this arrangement, agency managers remain administrators, but they are given greater freedom to administer central policies to fit day-to-day circumstances. In terms of the budget, the central ministry retains hegemony and maintains the right to reallocate resources among units, and the agency’s budget is subject to the usual annual budget review process. The agency has no separate status or legal identity and is predominantly funded from taxes, but the head of the agency is given responsibility for day-to-day management. To reap more of the potential benefits from this arrangement, centralized controls on managers’ use of inputs are often relaxed. This can take many forms: carrying over funds from one year to next (within predetermined limits); converting a portion of funds for running costs into capital and vice versa; retaining within the unit some or all of the savings realized; building a capacity to generate and retain income; and exercising some flexibility in staff management.
Step Three: Delegation
This arrangement represents a significant step beyond decentralization. Agencies, although legally still a part of the ministry or central government, are given greater autonomy and independence in decision making. Central supervision is at arm’s length, with significant management responsibility resting with an intervening supervisory board or single person authority (although the ministry generally retains ultimate power over the board or authority). A quasi-contractual form of budgeting is put in place, with targets set by the reporting ministry in consultation with the agency head. This type of institutional arrangement perhaps epitomizes the new performance budgeting approach. The reporting ministry has no power to move funds between agencies without prior approval of either the MoF if amounts are small, or the legislature if amounts are large. For the most part, the agency can be considered to have its own budget. However, this budget is part of a general budget law, and so the agency reports to the minister and is held at least nominally accountable by him for the use of budget funds. Typically, the chief executive will be nominated by the minister and will be a civil servant. The chief executive, once appointed, is given complete freedom in decision making but, in return, has fixed performance targets. In meeting these targets, the chief executive usually is given flexibility in fixing grades and pay, recruitment, and promotion. Staffing rules vary between a full civil service system and more differentiated controls. In many OECD countries, such agencies have been in the vanguard of performance budgeting reforms, being the first asked to move to output/outcome budgeting and accrual accounting.
Step Four: Devolution
This represents a more advanced move toward reallocating decision making from the central level to the implementing unit: legally separating the agency by giving it its own legal personality (partial or full). Such devolved agencies typically have greater freedom in policymaking, often with clear restrictions on the ability of central ministries to intervene in decision making. In many countries, these devolved agencies have boards to set strategy and to develop policies for implementing the strategy—sometimes it is only an advisory board, but more usually it is a management board, and sometimes it is a governing board. The minister usually participates in these boards, and in some cases directs them. Most typically, however, the minister has only indirect control. These devolved agencies are often subject to different management and financial rules from traditional, vertically integrated ministries, and their staffs are often outside the civil service. In terms of the budget, these agencies are given direct financial support from the ministry in the form of a transfer, and/or are financed through fees and charges or by their commercial operations. In many cases, they have the power to borrow, usually under the scrutiny of the reporting ministry or MoF. Typically, when they rely significantly on budget support, this is in the form of a contractual relationship with the reporting ministry. Although practice varies among countries, the minister’s role would be to inform the agency of the government policy, maybe to offer advice, and certainly to monitor performance.
Step Five: Divestment
Divestment can be viewed as representing perhaps the most extreme approach to decentralizing decision-making authority—but in this case, it would mean decentralizing operations outside the government sector. Such commercialization can take different forms, and a useful distinction can be drawn with respect to the degree to which assets change ownership between the government and private sectors. For example, when the government contracts out for services, few physical assets change hands. This can be contrasted with the complete transfer of ownership of physical assets from the public to the private sector that occurs with privatization. In the case of contracting, with few assets exchanged, the client within government is able to maintain some control over activities, monitor performance, impose financial penalties, and replace the contractor if dissatisfied. At the same time, there is a recognition that the contractor is carrying out what are still primarily public functions. In the case of privatization, with extensive asset transfer, control is given over to the markets, perhaps within some general regulatory framework for that market, but with recognition that the new owner is not primarily carrying out a public function. Bodies created for this purpose can be regarded as quasi-corporations which usually operate under private law with their staff employed under general labor laws. They are mostly financed by their own sales; they have the power to borrow and lend; and their budgets are separate from those of the ministries. Concessions and other public-private partnerships fall into this divestment category.
The Five Ds in Practice
The first two Ds—deconcentration and decentralization—reflect institutional arrangements associated with traditional, vertically functioning ministries. The second two Ds—delegation and devolution—are offshoots of the new performance budgeting approach which has led to the creation of a wide range of public bodies that are part of the government but have been given varying degrees of managerial autonomy, or independence. Moving from delegation to devolution can be viewed as simply a progression in managerial or operational autonomy.
Different Types of Autonomous Public Bodies
| Departmental Agencies | Public Law Administrations | Private Law Bodies | |
|---|---|---|---|
| Legal Status | Part of ministries with no separate identity; function under public law | Partially or completely separate from ministries; function under public law | Not companies, but with full separate legal identity; function under private law |
| Governance | Chief executive, directly appointed by minister, has operational control | Usually have a governing or advisory board, with minister exerting indirect control | Governing Board, with minister exerting indirect control |
| Staff | Employed under general civil service rules | Generally subject to rules for civil servants, but staff rules vary even including general employment rules | Usually under general employment law |
| Funding | Allocations from state budget | Usually financed by tax revenues but often allowed to carry over surpluses | Have budget separated from ministry, mostly financed by sales revenue; can carry forward surpluses, borrow, and lend |
| Examples | Germany: Direct federal administration Netherlands: Agencies New Zealand: Semi-autonomous bodies Spain: Autonomous organisms United Kingdom: Executive agencies United States: Performance-based organizations | France: Administrative public establishments; professional public establishments; autonomous administrative authorities Germany: Indirect public administrations Netherlands: Public Law ZBOs (independent administrative agencies); New Zealand: Crown Entities Spain: OAs (organismos autonomos), administrations, and selected regulatory bodies United Kingdom: Executive nondepartmental public bodies | France: Industrial and commercial public establishments Germany: Private law administrations and charged administrations Netherlands: Private Law ZBOs United Kingdom: Some nondepartmental public bodies |
| Departmental Agencies | Public Law Administrations | Private Law Bodies | |
|---|---|---|---|
| Legal Status | Part of ministries with no separate identity; function under public law | Partially or completely separate from ministries; function under public law | Not companies, but with full separate legal identity; function under private law |
| Governance | Chief executive, directly appointed by minister, has operational control | Usually have a governing or advisory board, with minister exerting indirect control | Governing Board, with minister exerting indirect control |
| Staff | Employed under general civil service rules | Generally subject to rules for civil servants, but staff rules vary even including general employment rules | Usually under general employment law |
| Funding | Allocations from state budget | Usually financed by tax revenues but often allowed to carry over surpluses | Have budget separated from ministry, mostly financed by sales revenue; can carry forward surpluses, borrow, and lend |
| Examples | Germany: Direct federal administration Netherlands: Agencies New Zealand: Semi-autonomous bodies Spain: Autonomous organisms United Kingdom: Executive agencies United States: Performance-based organizations | France: Administrative public establishments; professional public establishments; autonomous administrative authorities Germany: Indirect public administrations Netherlands: Public Law ZBOs (independent administrative agencies); New Zealand: Crown Entities Spain: OAs (organismos autonomos), administrations, and selected regulatory bodies United Kingdom: Executive nondepartmental public bodies | France: Industrial and commercial public establishments Germany: Private law administrations and charged administrations Netherlands: Private Law ZBOs United Kingdom: Some nondepartmental public bodies |
Delegated and devolved organizations have a longer history in some OECD countries, but the latter three decentralization trends—delegation, devolution, and divestment—noticeably accelerated in the 1980s and 1990s. The form and the name of the resulting organizations vary widely among countries, and they represent an important share of government spending.125 They generally share the objective of providing greater management flexibility, but the level of this flexibility varies greatly between countries. These bodies function outside the usual vertical ministerial controls, typically under quasi-contractual or full contractual relationships with the ministries, especially those associated with service delivery.126 Again, the degree of autonomy tends to vary between countries, as indicated in Box 38, as do the functions they carry out. Generally, the departmental agencies and public law administrations are engaged in the delivery of noncommercial services to citizens, support services to other state bodies, and some regulatory and quasi-judicial functions. The private law bodies, included here for completeness, are most often judged to operate in the commercial sector by SNA standards and often include government institutions on their way to privatization. In this study, the two former groups—departmental units managed at arm’s length from their supervising ministry, and public law administrations—are referred to as agencies.
In many countries that have pursued these institutional reforms, it subsequently became clear that managing on a decentralized basis, of whatever form, creates specific accountability and control issues. As emerging economies undertake parallel reforms, it is important that these issues be fully recognized. Many relate to two areas: how to establish accountability at arm’s length, focusing on the role of contracting within government; and the choice and design for decentralized institutions to implement this approach, focusing on the role of the “agency.” These two complementary aspects of the new institutional framework are critical for ensuring the success of wider performance budgeting reforms.
Lessons from the OECD Experience: Delegation by Contract?
Performance contracting has emerged as a key tool for increasing the efficiency of service delivery for government activities where market failures weigh against market provision. It has proved to be a useful mechanism to generate desired behaviors in a devolved management structure, when day-to-day management is in the hands of autonomous rather than centrally controlled units. The aim is to move to a system that continuously monitors management’s attainment of objectives and makes managers accountable for results. Performance “contracts”127 can be a way to define responsibilities and expectations between parties to achieve mutually agreed results (OECD, 1999a, p. 7). By doing so, they can strengthen both central and line units’ effectiveness by clarifying their respective roles. The center no longer manages directly but sets objectives, assists autonomous units, evaluates results, and facilitates in redefining objectives.
Contracts tend to have three main elements. First, they link budget negotiations more closely to units’ objectives and performance measures, and in doing so they assist in developing a framework through which performance is given greater emphasis. Second, they focus the work of central units on strategic priorities and away from intervention in line units’ day-to-day operations, clarifying the division of labor between the different levels. Third, they develop appropriate measurement and reporting arrangements to ensure full accountability. Although the performance contracting approach is often characterized as separating policy and delivery, typically in practice this is not a strict separation. While separation is sometimes needed for managerial autonomy of units, the center must also recognize it is these units that are most aware of practical issues and impacts, and hence may deserve a say in policy.
In form, contracts vary widely, reflecting the fact that different approaches to performance contracting are appropriate for different circumstances. The OECD has identified seven broad types of performance contract (Box 39), stressing that the specific design of the contracting arrangement will depend on a variety of factors, such as the nature of the transactions covered, specific national features of the country’s legal and administrative systems, and the broader governance arrangements within which the contract would function.
From this wide variety of experience, some key issues can be identified that affect the effectiveness of performance contracting:
Transaction costs: The costs of performance contracts can be high, at least initially. These include transaction and compliance costs associated with negotiating and monitoring contracts, assessing and managing risk, and enforcing contract provisions. There is also a considerable investment in human resources. Performance contracting demands new skills and ways of operating that may impose considerable costs on an organization. Similarly, when there is a need to share data, the required IT systems may impose other significant costs.
Defining performance: Many of the fundamental problems identified in the literature revolve around the difficulty of defining performance in a contract, involving issues discussed in Section IV. Should performance be defined in terms of outputs or the outcome of these outputs? Should performance be defined as a static concept or evolve over time? For example, after an initial period in which priority is given to reducing costs and improving productivity, performance may need to be adapted to broader objectives such as effectiveness. For many OECD countries, defining objectives has proved a difficult task. A common problem has been to set too many objectives and to cover all sectors of a unit’s activity, but fail to specify priorities. The difficulty of measuring performance often means that any dimension of performance that can be measured may automatically become an objective.128 There is a marked and well-documented tendency to define procedures rather than simply stating objectives and instruments of control/evaluation.
Measuring performance: The other side of the problem is obtaining the information on which to assess performance, however defined in the contract. Skeptics of this approach have compared government contracting with the stricter view of contracting prevailing in the private sector. They point to fundamental problems in operating a contract with proven measurability problems, given the ambiguity of defining outputs in the public sector (not to mention the quality of these outputs) and of determining “prices” for such outputs. Their strongest criticisms are directed to the challenges of enforcing contracts internally within government (Robinson, 2000)—how effective can sanctions be against an agency that fails to meet the requirements of its contract? An additional problem is the availability of information, particularly if virtually all the information on the effectiveness of outputs comes from the service provider. Certainly, there is agreement across countries that setting targets and indicators is difficult and requires continuous reassessment—and is usually the most problematic aspect of performance contracting (OECD, 1999a, p. 29). The process of setting targets and indicators hinges on the degree of specificity in the contract. Determining this requires balancing the center’s need to ensure accountability for policy outputs and outcomes, which pushes toward specificity, against the provider’s need for flexibility in delivering services efficiently and effectively at reduced cost, which pushes toward generality. Ultimately, the contract must settle this trade-off, ensuring transparency and “reasonableness” in accountability but at the same time allowing both parties access to information necessary to effectively conduct their business. It is important also to ensure that the relationship between contracting parties remains cooperative rather than adversarial and to build a dispute-resolution mechanism into the contract.
Wider budgeting environment: Some basic level of management expertise is required to make the contract approach effective. Previous studies have stressed the links between the level of public management systems and successful implementation of performance contracting (OECD, 1999a, p. 17). In successful countries, the existence of accrual accounting, contracting out, and other management tools that allow programs and services to be unbundled have offered a starting point for performance contracting. A performance contracting regime is not a substitute for overall performance management, but is merely one element of a performance management framework for budget resources.
Seven Broad Types of Performance Contract
Framework agreements cover strategies and priorities for a department and agency between a minister and chief executive. The agreement provides the chief executive with autonomy in managing the organization in exchange for a commitment to meet specific strategic goals. Examples include “framework documents” for Next Step Agencies in the United Kingdom and “letters of allocation” in Norway.
Budget contracts and resource agreements cover agreement over budget levels between the central budget office or MoF and the chief executive of a department or agency. They provide aggregate budget authority and flexibility for managing resources in exchange for agreed performance targets and a method for monitoring performance. An example is Danish Contract Agencies which originally had multiyear budget guarantees.
Organizational performance agreements between a minister and chief executive break down overall strategic goals into program elements, setting specific and often detailed operational, process, and output targets in exchange for increased operational autonomy in achieving targets. Examples include Danish Contract Agencies, French Tax Administration, U.S. Performance-Based Organizations.
Chief executive performance agreements made between ministers and chief executives (often to complement organizational performance agreements) or between senior management and staff at various levels. Examples include such agreements in Australia, New Zealand, Norway, and the United Kingdom.
Funder-provider agreements focus on clarifying responsibilities by separating the role of the funder and the provider of the services. An example is that New Zealand ministers and chief executives negotiate agreements for the purchase and supply of specified outputs, detailing factors such as timing, volume, cost, and quality. Similar purchaser-provider agreements are found in Australia.
Intergovernmental performance contracts and partnership agreements are often linked to devolution of programs or funding from national to subnational level, providing state and local governments with funding in exchange for providing specified levels and quality of service. These are found in Canada, France, Germany, Norway, Spain, Sweden, and Switzerland.
Customer service agreements, statements of service standards provided by a program or service to its clients that specify the quality and level of services to be expected and in some cases, avenues of redress and compensation where services fail to meet standards. These are used in Belgium, Denmark, France, Italy, United Kingdom, and United States.
Source: OECD (1999a, pp. 10ff).The verdict on contracting in government is that, while it takes a very bad contract to be less efficient than centralized regulation, creating a good contracting regime is extremely difficult.129 Overall, despite the difficulties in OECD countries, the experience has been generally positive (Box 40). It has been the basis for the introduction of much of the current “commercialization” within OECD governments (Box 41). A not inconsiderable part of this endorsement arises from the value added by the contracting process itself, including the definition of roles, specification of the elements of the contract, and the effort to design mechanisms to measure and monitor whether the participants are fulfilling the contract (both during the contract period and at its end). In this way, contracting can be viewed as a learning and strategic planning exercise that is important for performance-oriented management.
Pros and Cons of Contracting
Pros
Helps lower costs and improve the quality of service.
Encourages greater innovation and responsiveness.
Allows a sharper focus on “core” government functions.
Enhances accountability by introducing more rigorous performance monitoring and, usually, establishing mechanisms for redress when loss and damage occurs.
Cons
Raises the costs of monitoring and supervision.
Is difficult to control for quality.
Lessons from the OECD Experience: Devolved Agencies as a Panacea?
Since the 1980s there has been an explosion of interest in devolved agencies in many countries.130 The driving force for most OECD governments has been the need to reduce spending, on the one hand, while on the other hand, strengthening the effectiveness of the remaining spending by improving the quality and responsiveness of public service delivery. The agency model promises the advantage of separating implementation tasks from policymaking and of making them more achievable by better defining responsibilities. Performance targets can be specified more clearly, leading in turn to higher efficiency, economy in the use of resources, closer customer relations, and hence more responsiveness to customer needs—that is, a higher quality of service. To these “traditional” arguments have been added several new, perhaps less justifiable, ones.131 However, what is clear is that decentralized institutional arrangements are an integral part of OECD budget practices.
For countries contemplating the move to more devolved institutional arrangements, there are certain key lessons from OECD experience.
There Is a Need for “Institutional Clarity”
An important message in a major study by the OECD (2002b) on country experiences with devolved agencies is the need to clarify their institutional status, and hence their accountability arrangements.132 Countries should be clear on the criteria for creating devolved bodies. Historically, individual agencies have been established in response to specific needs, with their powers and attributes designed to respond to those needs as perceived at the moment of their creation. Only later, as part of the reform process, have OECD countries made an effort retrospectively to divide agencies into groups and to create common management rules for the agencies in each group (OECD, 2001, p. 27). One criterion often used, following the New Zealand model, is to split an organization into separate purchaser and provider agencies. However, this may involve costs that become apparent only with time. For example, one cost may be the loss of institutional capacity to learn from experience, and another may be a growing disconnect between the policy and service levels.133 A good deal of caution is also appropriate when determining the legal status, mandate, and powers to be accorded to a particular agency because an identical design model can produce vastly different consequences when applied to agencies with different types of tasks. One key factor appears to be scale: if the task requires that an agency be very large, it is likely to succumb to the same bureaucratic tendencies as any other organization of similar size and yet, on the other hand, it may prove powerful enough to resist the control efforts of the supervising ministry (OECD, 2001, p. 24).
OECD Practices: Degree of Commercialization in Budget Management
| Percentage of OECD Countries | ||
|---|---|---|
| 1. | Systems in place to charge a price for goods/services by one government organization to another: | |
| a. Used a lot | 20 | |
| b. Used moderately | 32 | |
| c. Used rarely | 16 | |
| 2. | Government organizations allowed to collect user charges: | |
| a. Generally | 27 | |
| b. Only for specific purposes | 70 | |
| 3. | Government organizations allowed to keep user charges: | |
| a. Generally | 24 | |
| b. No general rule, determined case-by-case | 48 | |
| 4. | Capital charge imposed on government organizations for using capital assets: | |
| a. Generally applied | 17 | |
| b. Specific to certain sectors | 22 | |
| 5. | Managers of government organizations can keep savings from efficiency gains to make other expenditures: | |
| a. Without restrictions | 15 | |
| b. With restrictions | 33 | |
| 6. | Use of performance agreements specifying expected outputs | 42 |
| Percentage of OECD Countries | ||
|---|---|---|
| 1. | Systems in place to charge a price for goods/services by one government organization to another: | |
| a. Used a lot | 20 | |
| b. Used moderately | 32 | |
| c. Used rarely | 16 | |
| 2. | Government organizations allowed to collect user charges: | |
| a. Generally | 27 | |
| b. Only for specific purposes | 70 | |
| 3. | Government organizations allowed to keep user charges: | |
| a. Generally | 24 | |
| b. No general rule, determined case-by-case | 48 | |
| 4. | Capital charge imposed on government organizations for using capital assets: | |
| a. Generally applied | 17 | |
| b. Specific to certain sectors | 22 | |
| 5. | Managers of government organizations can keep savings from efficiency gains to make other expenditures: | |
| a. Without restrictions | 15 | |
| b. With restrictions | 33 | |
| 6. | Use of performance agreements specifying expected outputs | 42 |
A strong inference from the OECD experience is that the process of creating devolved agencies is more effective when there is a clear policy on the degree of autonomy to be granted as a basis for determining their institutional status and accountability arrangements. If this has not been done, there may be a need to classify existing institutions to clarify their accountability arrangements.
There Is a Need to Create a Framework for the Management of Devolved Agencies
If agencies are to increase efficiency in service delivery, the correct management framework must be put in place. There are dangers in granting independence to agencies without clarifying their responsibilities and their accountability. For those governments beginning such reforms, there are inevitably problems in defining an agency’s degree of operational independence and the role of the ministry or supervisory organization. This challenge has been addressed differently by different countries so that there is no ready model to apply.134 Even when there is strong desire to make line units autonomous, the relationship with the center inevitably remains hierarchical because the center must protect the public interest and must retain the power to amend the terms of any contract it has with the agency. The limits of this asymmetry in power have been difficult to define, but they determine the design of the mechanism by which the center will endeavor to control at a distance.135 The extent of the center’s discretion over the agency needs to be made explicit.
Ultimately, a central question to be answered is the agency’s degree of autonomy to propose its objectives. On the whole, the trend has been to increase this autonomy. Some OECD countries have come to recognize the value not only of allowing agencies latitude in choosing their modes of operation (subcontracting, partnerships, and others), but even of allowing them to adjust priorities according to their specific situations, provided they can justify the adjustment. Some go so far as to allow agencies to define their objectives and also translate them into targets, simply because of their superior knowledge of problems on the ground.136 It is important, however, that such flexibility is not granted by default through the poor capacity of the center to provide policy guidance and oversee results.137 The center must ensure adequate monitoring and must clearly define accountability, so that the contracting parties know who is accountable for what and in what form, and what the reporting requirements are. Some accountability features of current OECD practices related to devolved units are summarized in Box 42.
There Is a Need to Strengthen Reporting and Accountability Mechanisms
In a devolved management setting, in return for their autonomy, agencies should have to report back on their activities, results, and performance. In exchange for flexibility in the use of inputs, they must report more systematically on their outputs and outcomes. This is the major reorientation at the core of performance budgeting reforms. As noted, most countries have started to implement output-and some outcome-oriented reporting through activity-based costing, and some have put in place multiyear agreements and monitoring mechanisms. Again, country experience is varied, and there remain many open questions. For example, should performance be gauged by outputs only, or by outcomes? Some OECD countries such as the United Kingdom and New Zealand stress the measurement of outputs given that the autonomous unit is not generally perceived as responsible for outcomes (which is seen to be a matter for the ministry). Others such as Australia measure outputs but emphasize the importance of knowing outcomes. Because agencies are involved in producing both outcomes and outputs, they have to design impact indicators and measure results. Most OECD countries concentrate on measuring outputs, or if they measure the impact of public policies, they do so separately from the measurement of outputs (OECD, 2003, p. 83). Whatever the particular country solution, what is clear is that it takes several years of adjustment for large agencies to move from input-focused to more output- or outcome-focused management. For many OECD countries, this is a continuing process.
OECD Practices: Performance Management in Government Agencies
| Percentage of OECD Countries | ||
|---|---|---|
| 1. | Use of performance management in agencies: | |
| a. Arm’s length agencies | 59 | |
| b. Public law agencies | 68 | |
| c. Mixed agencies | 67 | |
| 2. | Combination of output and outcome targets included in budget process: | |
| a. Arm’s length agencies | 54 | |
| b. Public law agencies | 64 | |
| c. Mixed agencies | 70 | |
| 3. | Use of yearly contracts on programs and activities: | |
| a. Arm’s length agencies | 75 | |
| b. Public law agencies | 58 | |
| c. Mixed agencies | 50 | |
| 4. | Regular performance reports submitted to the parent ministry: | |
| a. Arm’s length agencies | 33 | |
| b. Public law agencies | 41 | |
| c. Mixed agencies | 30 | |
| 5. | Financial targets written in a formal contract arrangement with the parent ministry: | |
| a. Arm’s length agencies | 41 | |
| b. Public law agencies | 41 | |
| c. Mixed agencies | 67 |
| Percentage of OECD Countries | ||
|---|---|---|
| 1. | Use of performance management in agencies: | |
| a. Arm’s length agencies | 59 | |
| b. Public law agencies | 68 | |
| c. Mixed agencies | 67 | |
| 2. | Combination of output and outcome targets included in budget process: | |
| a. Arm’s length agencies | 54 | |
| b. Public law agencies | 64 | |
| c. Mixed agencies | 70 | |
| 3. | Use of yearly contracts on programs and activities: | |
| a. Arm’s length agencies | 75 | |
| b. Public law agencies | 58 | |
| c. Mixed agencies | 50 | |
| 4. | Regular performance reports submitted to the parent ministry: | |
| a. Arm’s length agencies | 33 | |
| b. Public law agencies | 41 | |
| c. Mixed agencies | 30 | |
| 5. | Financial targets written in a formal contract arrangement with the parent ministry: | |
| a. Arm’s length agencies | 41 | |
| b. Public law agencies | 41 | |
| c. Mixed agencies | 67 |
There Is a Need for New Skills
The time required to adjust to the new devolved management framework largely reflects the time required to acquire new skills. Of course, the type of work that autonomous units carry out, and the skills they need to apply, will differ greatly depending on the degree of autonomy they are accorded. The necessary managerial skills can usually only be developed if the unit has the means, either from its own resources or from outside, to gain a thorough understanding of its customers, to develop a strategic vision of its priorities, and to undertake a detailed analysis of its environment. Small units rarely have such skills. For this reason, perhaps not surprisingly, a devolution of budget management tends to go hand in hand with a devolution of human resource management, or even wage negotiations, to allow agencies to acquire the proper skill mix. However, this again brings managerial staff into areas for which they may not be trained.138
Similarly, the center may also have to gear up to meet the challenges of the new environment. Some have focused on the changing role of the budget office, but the specific contribution of other central units must also be redefined. In some cases, the central units may not have undertaken adequate policy analysis or development, and have instead limited their role to being regulators.139 Central units are obliged to define their objectives more clearly and to give themselves the means to achieve these objectives. This involves creating a forecasting capability, improving their understanding of technological issues, investigating customers’ overall expectations, and setting up units to carry through and monitor reforms. These units must provide advice to line units; collate and evaluate approaches; draw up methodologies, guidelines, and rules for action; and monitor autonomous units’ performance.
Devolution also poses new challenges for parliamentary control. Parliamentary committees often find it difficult to keep track of the different bodies created and the financial and management rules that apply to them, and they need to develop the capacity to analyze the new data being reported.
There Is a Need to Nest Devolution in a Wider Reform Framework
In a number of countries, particularly at the political level, there has been a notable reluctance to embrace devolution. In some countries, this is because compliance issues are judged to be more important than performance issues. In other countries, provision of services by the public sector is regarded as superior to provision by the private sector. In other countries, a lack of stability in the resource base and the need for in-year adjustments to budgetary funding create managerial problems.140 In still others, such changes are adversely perceived as giving too much power to unelected officials at the expense of elected representatives. They may also be perceived as opening up too many possibilities for improper or inappropriate behavior, especially in countries with noted governance problems. For example, agencies must not make borrowing decisions that create unsustainable contingent liabilities for the government, increase public debt beyond the limits envisioned in the government’s fiscal plan, or exceed the borrowing authority approved by parliament (OECD, 2001, p. 32). This caution to nest devolution in a broader framework of reform is even more relevant to countries that have created agencies only to avoid fundamental political or institutional reforms such as civil service reform, or to avoid hard policy choices such as downsizing or deregulation. Agencies should not be viewed as a “magic bullet.” The full benefits of devolved budget management can only be reaped in a nurturing and supportive reform environment.141
In developing and transitional economies, devolved agencies have been proposed as a way of countering poor governance, insulating some important functions (such as regulatory activities), or making aid more effective. However, experience with this approach is unconvincing. For example, independent revenue authorities (IRAs), which have often been created on such grounds, may experience some initial success but, because they cannot be completely protected from the wider governance environment, generally become subject to political and bureaucratic influences. In Peru, the state revenue authority (SUNAT) was protected initially, but eventually was undermined. Similar fates befell IRAs in Ghana and Uganda (Laking, 2002, p. 6). Even when governance is not the main issue, the experience of many developing countries highlights the importance of establishing supporting preconditions to enable the agency concept to succeed. The difficulties experienced by Tanzania, one of the most reform-minded African countries, illustrates some of the problems encountered by agencies in less than fully supporting environments.142 As part of its public sector reform program launched in 1991, Tanzania passed legislation in 1997 establishing “executive agencies,” modeled on the United Kingdom’s Next Steps agencies. Although the executive agency program is still in its infancy, major challenges have emerged in its implementation (Box 43).
Lessons from the OECD Experience with Divestment
There are many options for divestment, short of outright privatization. All seek to commercialize public services, making service provision more responsive to customers by giving them a purchaser role (Box 44). The exact approach should be determined according to the market environment. When it is decided that services can be provided in a competitive market, schemes relying on vouchers or similar instruments can be employed to give consumers a direct purchaser role in selecting their service provider. When it is inappropriate or impracticable to give consumers a direct purchaser role, a popular approach is competitive tendering and contracting that allows the in-house public sector service provider to compete with outside contractors by submitting a tender. Some governments have also experimented with user charges for internal administrative services. Contracting out, or outsourcing, signifies competitive tendering only among outside contractors. This is most successful where the service is easily defined, there is little specific capital required for its delivery, and there is an existing, competitive private market.143 When market conditions require that the service be provided through monopolistic supply arrangements, potential market failure dictates the need to grant a monopoly in a particular area. In such cases, concessions and public-private partnerships are increasingly popular. What follows is a discussion of lessons from the OECD experience with various divestment options. Because some are more relevant from a public expenditure management perspective, this section concentrates on competitive tendering and concessions.
Tanzania’s Experience in Creating Executive Agencies
In 1997, Tanzania passed the Executive Agencies Act. There are four notable features of the program:
Decentralized management
Agencies were deliberately constituted to be distanced from often politicized central departments. While the minister is theoretically responsible for the agency and technically establishes its advisory board, it is the chief secretary (the senior civil servant) who approves the agency’s mandate, and it is the ministry permanent secretary (PS) who negotiates the performance agreement with the chief executive (CE). CEs report to their PSs, not to the ministers; in turn, the PSs report to the chief secretary, who interacts with the president. In this way, the decentralized agency management system has been introduced in a highly centralized power structure with weak ministerial responsibility and ultimately weak governance of executive agencies.
Performance contracting
The CE is recruited into a principal/agent relationship, is appointed through open competition, and operates under a performance agreement. Performance is specified in a framework document, setting out objectives, roles, authority, and performance standards. However, performance measurement has been left largely to the agencies, and PSs often appear unsure as to their role as “strategic managers,” leaving everything to the agencies. In turn, the CEs feel let down by their parent ministries. There is little performance monitoring in place in the ministries, and this is left to the advisory boards, which receive half-yearly reports. The adoption of accrual accounting systems by the agencies has compounded reporting problems to the ministries because the latter lack capacity to interpret accrual accounts (most ministries use cash-based systems). This is aggravated by a weak external audit environment.
Output focus
The Executive Agencies Act defined agencies’ mandate as providing the best service to their customers and being responsive to their needs. Pilot agencies were identified with potential to operate on a cost-recovery basis. Agencies have had much less success in operating on a commercial basis when their customers are other government departments. Government departments had no culture of paying for services, nor were they able to pay obligations because of their own uncertain budgetary positions due to the uncertainty of the release of their budgeted funds. This uncertainty and unpredictability also affected the operations of those agencies dependent on government subventions through their parent ministries. The expectation that internal markets will work, especially for units providing a public good and dependent on public sector clients, proved unrealistic.
Human resource capacity
Performance management has foundered on staffing issues. An objective of public sector reform is to downsize, and this left agencies with substantially reduced personnel. At the same time, there has been the need to train staff in new ways of working. This has resulted in a heavy burden on middle managers, who have little time for strategic and business planning. Most agencies have yet to develop performance measures or benchmarks for evaluating outputs.
Source: Caulfield (2003).There Is a Need to Avoid Three Common Pitfalls that Can Limit the Cost Savings of Contracting Out and Outsourcing
Contracting out and outsourcing—and, more generally, the commercialization of public service provision—involve opening up to competition a set of activities that were previously immune from it. Box 44 outlines various strategies for commercializing public services. Contracting out is a widely used mechanism for reform of public sector service provision, which involves introducing competition for the market through competitive tendering.144 Other things equal, the lowest price tendered wins the right to supply for the duration of the contract term. In this way, the government is able to secure the provision of services at the lowest possible cost. The government is expected to retain a fair measure of control over the activities concerned, monitoring performance, imposing financial penalties, and replacing the contractor in cases of outright performance failure.
Empirical evidence suggests that contracting can have significant impact in reducing the cost of providing a whole range of publicly funded services. Hodge (2000), when reviewing the international experience of contracting out of public services, estimated cost savings averaging 20 percent for a whole range of services, mainly derived from the cost savings gained from exploiting flexibility in the workforce. A key finding is that cost reductions are attained whether the contracts are won by public sector organizations (contracting in) or private sector organizations (contracting out) (Domberger and Rimmer, 1994). This indicates that competition is the driving force behind savings rather than the means of delivery. However, there are some drawbacks to commercialization, and the potential savings should be adjusted to accommodate these problems:
Commercialization of Government Services
Governments have adopted different strategies to introduce competition as a means to reduce operating costs and improve service delivery.
Retention with internal reengineering
The government continues to provide a service, but modifies its approach along market lines to improve delivery, to reduce operating costs, or to do both.
Example: A department reorganized; the in-house bidder wins a competitive tender; users are charged for internal services.
Commercialization through outsourcing
The government outsources a service to another provider, retaining responsibility for that service.
Example: A private sector vendor wins a competitive tender.
Commercialization through partnering
The government enters a partnership with another provider to provide a service through shared delivery and/or responsibility.
Example: A build-operate-transfer (B-O-T) agreement is reached with a private consortium to develop infrastructure.
Commercialization with partial divestment
The government transfers a service to another provider, retaining ultimate responsibility for that service.
Example: A concession is granted to a private company.
Commercialization with full divestment
The government transfers a service to another provider, divesting itself of any responsibility for that service.
The problem of transaction costs: In specific circumstances, the costs of contracting in the marketplace can be high enough to offset the benefits. Even for OECD countries with adequate human resources and expertise, the contracting process (developing specifications, preparing contracts, organizing the contract process, etc.) represents a sizable overhead. Moreover, the inherent incompleteness of contracts (see the next item) complicates and adds to the costs of contract monitoring. When this occurs, in-house or integrated production may be a better option.
The problem of making comprehensive contracts: Contracts are inherently incomplete. It is impossible to write a contract that incorporates every contingency, or every dimension of the service. In particular, because certain aspects of quality are noncontractible, it is difficult to establish that a private contractor is failing to provide the level of service specified in the contract. As a consequence, the contractor’s incentive to reduce costs tends to override the incentive to maintain or improve service quality—referred to as the “quality-shading hypothesis.”
The problem of ensuring that the benefits to society are adequate and sustainable: It is important that the gains from contracting are passed on to the community and are not absorbed by the managing organization. Experience shows the very real danger that benefits will accrue internally, instead of externally. Moreover, in countries with poor general governance, the move to contracting out poses a very real risk of promoting corruption.145 It is also important that cost reductions are sustainable over time and do not dissipate. In this regard, the contracting party must be aware of all considerations embodied in the tenderer’s low price. For example, private vendors may have a large enough customer base to enable them to lower the price to gain the contract, and then to make up the difference by attracting additional customers, especially if they have many lines of activity. Moreover, private firms generally can take a longer-term view, and so they may be prepared initially to cut the price as a loss leader, making up initial losses through subsequent business (Davenport, 1996).
Box 45 offers some general guidelines for contracting out and outsourcing.
There Is a Need to Carefully Design Projects and to Put in Place the Correct Control Mechanisms in Order to Realize the Full Potential of Concessions and Public-Private Partnerships
Concessions and public-private partnerships (PPPs) take many forms: leases, afterimages (a type of lease widely used in France), B-O-T contracts, divestitures with revocable licenses to operate, and more. They are generally used for publicly provided services with natural monopoly characteristics—that is, when least-cost production requires that there be only a single service provider at any one time.146 Public infrastructure projects and services most often fall into this category: water, power, gas, railways, and roads. Governments often grant exclusive rights to the concessionaire, but in many cases this may not be desirable—permitting entry by new competitors helps ensure that direct competition will take place wherever possible and can pressure the incumbent to maintain good performance.
Guidelines for Contracting In and Outsourcing Government Services
These are key factors for realizing the potential benefits of contracting in and out:
Contracting in and outsourcing should be integrated with the overall corporate strategy of the organization. It should not be a mechanistic exercise but an opportunity to reevaluate and reengineer internal work practices.
It is of primary importance to involve affected staff and minimize any period of uncertainty.
Competitive supplier markets are required to achieve the full benefits of contracting out. These should be fostered by contracting out practices, where government can play a role in developing markets for relevant services.
Effective contract management requires a new set of skills, and so recruitment and staff training need to be geared to providing these. To deal adequately with the contractor, organizations need to maintain their knowledge of the market and their technical knowledge of the activity.
All alternatives, including continued in-house provision, must be comprehensively evaluated. All costs and outcomes/outputs should be considered, including comparative quality and any risks assessed.
In-house bids should be treated the same as outside bids, with care taken to incorporate all cost items faced by private contractors as well as potential improvements in the work process. If successful, the work should be awarded to the in-house bidder on the basis of a formal document obliging staff to meet the terms of the bid.
Service requirements should be specified in terms of outcomes or outputs, not inputs, and should be specified as fully as possible to include appropriate service quality measures.
Contracting out does not diminish the responsibility of the organization for performance, and so there should be procedures established to regularly and formally monitor the performance of the contractor. This process should reflect the mutual interest in developing a cooperative rather than adversarial relationship.
Certainly in emerging economies, and also in OECD countries, schemes for private participation in infrastructure have expanded dramatically in the last decade. Such PPPs have at times succeeded in transferring significant commercial risk to the private sector, mobilizing private financing for public services, and improving the efficiency and availability of such services. At the same time, most governments have taken care to ensure a high level of accountability for the use of public funds. However, in the developing world, the results have generally been disappointing. In many developing countries, PPPs have been adopted to enable an expansion in government services without showing the full cost on the budget. In other countries, incentives for efficiency and innovation have been weak, accountability for performance has been absent, and opportunities for leveraging scarce public resources through private financing have been limited (Smith, 2001, p. 91). This experience stresses that the full potential of PPPs can only be realized when projects are well designed and when the correct control mechanisms are put in place. Unfortunately, there are no standard models or blueprints, and approaches need to be adapted to the characteristics of the service and the environment in which they will be delivered. However, some of the requirements for successful concession contracting have emerged:
Outputs must be clearly defined: Performance is defined as rigorously as possible, including specifying the recipient target group and defining an identifiable level of quality. Correctly identifying indicators for these outputs is critical; misspecified or incomplete indicators can lead to counterproductive or biased behavior by the service providers. In order to preserve the flexibility of the concessionaire’s operational arrangements, performance should focus on the end results to be achieved rather than on the means to be used. Performance targets also can be designed to allow for renegotiations under specific preestablished procedures.
Design issues must be fully addressed: The allocation of risks between the involved parties is at the core of the concession design.147 A careful analysis is necessary to distinguish between costs that are truly exogenous to the operator and those that are not. Only exogenous costs should be passed on to other parties such as consumers, suppliers, or the conceding authority. The choice of how long the monopoly will last is part of the process of ensuring that the provider has an adequate incentive for efficiency. It is generally agreed that competitive bidding for time-bound concessions can provide a useful discipline over suppliers.
The form, level, and structure of payment must be decided: This is crucial for determining the incentives for suppliers and the possibility of mobilizing private financing. Here there are a number of difficult issues to resolve. How tightly should payment be linked to performance? Linking pay to performance indicators provides stronger incentives, but since quality is more difficult to measure, this approach increases the risk that suppliers will engage in undesirable behavior (for example, cutting costs by reducing quality). How to deal with trade-offs between quality and quantity? This often hinges on the degree of choice offered to consumers of the service based on their preferences and ability to pay. Should cross-subsidization be allowed? It is generally agreed that cross-subsidies are to be avoided—being distortionary, anticompetitive, and nontransparent. Other alternatives may be preferable, such as direct financing subsidies from the budget, or subsidies through special funds. There are also open questions with no definitive answers. How heavy should be the reliance on user fees when there are merit good implications? (Smith, 2001, p. 3) Should the service provider receive some up-front payment, or should the provider be paid only after a satisfactory delivery of services has been verified? All such issues must be resolved on a case-by-case basis.
Mechanisms to regulate the concession must be established: A central issue is how to ensure that service providers are in a position to deliver in response to incentives, at arm’s length from regulators and the funding source. Some body must be charged with this task. Should a single entity be in charge, or should some functions be delegated or contracted out? Establishing specialized, cross-sectoral regulatory bodies that are independent of the government has often proved advantageous. “Competitive aware” mechanisms are also effective. However, when it is more appropriate to negotiate procedures, then there should be some built-in safeguards like benchmarks or a process for other providers to better the proposed terms. Not surprisingly, there is always a need for some regulatory discretion, but at the same time, its successful exercise requires technical capacity.
There is a need for specialized skills: The negotiation and supervision of concessions is equally if not more demanding for government organizations. Concessions generate high transaction costs, and the weaker the institutional capacity, the higher these costs are likely to be. On average they can be as much as 5 to 10 percent of total project costs (Klein, So, and Shin, 1996). Governments must organize themselves to manage the process of designing and awarding concessions, and then to formulate laws and regulations that affect the operation of those concessions. Kerf and others (1999, p. 9) warn that inefficient organization can result in substantial costs to government, developers, and consumers. They stress the need for governments to retain qualified and experienced experts who are able to provide sound advice on a range of issues. While detailed technical expertise can be contracted out, governments must have staff with relevant expertise to hire and oversee the consultants and to incorporate the lessons of experience for future concessions.
Concluding Remarks
It is necessary to view this discussion of institutional arrangements in the wider context of how the move to more decentralized budget management decision making is operationalized, and hence how the government operates. These institutional changes are a means to an end, and not an end in their own right. Countries considering such institutional changes should recognize this at the outset and be prepared to commit to undertaking the more fundamental changes to their budget systems implied in this process. Obviously, high-level policy commitment is required if for no other reason than institutional change—of any kind—takes time to implement.
OECD countries have generally adopted a phased approach to introducing such changes. Some have adopted a policy of gradual voluntary change, deciding to let operating units move to a new management culture at their own pace, albeit with some technical support and guidance from the center. Others have piloted the new systems in more progressive units, with more active encouragement by central organizations. Once reforms have taken hold, and have passed some critical threshold, they may then decide to make reforms compulsory or at least to promote them more vigorously against an agreed timetable, solidifying the new arrangements in new legislation. However, given the variety of country experiences, answering basic questions on the sequencing of such reforms is difficult. Where should reforms start? What is a reasonable timetable for their completion? Should changes be required of all units, or should the reform process be selective? There is no single optimal answer, and the pace of reform has to be country specific.
With this significant qualification, OECD experience does suggest some necessary elements for successful institutional reform.
A staged approach is less risky. Institutions should be progressively prepared to move from traditional, input-focused budget management to output-focused and then to outcomes-focused management systems—that is, to move progressively along the continuum of the five Ds, from deconcentration to devolution, and in some cases to divestment.
Preparing institutions to progress in this way usually requires that their management and control systems be upgraded. These enhanced systems then need to be tested by a staged process of granting them greater and greater autonomy and flexibility in management decision making.
The process involves a progressive change in the internal culture within government, and this must be reflected in a heavy investment in human resources. Experience indicates that technical innovations meant to improve performance must be reinforced by a parallel process for putting in place mechanisms to improve managers’ accountability to users and, more generally, to taxpayers.
Following from this, a point will be reached when further budget management reform will require a change in the legal status of the staff and units concerned.
Finally, and most important, it is necessary to commit resources to steer and manage the reform process. The mere fact that institutional change takes time implies that there is a high likelihood of it being derailed. A phased approach implies that new principles and processes may not apply to the entire government sector, and this means that managerial imbalances can arise, human resource problems can develop, and reform can stall before a critical threshold is reached. Success or failure will depend on high-level commitment and skill in managing the reform process.
See IMF (2001a, p. 5, para. 1.32).
Examples include depreciating new buildings 100 percent in the first year, to reflect the entire “capital cost” as an expenditure in the same fiscal year (as in Canada) or valuing heritage assets by a token value. Other countries eliminate the difference between “expense” and “expenditure” by assuming immediate consumption of stocks on purchase and other means.
For a discussion of the significant measurement problems faced by performance-oriented budget management, see Section IV.
It is more convenient to group institutional arrangements along the spectrum of the movement away from centralized decision making because, internationally, it is not easy to distinguish central or core government institutions and there is no generally accepted classification of the vast variety of public institutions outside the central or core level.
This represents a typology of vertical decentralization, which has parallels and can be applied on a horizontal basis, in the relationships between different levels of government.
Partial data available suggest their share in public expenditure and their share of civil servants employed can be over 50 percent, and in some countries above 75 percent. For example, the United Kingdom has 131 executive agencies that employ over 75 percent of the civil service; in Spain, 51 percent of the budget is spent by government-related entities; the New Zealand Crown entities employ around 80 percent of state-sector employees; in Germany, 22 percent of public employees work in federal agencies; in the Netherlands in 2002, 30 percent of the civil service worked in agencies, a percentage which continues to increase steadily. (OECD, 2003, p. 8)
This excludes state-owned enterprises, bodies resulting from administrative decentralization, and constitutional bodies (such as courts, audit bodies, and the like).
Note these agreements tend to be “relational” rather than strictly legal, as in the private sector. They are enforceable and are characterized by less formal dispute-resolution mechanisms. This is discussed more fully in Petrie (2002, pp. 120ff).
Poor specification of performance can also lead to “gaming” in the setting of performance targets or misrepresentation of performance statistics (Laking, 2002, p. 8).
Matheson, in OECD (1997b, p. 176).
However, such devolved units have a long history, for example, dating back to the sixteenth century in Sweden and the 1870s in Germany.
One specialized reason is legitimizing policy and ensuring impartiality through politically independent organizations, for example, central banks and regulatory and investigatory institutions. However, as Laking (2002) points out, there are many other reasons that are less justified: “Agencies may also be created to protect a function for legislative interference, pay off political allies or create power bases for specific functions or to capture public assets or resources for private interests” (p. 5).
Gill (2002) points out how some governments have created problems for themselves by setting up many such organizations operating under different rules. He points to New Zealand, a pioneer in the field, which created a wide range of new agencies out of government departments in the 1980s and 1990s, which in turn led the present Labor administration to introduce legislation to bring some order and consistency into their governance arrangements.
An early criticism of the performance contracting system in New Zealand was the lack of incentives in purchase and performance agreements for chief executives to coordinate their policies and programs, to operate across organizational boundaries, and to focus on longer-term issues of corporate capacity beyond the terms of the contract (OECD, 1999, p. 20).
The United Kingdom’s Next Steps model has been widely influential. Even though each agency has operational independence, it should be clearly responsible to its minister or parent department. However, many contemporary agencies in other countries clearly fall short of this. (Schick, 2002)
The center must learn to move from “rowing to steering.” As Schick (2002) points out, improperly applied, this prescription may lead to a government that does neither rowing nor steering well (p. 35). Delegating management freedom always carries the risk that the agency will not be fully compliant with more general public interests.
Within some OECD countries, it is possible to detect a reevaluation of the risks entailed in this approach, and in some countries such as the Netherlands, there has been an attempt to redefine agencies’ autonomy to bring them under closer control of ministries.
This risk increases with the number of agencies. How is the center to ensure that agencies work together to meet important public objectives? or to ensure there is no overlap in responsibilities? or that important areas are not missed? The United Kingdom’s recent initiative for “joined-up government” attempts to address this problem.
The quality of human resources may be a key factor in the success or failure of reform (OECD, 2003, p. 76). Employment contracts may be required to encourage managerial talent. In the United Kingdom, agency directors are appointed on fixed-term renewable (three- or five-year) contracts—that is, for the duration of the framework contract governing the agency. Incentive schemes may also be required for staff to accept and integrate change.
This occurred, for example, in France. See OECD (2001, pp. 66ff).
The need for safety valves is recognized even in OECD countries. For example, the use of medium-term budgetary strategies is important in avoiding cuts. Some countries have a budgetary reserve to meet unexpected problems, others respect contractual commitments (Australia) or guarantee resources for a specific period (Denmark, Ireland), so that cuts can only apply to areas not covered by agency contracts. At the same time, moving too far to protect agencies from cuts imposed on others could be regarded as working against the flexibility they are trying to promote.
As so eloquently put by Schick (1996), “It is naive to assume that agents who opportunistically pursue self-interest when they are formally controlled by principals will be more compliant when they are organizationally independent. It is equally naive to assume that departments which gave inadequate attention to service performance when operations were run by their own administrative subdivisions will be more attentive when services are hived off to independent entities.” (p. 31)
As Scott (2001a) observes: “Public management reform creates winners and losers and the losers are those that benefit from the old system and they are usually in very powerful positions” (p.12). The conclusion is that technical reform cannot substitute for political reform.
Examples are computers, transport, cleaning services, building maintenance, minor capital works, printing stationary, and office accommodation, among others (Laking, 1996, p. 14).
The distinctive feature of contracting out is the element of ex ante competition—competition for the market as opposed to competition in it. The market in this case is defined by the contract specification, and the bidding procedure resembles an auction.
Corruption, of course, is not confined to only those countries. A clear and direct connection between political party campaign contributions and subsequent contracting out decisions has often come to light in the United States.
The capacity of ex ante competition to yield efficient outcomes despite structural conditions of natural monopoly was persuasively argued by Demsetz (1968). In a similar way, Baumol (1982) and Baumol, Panzar, and Willig (1982) introduced the concept of a “contestable” market which, while not competitive in the sense of having several suppliers, can nevertheless generate competitive outcomes in terms of price and output. Contestability occurs when the sole supplier does not have a permanent hold on the market and could be displaced by a more efficient producer, charging lower prices.
While theoretical principles are well known—risks should be borne by the party best able to control, manage, or hedge against them—their application in practice often raises numerous difficulties.